Wednesday, February 13, 2008

Bristol-Myers Squibb Fires the Wrong Man In Asset Debacle

On its January 31 earnings conference call, Bristol-Myers Squibb Co. (BMY-$23.19), surprised Wall Street by reporting an unexpected fourth-quarter impairment charge of $275 million on the company's investments in auction rate securities (ARS).

As of December 31, 2007, the drug manufacturer had approximately $811 million of principal invested in ARS. The Company's investments in ARS represented interests in collateralized debt obligations (CDOs) supported by pools of residential and commercial mortgages or credit cards, insurance securitizations and other structured credits, including corporate bonds. Some of the underlying collateral for the ARS held by the company consisted of sub-prime mortgages, too!

With the liquidity issues experienced in global credit and capital markets, the ARS held by the company at December 31, 2007 experienced multiple failed auctions as the amount of securities submitted for sale has exceeded the amount of purchase orders. In addition, in the fourth quarter of 2007, $79 million of principal invested in ARS held by the company were downgraded and others were placed on credit watch.

The estimated market value of the company's ARS holdings at December 31, 2007, fell from $811 million to $419 million, reflecting a $392 million adjustment to the principal value of $811 million. Based on third-party valuation models and an analysis of other-than-temporary impairment factors, the company recorded the aforementioned impairment charge of $275 million in the fourth quarter, reflecting the portion of ARS holdings that the company concluded had an other-than- temporary decline in value.

Albeit the $275 million impairment charge did not have a material impact on the company's liquidity or financial flexibility, management had to record an unrealized pre-tax loss of $142 million in other comprehensive income as a reduction in shareholders' equity, $117 million of which reflected adjustments to ARS holdings.

Last Wednesday, speaking at a Merrill Lynch conference in New York, Chief Executive James Cornelius announced the firing of an un-named corporate treasurer allegedly responsible for the poor investment decision, saying, "I'm a big believer in accountability, and we're looking for a new corporate treasurer and a couple of people under him."

CEO Cornelius’ action demonstrates—once again—the beauty of The Peter Principle: The theory that employees within an organization will advance to their highest level of competence and then be promoted to and remain at a level at which they are incompetent. [After Laurence Johnston Peter (1919–1990)]

The incompetent employee who should have fallen on his corporate sword was the Chief Financial Officer, Andrew R.J. Bonfield—not some un-named number cruncher.

Finally, he [Brutus] spoke to Volumnius himself in Greek, reminding him of their student life, and begged him to grasp his sword with him and help him drive home the blow. And when Volumnius refused, and the rest likewise ... grasping with both hands the hilt of his naked sword, he fell upon it and died. ~ Greek Historian Plutarch, The Life of Brutus (46 – 120)

Albeit the treasury department invests corporate funds, in the hierarchy of the Company, the treasurer reports directly to the CFO (who has the fiduciary responsibility to analyze and review all the financial data and performance of the company). In other words, the ultimate responsibility of the CFO is to "routinely check the corporation’s financial health and integrity."

Think of it this way—if Bristol-Myers Squibb had reported an investment gain of $275 million in its ARS holdings, the individual standing front-and-center, crowing about his investment acumen would have been one R.J. Bonfield!

The September 2006 departure of former CEO Peter Dolan demonstrates that the Board of Bristol-Myers is loathe in dismissing 'one of its own.' In fact, we strongly believe that if not for the external pressure from Christopher J. Christie, the U.S. attorney for New Jersey and former federal Judge Frederick B. Lacey (whose job it was to monitor Bristol's conduct during its deferred prosecution agreement, and who made a preliminary recommendation that Dolan be terminated), Dolan would still be CEO!

History as a guide, corporate governance is not a strong suit at Bristol-Myers, and we do not expect Bonfield to lose his keys to the executive washroom anytime soon. But here’s a thought, maybe Bonfield could spend some of the $10,000 he receives annually for financial planning (as part of his compensation package) on an investment class, schooling him on the downside risk(s) of investing in auction rate securities.

As if worries about loss of patent protection and generic intrusions were not enough to rattle investors, now Bristol-Myers Squibb stockholders need to add tranches, CDOs and auction rate securities to their lexicon.

Editor David J. Phillips holds a financial interest in Bristol-Myers Squibb common stock. The 10Q Detective has a Full Disclosure Policy.

No comments: