Things were good for Robert Knowling in the summer of
The market was expected to grow by leaps and bounds-or to between $15 billion and $18 billion by 2003, according to Deutsche Banc Alex. Brown estimates. Forrester Research forecast 27 million users with high-speed Internet access by 2003. Add to that the expectation that transoceanic telecom capacity would increase by more tha500 percent from 1999 to 2001, according to international telecommunications research house TeleGeography, and the potential for growth was positively mouth-watering.
Knowling, a former U.S. West executive who had been playing in the telco space since 1977, got Covad off to a running start, bringing much-sought-after high-speed Internet access to businesses in city after city through deals with ISPs, such as Prodigy and Earth-Link, and affinity groups, such as Gateway and telecom carriers. In 2000, the CEO ably locked up several line-sharing agreements-which represented critical cost-savings vs. the expense of running second lines to consumer homes-with incumbent local exchange carriers (ILECs), including U.S. West, Bell South, and Bell Atlantic. In March 2000, Covad’s shares were trading at around $66 and most analysts were pushing the stock, rating it a strong buy. Things looked good, indeed.
And then trouble came to call. A series of missteps, miscalculations, and financial surprises-coupled with telecom tumult and mayhem on the Nasdaq-sent Covad’s stock right into the ground. Just 27 months after he was aggressively courted away from U.S. West, Knowling resigned, ending a fast and furious ride that left the company at suspicious odds with Wall Street and its share price in smoldering ruins.
As it turns out, this abbreviated CEO cycle-from golden boy to sullied scapegoat-is gaining a familiar ring. Covad’s hapless CEO is just one of dozens-including Xerox, Lucent, Gillette, Campbell, Maytag, and Procter &. Gamble-to fall victim to what appears to be a growing epidemic in the new century.
The cavalcade of failures underscores a trend that experts say was overdue. As long as stock prices continued to surge despite zero profits, negative earnings, and soaring losses, investor patience for profitability seemed infinite. But the ballooning of valuations in ’98 and ’99 set industry up for a hard fall-and indeed, the giants are falling faster than ever. (At Chief Executive, we consider it a sign of the times that the presses had to be stopped on CE’s December cover story profiling Knowling, as his resignation came just days before the issue was scheduled to print-a first in the magazine’s 24-year history.) Board members today, hell-bent on protecting shareholder interests, not to mention their own skins, are sending a message with their swift, and some say precipitous, action: CEOs, beware-make one mistake too many and you won’t have the chance to make any more.
A Multitude of Shooting Stars
The timeline from first warning to final exit is shrinking noticeably. While Knowling’s tenure at Covad might be considered brief by conventional standards, consider Rick Thoman’s paltry 13 months at Xerox, Lloyd Ward’s 15-month stint at Maytag, and Michael Hawley’s 18 months at Gillette-a company to which he’d devoted 40 years. It seems 2000 was a year of reckoning for CEOs in all industries, as shareholder intolerance in the high-tech sector began leaking into more traditional markets, causing boards to take a harderthan-usual line with CEOs.
But the current trend may simply be a return to normalcy, or, if nothing else, a natural extension of the frenetic Internet age. Fast times call for fast-moving CEOs. A closer look at the Covad story, critics say, reveals just cause for the change. First, while Covad’s subscriber line count rose from 16,000 to more than 200,000 under Knowling’s watch, and revenues increased, so, too, did net losses. It was a pattern that investors in the ravaged tech sector had likely tired of by the time Covad announced a first quarter 2000 net loss of $107.2 million, up more than 50 percent from losses in Q4 1999. So when Knowling announced Covad was going to spend about $200 million to buy BlueStar Communications, a provider of DSL in second-tier markets in the Southeastern U.S., even its loyal investors recoiled, hammering the company’s stock down 27 percent that day alone, and blowing out nearly $1 billion in market cap.
But Knowling may well have been trying to follow a trend in his industry. The BlueStar acquisition represented a small departure from a previously wholesale-only strategy and an attempt at an end-to-end solution for Internet service, which some industry analysts have said is critical to the success of competitive local exchange carriers (CLECs). “We examined the wholesale-only model in data CLECs offering DSL a year ago and forecasted its downfall,” says Matthew Davis, senior analyst for Boston-based Yankee Group. “The wholesale model was just not going to be sustainable over the long term.”
