Wall Street seems to hate new Merck (MRK) CEO Kenneth Frazier's decision to stop issuing earnings guidance, the forward-looking estimates of future performance against which investors measure a company's actual progress. Bernstein Research's Tim Anderson called it "disingenuous" in a note to investors, and suggested to Frazier on his Q4 2010 conference call that the move may have been result of "miscalculations." Catherine Arnold of Credit Suisse called the change "befuddling" in a note to her clients. Investors didn't like it either, sending Merck's stock down 3 percent.
Frazier, therefore is off to a rocky start, to say the least. Frazier said he stopped issuing guidance because the business environment has become too unpredictable:
Given the realities of the external environment, including European austerity and pricing pressures around the world, U.S. health care reform and our recent vorapaxar news [a trial of an anti-clotting drug was called off over safety concerns], it is clear that the only way to achieve our 2013 EPS target would be through deeper, short-term-oriented cost cutting. That would result in significant under investment in our longer-term growth prospects, and could limit our ability to pursue external opportunities. Instead, I have decided that investing in our growth is the best long-term strategy for the business and our shareholders.
As a result, we are withdrawing our 2013 EPS target. I want to emphasize to you that I did not take this decision lightly, and I hope I have been clear in explaining strategic rationale behind this decision.Analysts tend not to argue or confront CEOs on conference calls. Their discussions are conducted in tones of almost academic politeness. It's their choice of words and topics that counts, so it was unusual when Bernstein's Anderson twice suggested to Frazier that he was not withdrawing guidance due to external uncertainty but due to Merck's own mistakes. Merck has known about healthcare reform and European drug price cuts for months, he said:
I want to go back to that long-term guidance because the U.S. health care reform issues has been known for about a year and European price cuts about just as long, and vorapaxar couldn't have been a big contributor. So it really says to me that there were other things that have changed along the way that may have been miscalculations on Merck's part, and I'm wondering if you can clarify what those miscalculations may have been.
... And equally importantly, when can we expect you to give us new guidance? Your peer companies, in some cases, have lowered their guidance but no one's withdrawn it outright, and I'm wondering when we can see updated guidance from you.No cuts, no guidance
Frazier replied that, basically, to meet its existing guidance Merck would have to make a bunch of cuts that Frazier didn't want to make:
Tim, I want to make sure that I try to do this as well as I can. With respect to European price austerity measures and health care reform, it is certainly the case that we knew about the general subject matter.
And so I want to be clear, it isn't that we couldn't cut costs enough to make the long-term guidance. Our choice was to do that. But we couldn't do that in our estimation fast enough without sacrificing the growth opportunities, and that was the choice that we made.In his note the next day, Anderson ripped Frazier a new one:
This felt disingenuous, partly because healthcare reform and price cuts should have been fairly well understood much earlier than now; with vorapaxar, it is hard to see how the setback with program would have played into 2013 guidance given that the drug would not have likely launched until late 2012. This suggests there were other miscalculations made by MRK, and helps cement fears that MRK -â€" being new to doing big mergers -â€" may have execution issues of some sort.The Street disliked the move because it suggested that a lack of cuts would hurt Merck's profit margins, and thus lower the earnings-per-share that investors were hoping for. Suisse's Arnold said "there needs to be more sharing of pain."
The meeting gave the overall impression that Frazier hasn't quite got a handle on his company yet. His move not to cut internal investment -- praised by Forbes as "gutsy" -- was the opposite of Pfizer's, whose new CEO (responding to an almost identical business environment), used his first conference call of 2011 to announce that he was further gutting Pfizer's R&D programs.
But perhaps there's another reason why Frazier called off his forecasts. The biggest variable in Merck's short-term future is the fate of its secret arbitration hearing with Johnson & Johnson (JNJ) over the drug Remicade. If talks go the wrong way, Merck could suddenly lose $2.6 billion in revenue. If Frazier got any concrete information about which way the decision will go, it would immediately affect his guidance and possibly require a disclosure changing it. Thus a guidance change could be seen as a proxy for the likely outcome of the Remicade arbitration. Frazier hinted this might be the case on the call:
We have not put new guidance in because there are some important events coming up. I thought it was prudent to say that we would not restore guidance at this point in time.Either way, it's another management lesson in transparency: Companies that become more mysterious see their value discounted -- by 3 percent, apparently.