This is an exert from an intelligent investor article related to directors holdings and management incentive. Although I wouldn’t want to invest just based on someone else’s purchases, it surely casts an even greater warning.
Having said that, the share price seems to have taken a greater dive than I would have expected given the changes in the fundamentals
Apologies if it has been quoted before.
‘The next round-up
And that brings us back to the power of incentives. In 2014, the board tweaked the remuneration package for chief executive Scott Richards by removing short-term bonuses tied to the company’s operating performance and advancement of its research pipeline. The amended scheme split his pay between a fixed salary and stock grants.
Let’s ignore for a moment the fact that over the past three years Richards’ total remuneration package has risen from $971,000 to $2.8m (including a tidy salary bump from $539k to $860k).
The real issue is how the incentive structure has changed. We love companies with a long-term orientation, but the way Mayne has structured Richards’ pay looks like a rattlesnake round-up in the making.
Table 1: Mayne historical financials
Year to Jun 2017 2016 2015
Revenue ($m) 572 267 141
Gross profit ($m) 316 168 80
EBIT ($m) 106 49 12
NPAT ($m) 86 35 8
EPS (cents) 5.7 4.2 1.0
Net debt ($m) 270 26 1
Shares outstanding 1,511 810 786
Firstly, there are no short- or long-term incentives that reward earnings
per sharegrowth, which is arguably the greatest long-term influence on a stock’s intrinsic value and a fairly standard inclusion in executive pay for an ASX-listed company.
Is it any wonder, then, that Mayne is addicted to issuing stock to raise capital for acquisitions and pay its employees? The number of shares outstanding has risen in each of the past eight years – and it’s up
tenfold since 2012. Even if we were confident in how Mayne’s business would develop over the next decade, we have no idea what the future share count will be. It’s difficult to value a slice of pie when the number of slices keeps changing.
The number of shares management is awarded is also based on a single factor: total shareholder returns exceeding 5% (or 10% for a full allotment). Sure, in theory this incentivises what shareholders want, but it subtly promotes actions that boost the share price in the short term, rather than grow the underlying intrinsic value per share over the long term.
In fact, a
2015 Harvard University study found that ‘including [total shareholder return] in a long-term incentive plan does not lead to improved company financial performance’ and that ‘there is no evidence that using the metric in an incentive plan actually improves future shareholder returns’.
Worse, Mayne provides a non-recourse loan for management to purchase the shares – the executives have no downside; it’s a one-way bet. This incentivises risky behaviour to boost the share price, which could explain why the company had a net cash position until 2013, but management was comfortable for net debt to rise from $26m to $270m in 2017 to acquire a portfolio of 42 drugs from US-based Teva/Allergan.
The current remuneration package incentivises empire building, and management is off to a good start – the US$652m spent on the Teva/Allergan acquisition was two-thirds the company’s market capitalisation at the time.
Management says it has 'a clear strategic ambition' to 'triple the size of the business in revenue terms to $1.5bn' by 2021. Mayne has a top-notch research pipeline, but there’s little chance of it hitting that target without further large acquisitions. Overpaying for those acquisitions and adding debt is a significant risk – and more dilutive capital raisings are practically a given.
Mayne’s stock is trading on a tempting price-earnings ratio of just 12. However, with a deteriorating balance sheet, pricing pressure in the US, and management incentives that encourage risk-taking, we’re happy to watch from the sidelines.
AVOID’
(20min delay)