That put Covad in a bit of a pickle. First, selling direct to companies and retail customers would mean even higher costs and greater losses for the foreseeable future. It would also mean directly competing with its own customers-which put Knowling into hot water when the BlueStar deal was announced. “The channel partners did get very upset at first,” Knowling conceded. “The day after the announcement, I sat down with one of my top 22 accounts for four hours with our entire management team. I walked in and they were just spitting nails. And BlueStar’s not even in any city they sell in today.” While Knowling did plan to go toe-to-toe with channel partners eventually, he said, it wouldn’t be until after exploiting tier-two and tier-three markets. Besides, he added, competition is always good for the market. And once he’d had a chance to explain his strategy, he said, all but two partners got on board.
But Knowling was making people nervous. And the first round of damage to Covad’s stock had already been done. According to at least one source on Wall Street who declined to be identified, the investment community was growing irritated with Knowling’s overconfidence. If that was, in fact, general Street sentiment, it’s no surprise analysts turned their backs when even more disappointing news came with third quarter earnings-a larger-than expected loss of nearly $190 million or an EBITDA loss of $120.4 million.
And analysts have shown just how unforgiving they can be when they feel played for fools. Most who had previously been bullish on Covad’s stock-including Deutsche Banc Alex. Brown’s Michael Bowen-did not return requests for comment, while others said they had dropped coverage. One senior telecommunications analyst for New York-based Sands Brothers, Andrew Hornick, called third quarter earnings “the straw that broke the camel’s back.” Knowling, however, was quick to say that many factors contributed. “It was a series of unexpected things that transpired,” he said. “But it would be wrong to say that [third quarter earnings] was the sole context for this.”
Homick’s report downgrading the stock from Buy to Neutral placed some of the blame on Covad’s excuse for poor results: that it was unable to collect on $11 million worth of accounts receivable. “It now appears probable that additional private customers of Covad’s will announce liquidity problems and become delinquent in the future,” the report says. While the problem was likely the fault of capital-raising woes suffered by telecom companies in general, “this fact does not lessen the severity of the outcome, particularly if some of these companies declare bankruptcy.”
In his own defense, Knowling claimed he learned only one day before the earnings announcement that Covad’s auditors at Ernst & Young would not permit it to book the revenue from delinquent customers. But that, says Peter Crist, vice chairman of executive search firm Korn/Ferry International, is just the kind of nasty surprise that gets CEOs knocked from their perches. “Why didn’t you know that? Why didn’t you have a CFO who was telling you that? There are ways in which you manage your business that require you to have a certain adroitness about how you handle these things and it’s a reflection on the leadership of the company if you can’t pull that together.”
To be sure, it can be an awful lot to pull together-particularly for the CEO of a high-tech growth company. While a more established company focuses on any number of tasks-raising capital, product innovation, launches, customer training, marketing, investor relations-oftentimes, they’re happening in succession, not simultaneously. “At a dot-corn or startup, all those things are going on at the same time, because instead of building something over a three- or five-year period, you’re literally building something over a six- to 12-month period,” says Kathy Misunas, former CEO of Brandwise.com, which closed its doors in May. “All those same components are important. It’s just that they’re measured in days, not months or years.”
Taking Risks, Paying Prices
In that context, it’s easy to imagine today’s younger, less seasoned CEOs, like Knowling, having trouble juggling these tasks-particularly when many of them have management experience only in times of plenty. “As great as the four or five top players on GE’s bench might be, none has ever run a publicly traded company,” says Crist. “So there’s risk involved there.”
Yet the shortage of CEO talent in the market leaves boards with little choice but to roll the dice, after doing however much due diligence they can. On the downside, the young CEO may not be up to the task. He or she may squander opportunities and make bad strategic decisions, causing the company’s stock to plunge and erasing confidence on Wall Street. But on the upside, if the risk bears fruit, the board could find itself sitting with a star quarterback. “Take Mike Capellas,” says Jim Citrin, senior director for global executive search firm Spencer Stuart. “He’s emerging as a spectacular CEO for Compaq. And he had been a CIO, a young guy, and yet he’s grown immediately into the role, established great credibility and great vision. All of the sudden, the company’s on a torrent again.”
