Client Update, October 12, 2024: New CEOs and the Leadership Question
“Superior businesses produce a lot of positive surprises. Bad businesses throw up one headache after another.”
Value Investor Li Lu
Last month, we highlighted sports retailer Nike (NYSE: NKE) as an exciting recent acquisition thanks to its fundamental underlying strengths combined with a low price relative to value. Having its worst trading day ever earlier this summer simply brought the price of the company well below its intrinsic value, making the buy attractive. We discussed the economics of the position in detail in August, writing: “The company has been down at multi-year lows but continues to show long-term staying power.”
Since that letter, a major change has hit the company: John Donahoe is being replaced by former Nike alum Elliott Hill as CEO.
Hill previously worked at Nike from 1988 to 2020, retiring after Donahoe was picked to replace then-CEO Mark Parker. Before that, Hill had worked at Nike for 31 years in a variety of roles. By all accounts, he is incredibly humble and very well-respected by the Nike community. We are legitimately excited by this leadership change! In our view, this transition makes a strong position even stronger.
To be fair, every indication at the time of his hiring suggested that Donahoe would perform well in the role, and not all of Nike’s recent volatility and underperformance can be laid directly at his feet. He brought an enormous amount of blue-chip experience, having led companies like eBay and Bain & Company. However, it appears he never quite gelled culturally with the mission- and value-driven culture at Nike. The result? Well, Bloomberg was unsparing in its own assessment: “He flopped.”
This is where Hill comes in: given his prior experience at Nike, he likely understands the essence of the company in a way Donahoe never could. In turn, that understanding could translate into positive impacts on employee morale, the glue that ties great brands together. Nike attracts people committed to a mission; in other words, these are people for whom it’s not just a job. When they feel that mission has collapsed or is being under-served, they’re more likely to leave. Perhaps Hill’s return might even serve as a catalyst for bringing back talent that had already left the company. As Fast Company wrote in its analysis of the changeover, “Hill is a relatively unknown name to the public…. But to some Nike employees, he’s not only recognized; he’s venerated.”
This leadership turnover at Nike raises an interesting larger question: how is the leadership experience and background of a newly hired CEO likely to affect their performance in a new role?
Every situation is different, of course, but Donahoe’s case raises the specter of Bob Nardelli at Home Depot (NYSE: HD), which we discussed in a recent letter. On paper, these leaders offer a lot of what we might want: operational experience with a finance-oriented approach, often directly focused on shareholder benefit.
Yet, it’s equally critical that any CEO understand the fabric of the brand they lead, especially outsider CEOs. Not everything can be boiled down to how it looks in a spreadsheet. For example, cutting costs is a lever CEOs can pull all day to juice the numbers, but if they do that without any appreciation for the secondary effects, like declining employee morale, they may end up causing more problems than they solve, especially if there’s a cultural mismatch.
Nardelli at Home Depot illustrates this point. He came from a relatively cutthroat culture at General Electric Co. (NYSE: GE) under Jack Welch, with a leadership roster populated by ambitious people always eyeing their next job opportunity and consequently making very results driven calculations. Had Nardelli succeeded Welch in the CEO spot there, he might have proven very successful within that environment. But at Home Depot, with dedicated, long-term employees deeply engrained into their local communities? That’s a different calculus, and it’s the job of the CEO to understand that reality and to think about how their decisions are going to land in a deeper way than can be captured solely by a spreadsheet. Here, Nardelli (and likely Donahoe at Nike) stumbled, and it is why they were replaced.
Another company with a CEO who truly gets the mission and culture of the company that he leads (he is a cofounder, after all) is Brian Chesky of Airbnb, Inc. (NASDAQ: ABNB).
Chesky spoke last month at the Goldman Sachs Communacopia + Technology Conference, along with Airbnb CFO Ellie Mertz. A recorded webcast of the session is available here. This was a fascinating glimpse inside not just the standard financial outlook but also the strategic vision of Airbnb. GDS Investments owns Airbnb because it is a textbook example of the type of company we like. Yes, there’s been a smattering of anti-Airbnb legislation on the local level limiting the ability of property owners to rent out rooms or units), but even then, Airbnb still enjoys plentiful, often-untapped opportunities for growth, especially internationally. Based on their presentation, the management team is clearly focused on those opportunities.
