Dan Heller's Photography Business Blog Industry analysis from www.danheller.com

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Thursday, August 02, 2007

Getty: circling the drain?

Today's news that Getty's stock price dropped 8.70 to 36.14 -- nearly 20% in one day -- struck me in two ways. First, it's no secret that I have been a strong critic of the company's management and strategy, so in many ways, this was par for the course in my mind. So, that it dropped didn't surprise me. Instead, it was the reason why it did that got my attention.

Readers of my blog may have noticed that my antennas perked up in the past few weeks on various news items surrounding Getty, which prompted me to write Getty's "stay the course" stock price, a thinly veiled attempt to show that the emperor is wearing no clothes.

That article on July 9 prompted an investor group to hire me to do a more in-depth private analysis for them. The portions of the research that the client allowed me to post publicly on my blog can be found in my subsequent follow-up, titled, The Solution to Getty's Woes.

(There was a coincidental email exchange I had with someone else about Getty's 10-K, which actually helped lead me to yet other resources I hadn't considered.)

Lessons Learned
The real lessons learned about Getty was two-fold. The first was a more of a reminder that CEOs have tunnel vision--they see what they want to see, and nothing else matters. As outsiders, people (investors) often overlook this subtle, but important, characteristic, and are usually forgiving to a point. The psychology of the investor involves faith that poor decisions are merely short-term miscalculations that can be remedied.

But, the pattern of decision-making by Getty has been consistent. All of my previous blog postings about Getty illustrate that they don't fundamentally appreciate the total size of the market, and how the internet itself plays a much, much larger role in the industry. More importantly, the internet will play an even more pivotal in the future of stock.

Getty views the fundamental photo market as a smaller universe in which they are the largest entity. This ill-perceived view--that the universe is small, not that they are the largest entity (which they currently still happen to be)--is what leads to other poor decisions, like what companies to absorb, what markets the penetrate, what markets to avoid, and other strategic directions.

Again: this is a pattern. And management of larger companies tend to stick to their patterns. So, to expect Getty to suddenly realize a new direction would be uncharacteristic. Yet, this is important because it leads to the second lesson I learned about Getty, and this one I didn't anticipate: that the company was going to continue drastic cost-cutting measures to assure that their EPS (earnings per share) doesn't erode.

Why would I be surprised by this? After all, it's not that this is inherently a bad idea. Cutting costs is very good, especially in businesses that have inefficiencies and wasteful spending. But this is more typical in industries with high labor costs, huge capital equipment expenditures, and bureaucratic processes that become top-heavy. But, Getty doesn't have any of these problems. What costs are they going to cut that won't cut into the core business functions it performs?

To choose to "cut costs" at this point has one of two possible explanations, both of which are pretty dim: 1) if the company really did have wasteful spending (on what, I have no idea), then it suggests the management is in worse shape than I anticipated before; Or 2), they could be making a similarly bad decision by cutting off future business opportunities just to meet the desires of short-term investors.

To explain what I mean by that second part, one needs to understand how investors think, and why Getty management may have capitulated to their whims.

The Problem with Investors
Public companies are at the beckon call of their shareholders because of "fiduciary responsibility." That is, if they don't make money, or worse, are thought to be squandering it, the shareholders can take action, ranging from having management replaced, to filing a class-action claim to recover tons upon tons of money for the shareholders' lawyers. (The shareholders themselves will get pennies on the dollar, but they usually don't know this going into it.)

Anyway, the CEO is under pressure to show growth and performance, or he's out.

Fair enough, but then comes the question of what is actually in the best interests of the company? If the long-term solution to a problem requires lack of income in the short term, the company has to have a pretty credible CEO to persuade shareholders to wait. That's a tall order, as most shareholders are short-sighted, often understanding little, if anything, of the business or market the company does business in. Indeed, a good example of this is illustrated in this article on the Motley Fool website.

The "fool" in this case, is writer Brian Pacampara, who pumps up stocks that he believes has good cash flow as a ratio of their stock prices. In Pacampara's view, he sees Getty's profit as a sign that the company is poised to deliver well into the future. What Pacampara doesn't realize (despite my email attempts warning him otherwise) is that when PE's are high like that, it can also mean the company's stock is overpriced, and a correction is around the corner.

But, Pacampara is a stock analyst only, and like many others like him, he has absolutely no idea what the stock photo licensing industry is like. He only looks at simple financial data, like the PE ratio. "You earn money? Great, we'll buy/recommend your stock." He isn't going to listen to people like me.

What that means is that CEOs of such companies are subject to the ill-considered analysis of people like Pacampara, and therefore have to make them happy. For if not, Pacampara pans the stock, people get out, and shareholders left with the bag get upset and take the CEO out to the backyard shed where the shotgun is.

The problem for a troubled public company faced with adversity is finding a solution that both works and is palatable to investors who don't fundamentally understand your underlying business. I have strong empathy for the CEOs of public companies because of this. But, my tears for Getty are of the crocodile brand for the sole reason that they simply don't get the market in the first place. Nothing I have ever seen Getty do or say in any of their public statements, actions, or investments has given me confidence that the company knows its way out of this mess.

So, there's nothing else for Getty to do other than to say, "We will continue to make money provided we spend less money." And it is for this reasons that Getty is circling the drain even faster than I had expected before.

Final Thoughts
While my previous posting said that I wouldn't short the stock because I didn't think it had much downside, I failed to anticipate that the company would react to investor pressure the way that they did. This is the type of event that could not possibly be anticipated through financial analysis, industry research, or anything else. It's the human element that throws all the numbers off, and human behavior can't be predicted.

Getty's strategic misjudgments about the industry have been evident for a long time, but it's important to note that they are "just" misjudgments. It is my opinion that there has never been any evidence that the company has intentionally misled anyone.

Getty has great images, they have great photographers, they have great clients, and they have great pricing models. They have a great fundamentals in the areas they cover. That's not the problem. The problem is that they don't cover all the areas they should, and they don't know how to leverage the power and culture of the Internet to maximize their potential.

Worse, the management is caught in a vicious cycle with their investors and stock analysts who also misunderstand the market. To wit: every stock analyst notes I've read who cover Getty (there are about eight of them at major investment banks) say that their primary concern is pricing pressure from competitors. This is only a problem if they continue to compete with those same competitors in the small, limited, overcrowded space in which they reside. If Getty were to break out into the broader universe that is open to still photo licensing (and their IP assets in motion video and music), then those specific competitive pressures would have less impact.

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