But what of those CEOs who hit a bump or two in their first year-a questionable acquisition, perhaps, or an unexpected change in market winds? “The grace period of allowing the CEO to get momentum moving and get the benefit of the doubt-that’s what you see shrinking now,” says Crist. “Heaven forbid the next CEO of GE stumbles
Heaven forbid the board has to think about a hiccup on that. Whereas, how many times did Jack stumble in his first fives years? I don’t know, but the new player won’t be given that benefit.”
It’s possible that board members who were somewhat skittish about hiring their CEOs to begin with may yank them before they ever get the chance to show their true colors. “Years from now, history will write that some of these players on the rebound did better than their initial boards allowed them to,” says Crist, noting that the legacy of Welch’s efforts came in the last seven years of his tenure. “In the first couple of years, I’m sure there were a few times when the board members were saying, `Did we do the right thing here?'”
Today those moments of doubt are more apt to lead to decisive action. Witness the quiet murmurings already stirring about Carly Fiorina, who had her first rocky run-in with investors after missing fourth quarter expectations by 10 cents a share. “I wonder how the board feels about Carly today,” says Crist. “Younger player, taken into the H-P situation, ballyhooed, wonderful. Now the first hiccup-how does the board feel about that? I hope they’re giving her proper latitude, but I don’t know.” The answer may lie in H-P’s next quarter earnings. If Fiorina can get the company back on track with expectations quickly, all may be forgiven. “But continued surprises lead to CEO turnover,” says Crist.
How a CEO handles surprises, when they come, is critical to his or her good standing. Most often, when problems arise, dozens of opinions and suggestions will pour into the corner office, and the CEO must play charismatic diplomat, as well as strategic and intellectual leader. “You can’t be too headstrong or so blind to feedback that the various markets or constituencies are giving,” says Citrin, “but it’s ultimately up to the CEO to synthesize that into the appropriate course of action for the times.” It’s an unenviable job, he adds-and one all too easy to criticize from the sidelines. “It’s much harder to do it.”
Clearly, the younger, less experienced CEO can afford far fewer surprises than a seasoned titan of industry. Any slip may be taken as an inability to expertly hold the reins. “The rules of engagement are changing,” says Citrin. “If a CEO misses a quarter badly without notice, that’s a problem. If he or she misses two quarters that’s a big problem. If they miss three out of four, that’s probably when the board will take action. It’s not a scale of years anymore.”
Another important factor, say experts, is the increasing space between boards and CEOs-in some cases due to the leader’s short tenure. Where historically board members were close friends of the CEO, today they are increasingly distant admirers, more beholden to shareholders, and more willing to pull the plug if things go awry. “Boards are more independent now,” says Mel Con-net, partner at Connet & Co., a Menlo Park, CA, executive search firm. “Replacing the CEO has become a much more acceptable method of dealing with problems, whereas in times past, it was only in a desperate situation that you would take a CEO out.”
Corporate governance advocates see this hypervigilance as a positive; it underscores a new willingness by some boards to hold shareholder interest above any personal relationship with the CEO. But the process of firing and hiring CEOs takes its own toll on the company. “You never know what you’re going to get on the hiring side,” says Connet. “It’s very expensive and costly to go without leadership during the time it takes to execute a search.”
But the ease with which CEOs seem to transition today is not all the doing of boards and shareholders, says Crist. The CEO’s mindset has changed. “It’s become more of an athlete’s mindset,” he says. “It’s, ‘I know I can only do this for a certain amount of time. I’ll give it my best, but at some point, I have to recognize that the game is over.’ “
For Bob Knowling, just one of many tech sector casualties-and a man once fought over by Ameritech’s Dick Note-baert and then U.S. West CEO Dick McCormick-the game ended on October 30th, at least at Covad. He says he’s had no shortage of job offers, but may instead work with charitable enterprises. “I’ve been on the fast track a long time.”
As for Covad, interim CEO Frank Marshall and Chairman Charles McGinn are keeping a lid on future plans with a “self-imposed quiet period,” according to a spokesperson. With its stock trading at around $3, they are likely pondering the options, which include being acquired, possibly by SBC Communications, given the 6 percent stake it purchased in Covad.) But if Covad does stay independent, Hornick says, it’s going to have to do “a much better job of communicating with the Street.” That means finding a CEO analysts admire, he adds. “Because they’ve already burned their bridges.”