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The Tragedy of Projections: Part 1

3/15/2012

At Rotary Gallop, we believe that measuring the right thing, with the right tool is REALLY important!

One of the biggest tragedies in the field of Investor Relations and Defense/Contested-Situation Advisory is one brought on by a terrible tool: Projections. Proxy solicitors popularized the name projections, but really all the experts we’ve talked to in the area of winning shareholder votes, (from successful activists, to Corporate Secretaries, heads of IR, IR consultants) are doing essentially the same thing. In fact, the problem described below is endemic to all analysis that involves starting at the top and working your way down a shareholder list (for convenience we’ll refer to all of this broader class as “projections”). Projections not only destroy useful information, but force people into measuring the wrong thing. These methods are wrong and destructive. So why is this terrible tool so wide spread? Because projections are intuitive and, in the absence of a better technology, were the only available choice.

What is wrong with Projections?

Your expert has LOTS of valuable information, which they generally use to predict a result (e.g. Projection - 63% of the vote For Managment). Unfortunately, the expert feeds this valuable information into their traditional method of analysis - projections. The problem is projections are inherently incapable of handling the vast number of outcomes (defined as combinations in which your shareholders might vote) possible in a shareholder vote! Projections are essentially a pencil and paper method that, with the help of an excel sheet and a really ambitions practitioner, might be able to consider, say, 100 different outcomes.

To drive home how inadequate this really is, below on the left is the number of atoms in the known universe. On the right are the number of unique outcomes possible in an election of just 1000 shareholders! A mind-boggling number!

Atoms in the Known Universe: 100,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000

Possible Outcomes in a 1000 Shareholder Election: 1,000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000,
000,000,000,000,000,000,000,000,000,000

So, in order to reduce the number of outcomes to something manageable your expert is forced to start adding in shaky information, and eventually even making outright assumptions. If you mix good information with even a tiny amount of bad information, especially in a flawed methodology, the bad information wins every time. Thus the output of projections is garbage. “Garbage in – Garbage out” isn’t just a saying. It is an inarguable fact about our world, like the area of a triangle, resulting from the way errors propagate.

Garbage in - Garbage out: Projections force the use of shaky information, poisoning what solid intelligence is available and inevitably producing inaccurate results.

Your expert has spent a career building the expertise and connections that make up their incredibly valuable knowledge. It is precious. We should be protecting it from harm. Don’t let Projections ruin your experts most valuable assets!

At Rotary Gallop, because we can handle the vast number of outcomes possible in your next shareholder vote, we can pool only the most certain information from all your experts and calculate useful, relevant, actionable intelligence - such as your control, your chances of victory, the control of each shareholder, and how much a given shareholder could change your chances of victory by siding for you or against you.

Next time I’ll explain how in addition to destroying your experts precious information, projections measure the wrong thing! It will be obvious once you see our latest innovation: The Map! If you have any questions email me at T@RotaryGallop.com.

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Understanding The Power Of Board Seats

3/5/2012

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I have a confession to make: unlike both of my business partners, I am not a natural-born negotiator. Like a lot of Americans, I have been conditioned by shopping in stores where the price displayed is the price paid. We agree at the outset or we don’t do business. Anything else is a rude and uncouth argument. I’ve witnessed my partners in action enough to know that that’s not the way the real world works. (On the lighter side I once witnessed, open-mouthed, one of my partners negotiate an $8 piece of cake for free in return for assurances that if they liked it they might buy it next time and even tell their friends about it!)

I knew this was an area I could really improve on, so I started read a lot of books about how to negotiate. For me, Roger Dawson’s “Secrets of Power Negotiating” stands head and shoulders above the rest. That book taught me to stop viewing negotiation as an argument, and to start seeing it as a fun and fascinating game of strategy.

So when the e-mails between John Cleghorn of Canadian Pacific Railway and Bill Ackman of Pershing Square Capital were released, I was extremely excited to see such high-stakes negotiation play out right before our eyes. I turned to Roger Dawson to help analyze the negotiating tactics between Cleghorn and Ackman.

I suggested to Roger, “between your negotiating expertise and my ability to measure the control of each side under each proposed scenario, we could really dissect and analyze this thing play-by-play and tell the whole story!”

He agreed but added, “the only thing that really stands out as interesting is that Bill Ackman seems extremely aggressive and confrontational. Do you know if this style of negotiation generally works for him, because it’s never worked for me, and I’ve never really seen it work well? Generally, this sort of tone shuts negotiations down.”

That got me thinking … I have never met Bill Ackman, but given his line of business and his success, I imagine he’s not a bad negotiator. Why would he make such a rookie mistake? What if he didn’t make a mistake?

This is the difference between an enthusiastic practitioner and a real master of his craft. I was lost in the trees, simply spotting glorious negotiating tactics flying this way and that, until Roger gently pulled me back – “Did you notice this forest?” The forest was quite fascinating! What I saw was that Ackman was walking a tight wire out of a subtle trap – the negotiations themselves.

Measuring (and gaining) control of a board of directors is difficult. Two seats are definitely better than one, but not exactly twice as good. It is better to replace a sitting member, than to pull up a new chair at the table, and better still to replace one of the opposition. It can all get very muddled. But when you can measure control directly, you can see the forest plain as day. Let me show you:

Exhibit 1 shows Managements’ (Blue) and Pershing’s (Red) control of the board of directors under various hypothetical scenarios. The first scenario is the current 15-member board of directors. Management has 77% control, meaning they hold the deciding vote in 77% of all possible voting outcomes on the board of directors [1].

As we move to the right on the horizontal axis we see the power structure if Ackman is given 1, 2, 3, 4, 5, or 6 seats added to the board.

The brick wall divides the scenarios likely to result from negotiation, from those that would almost certainly require a proxy battle to achieve. Under the possible negotiated outcomes, management retains significant control of the board. If Pershing were to accept 1 or even 2 board seats, they would have very little chance of causing change at Canadian Pacific.

Exhibit 1: Canadian Pacific Railway and Pershing’s control of the Board of Directors

Exhibit 1: Bill Ackman and Pershing square have very little chance of causing change on the board of directors with a negotiated settlement of two or less seats. Such a settlement would likely result in another year for current strategies to play out, while Ackman must wait for the chance to gain additional seats next year. To have an effect on Canadian Pacific now Pershing needs to engage in and win a proxy battle.

Now we see that Ackman cannot win negotiating. The best he can hope for from negotiations is to be stuck on a board he cannot influence for a year while he waits to try again next year.

It’s a tricky situation. Ackman is trying to combat the seemingly cooperative and congenial offer of a seat for himself on the board of directors that both sides know comes with essentially zero power to accomplish anything. If this wasn’t clear at the start, Canadian Pacific’s decision to add two new handpicked members to the board made it loud and clear, before they even made the offer. Now we can understand Ackman’s strategy. He has to negotiate, without appearing unreasonable, and without coming off as too much of a bad guy. To do otherwise would alienate other shareholders. At the same time, he cannot be trapped in a negotiated settlement. Hence the aggressive email followed by the befuddled apology, on the advice of his team.

The pairing of personalities at Pershing Square allows them to naturally implement one of the most powerful and well-known negotiating techniques: good-guy/bad-guy. A more useful, if less pithy, description of good-guy/bad-guy might be sympathetic-and-flexible/emotionally-charged-and-firm (Here is Roger on good guy/bad guy).

The email exchange is a fine example of this technique’s opening rounds, with Ackman’s team nicely set up in the good-guy role. Good-guy/bad-guy is a powerful negotiating gambit, and not easily countered when genuine, as is the case at Pershing Square. Ackman was smart enough to surround himself with cooler heads, and to know that he needs to keep them there. I suspect the cooler heads at Pershing see the value in Ackman’s passion as well. We’ve all seen enough cop-drama to know that when the team gets broken up, they’re useless without each other.

Control measurement reveals several more fascinating insights to the Canadian Pacific vs. Pershing Square case, which we doubt even the players involved fully understand. Check out this article on how significant representation for Pershing Square will double the power of existing independent board members!

[1]: For these calculations we have assumed that management controls 4 of the 15 votes on the board of directors. We have no inside knowledge and have never spoken to anyone on the board. However, we do believe this is a conservative assumption, given that 5 board members have been on the board for 10 years, one board member is the CEO, two board members joined the board in the same month as the CEO, and two more were added in response to Pershing Square.

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The Tragedy of Projections: Part 1

Understanding The Power Of Board Seats

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