We have always had a lot of respect for Chesky. He wants to build something at Airbnb that’s durable with a two-way, win-win value proposition. Chesky also makes it clear he understands how his business is serving multiple different customers and providing value to all of them.
Plus, Airbnb has a huge net cash position on the balance sheet and little debt ($2.3 billion in debt versus $9 billion in net cash), creating the ideal situation where they can experiment internally, with an approach that seems equally analytical and purpose-driven. In this sense, it’s not unlike Nike, albeit at a fundamentally different stage of the maturity curve. Notably, for an asset-lite business model like Airbnb’s, the hard boundaries that exist for other companies don’t exist in the same way. Who’s to say they can’t export their brand to other regions, for example, given that they don’t need capital to expand? As Mertz said in sharing her own long-term vision:
"What gets me continually excited in my second decade at this company is the untapped opportunity we have to offer more than our core offering. So in the last 15 years, we've built this really material scaled global business, over $70 billion of gross booking value. And yet that $70-plus billion of gross booking value is fundamentally one offering. And we haven't even begun to tap either side of the marketplace in terms of the incremental products and services that we can bring to both guests and host to - one, make their experience with Airbnb better; but two, fundamentally increase the scale of this business by multiple revenue streams and businesses."
The recorded session of their presentation (here) is well worth the listen.
Lastly, with the U.S. presidential election imminent, just a few final thoughts on the candidates.
We discussed our economic-specific thoughts about the two candidates last month (in summary: we are not terribly impressed with the specific economic proposals of either candidate). That said, as the election looms closer and emotions run hotter, it may be worth making a special note not to take their economic claims too seriously.
The economic promises (and really, any promise at all) coming from any candidate has a distinct campaign-marketing dimension separate from the real-world practical side. Would Trump truly implement the potentially disastrous tariffs he’s discussed? Maybe! But it’s possible he talks about tariffs mostly because he thinks it plays well with his voters, and Trump is very much a showman who caters to his audience. As Mark Cuban said, “Trump has a new tax cut or tariff for every city he visits."
It’s somewhat similar with Harris and grocery store price fixing. Maybe that’s a policy she would implement, but it could equally just be a position that her team believes will resonate with her desired audience. Both candidates are incentivized to offer ideas outside of what’s realistic depending on their voters’ priorities.
That said, we don’t mean to ‘both sides’ the two candidates. They are not equivalent people. We are probably more inclined to believe Trump when he talks about tariffs (which is a cause for concern). We are more inclined to think Harris would instead surround herself with economic advisers who are more grounded in practical realities. She seems to have a good sense of where her strengths begin and end. As a result, with Harris, we have more confidence that she’d take more of a team-oriented approach in her economic policy.
Trump, by contrast, claims to “know more than anybody” about a very wide range of issues, including the economy, debt, and trade issues. In this, we are reminded of Charlie Munger, who once said he would rather “hire a person with an IQ of 130 but who thinks it’s 120, as opposed to someone who thinks he has a 170 IQ, when he actually just has an IQ of 150.” In other words, he prefers a hire who knows his or her limits to one who doesn’t.
Regardless, when it comes to personal financial decisions possibly affected by the election, we continue to counsel caution and calm. As we pointed out last month, gloomy economic predictions about Trump’s electoral win in 2016 did not play out. Here now in 2024, none of us know what’s going to happen. All we can do is take a deep breath, keep calm, and look forward to the day (coming very soon now) when we will no longer be drowning in a flood of political ads everywhere we look.
Regardless of the election’s outcome, we at GDS Investments will continue to act for the benefit of your long-term interests by positioning the portfolio around companies which satisfy our rigorous assessment process, and which can be obtained at discounted prices. We thank you for the trust you place in us.
With warm regards,
Glenn
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