The analyst who gets it

We have previously criticised conventional financial analysts' pronouncements on the fortunes and futures of businesses. Too often we believe their assessments and opinions do not identify the key drivers of performance because they are too focussed on the financial factors.

However Richard Fletcher, city editor of the Daily Telegraph has spotted perhaps the first example of an analyst who in his words "gets it". Richard Fletcher himself must have been "getting it" for sometime himself because he clearly knows one when he sees one.

The analyst is Marc Geall and his 26 page note on Autonomy, a software business is the subject of Richard Fletcher's article in the Daily Telegraph on 13th October. He reports that Mike Lynch, the Chief Executive of Autonomy, "used to claim that the city analysts didn't get it. With limited experience of software companies, he argued, the city scribblers struggled to get a grip on the complex £3.4bn business he had spent years building".

However Richard Fletcher reveals that Geall actually worked for Autonomy for more than two years before joining Deutche Bank in June, so he knows the company from the inside. Richard Fletcher states that whilst "Geall does stress at the beginning of his note that Autonomy hs a "unique product" that "dominates", his dissection of the group's management and business model is damning".

Here are some of the extracts he quotes from Geall's note:

"The management structure, control and sytems at Autonomy are more representative of a start-up than a major global player ... The senior management team is talented but lacks bandwidth. This can lead to some decision paralysis as the middle management is sometimes limited in its autonomy".

Autonomy still manages a very flat structure with a tight chain of command into the CEO and CFO,"... Although they have managed this effectively to date, we believe the business is becoming too big and time is now becoming the limiting factor. There after all only 24 hours in the day and 90 days in the quarter."

But it is not only the senior management that is found wanting. Autonomy's sales force are "hunters not farmers", according to to Geall and ill-prepared for the inevitable transition to account management as Autonomy grows and the number of "repeat" customers increases."

"Autonomy's margin structure is too high ... and the investment in the business has lagged revenues ... [which] could affect customer satisfaction towards the product and value it delivers."

Autonomy's service business is "too lean" ... "risks falling short of standards demanded by customers".

We are not saying that Geall is necessarily right, we don't have the facts behind these statements to make that judgement. What struck us though is that for the first time in our experience here was an analyst focussing on HOW a business thinks and behaves and the potential consequences this has for future performance, rather than just WHAT it does financially. Compare this with a few other analysts' comments reported in the Telegraph on the same day.

"Traders said that the efficiency review had hit ... and that there were worries over the prospect of the government attempting to renegotiate contracts".

"... he expected first half cash flow to be miserly ... and advised investors to bring your magnifying glass. He added that he anticipated continued revenue declines".

"... one of the most compelling retail roll-out opportunities ... clear and visible growth over the medium term backed by strong cash generation".

"... remains structurally challenged given its geographical and revenue channel exposure ..."

We do not claim that any of these are wrong, just very one dimensional. They are commenting only on financial outcomes, WHAT has happened and WHAT may happen rather than on HOW these outcomes came about. By contrast Geall comments on aspects of the core characteristics of Autonomy's organisational culture, how it thinks and behaves and how these could impact on future performance.

There is a growing realisation, backed by a growing body of research that the deep seated managerial and behavioural values and competences of a business are the main determinant of whether, over time, it will substantially outperform its competitors and successfully withstand unpleasant surprises. These values and behaviours manifest themselves in the form of the Competitive Strength condition of a business, which is:

How capable a business is compared to those that want to beat it

and

How capable a business is of mitigating those forces out there that can cause it to be beaten.

So without knowing it, we suspect, Geall has offered his analysis of the weaknesses in Autonomy's Competitive Strength condition and what the consequences could be. These weaknesses may currently be hidden by the advantage of its products' uniqueness and market dominance. If Geall is right then the research on which the concept of Competitive Strength is based demonstrates they could be doing up to twice as well right now. Furthermore unless corrective action is taken the cracks will start to show, it is only a question of when.

Should Autonomy take Geall's comments on board, given that he cannot be accused of not knowing the business? Autonomy shares fell substantially after it warned two weeks ago that full- year profits would be below market expectations, blaming "volatility rather than demand" in its markets. So if we were them and knew what we know then we would take Geall's analysis seriously. But we are not them and they may or may not know what we know, so we shall see.

Finally thanks to Richard Fletcher for spotting and publishing the difference. Let's hope it encourages more analysts to think about HOW rather than WHAT.

Exceeding Expectations is brought to you by Steve Goodman and Tony Ericson of Business Breakthrough Coaching. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish regular articles using a recent business/financial topic to highlight different perspectives and conclusions to those obtained by conventional thinking and techniques. You can read the other three blogs at "Business Bloop Award", "You're having a laugh ... seriously?" and "Capitalism or ... Common Sense".