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I’d walk a mile for a CAMELS

March 26, 2013

For those of us of a certain age, the singular form of this tag line was everywhere.  These days, when you hear CAMELS, and you’re in Financial Services, you associate the word with the benchmark issued by the Office of the Controller of the Currency, by which a bank’s senior and key management team is graded on a scale of 1 (best) to 5 (worst).

With a genesis going back to the 1980’s S&L failures, and trying not to repeat that experience, this metric gives outside regulators and the Street an overall picture of how Management is running their bank.  The 6 factors making up the metric are:

Capital Adequacy: The amount of capital that must be held in the financial institution relative to the institution’s asset amount.

Asset Quality: The quality of the assets on a financial institution’s balance sheet.

Management: The planning, organizing, staffing, and directing of employees.

Earnings: The quality, trend, and sustainability of the net profits from a financial institution’s operations.

Liquidity: The ability of the bank to meet the demands of its depositors and other creditors when due.

Sensitivity to Market Risk: The position of the bank relative to inherent market risks.

How relevant is this metric? Very. It’s broadly acknowledged as providing an X-Ray inside a bank, focusing on Management’s ability to run the business in a very hands-on and tractable way.  In effect, it’s a strong indicator for Management’s ability-to-execute over the long-term, an essential driver for any company’s health.

Given this metric’s strength as a window into Management quality, I was wondering if it could be modified for SaaS, IaaS, PaaS and licensed software companies, where Management’s quality is most definitely a key factor in company success or failure.  This is particularly true in early company flight where the band between a climb and a stall is so thin.  With license taken, here’s my adaptation for Technology companies, T- CAMELS:

Capital Adequacy: Technology (online and free-standing) is an IQ intensive business, so Capital here means the ability to attract and retain the most disruptive thinking, hardest working, and socialized talent.  These best employees deliver the goods because it’s in them, trying to burst out.  Fanaticism is fine, but it’s not about the ratio of divas per square foot.

Asset Quality:  How strong is their patent portfolio?  Is their product or business model sufficiently disruptive they can either pioneer or dominate a market? How would you rate their Product/Market Fit? Is the offering sufficiently differentiated to keep Churn under 2.5% per month (if they’re SaaS), or are they on a revenue treadmill?

Management: The planning, organizing, staffing, and directing of employees to execute. Daily execution is hard and requires managing up, down and sideways; Technology companies can have more than their share of social-nerds and running a focused and customer-centric business can be challenging if Management is not up to it. Adult leadership also introduces a balance of vision and reality into the acquisition process.

Earnings: The quality, trend, and sustainability of the net profits from a company’s operations.  Not many investors these days are attracted to ideas without a firm EBIDTA delivery model.  The goofy days of anything Mobile being cool are long over.

Liquidity: Is this business spinning off free cash? As Wimpy would say in the Popeye cartoons, “I will gladly pay you Tuesday for a hamburger today”.  Didn’t work at Bluto’s restaurant back then, and won’t work today with any vendors or investors I know. Growth, Customer Service and R&D all cost real money.  Having a growing bank balance prevents asking for another round of financing and dilution.

Sensitivity to Market Risk: What happens when your new product comes out either less than feature-full or late, or both? Or you lose your vision or miss some emerging societal/market trend? Can someone leapfrog you in the interim? Will you have to cut your prices and become the value brand player in your niche, making your existing operation unviable going forward?

The April 2013 issue of the Harvard Business Review has an article entitled ‘Three Rules for Making a Company Truly Great’, based on an about to be published book. Not exactly a new category of book, I’ll admit. It espouses the results of some research, explaining how their view of the broad concepts for success are, Rule 1 – focus on better before cheaper, Rule 2 – focus on revenue before cost and Rule 3 – follow the first 2 Rules.  In Technology, these rules are not as applicable as they are, and perhaps even then not so much, in more mainstream verticals, but we should still review their applicability as anything with the HBR logo has a lot of instant market credibility.

Their Rule 1 doesn’t work in Technology where ‘better’ is the enemy of ‘commercially acceptable’, and cheaper is not relevant. For each type of technology offering there’s a definite band of applicable pricing someone will pay to solve a particular need using your functionality.  Rapidly evolving the Product/Market Fit and pricing model as conditions change, not being the absolute best, or cheapest, wins. Yahoo’s recent purchase of Summly for a cool $30 mil reinforces pushing for faster and commercially acceptable.  The app itself has questionable legal issues around copyrights (moot now – the app is off the iPhone App Store), no business model other than ‘futures’, and poor reviews around its key strength – navigation, where “confusing,” and “nonsense navigation” have been cited.

Rule 2 can kill you because initial revenues can hide a lot of sins which will prevent future profitable and sustainable growth.  Most companies have not done a very good job, in our experience, of controlling the expenses associated with the infrastructure, personnel, and the myriad of internal inefficient processes and policies associated with rapid organic growth and absorption of new acquisitions when everyone is thinking revenues, not EBIDTA. We have also seen where the hunt for revenues has led medium-sized Technology firms to bite off more than they could chew simultaneously, ramping R&D expenses far in advance of revenues, starving their core product’s R&D budget. Back to Summly – for $30M they got navigation to use in future mobile apps, 3 employees and no incremental revenues. They did get PR, but how many technology companies have over $5B Cash and Equivalents on the Balance Sheet (over $2.42 Cash Per Share for 2012) to spend trying to look future-relevant to young Millennials and Gen Z?

Rule 3 – follow the former 2 rules, might have been caused by their publisher asking them to finish the damn thing, already.  In Technology, Rule 3 should be ‘avoid oversimplified rules and focus on your T-CAMELS’.

Richard Eichen is the Founder and Managing Principal of Return on Efficiency, LLC, http://www.growroe.com and is one of their senior turnaround leaders/CROs, Program Rescue and Interim Executives with over 25 years’ experience reshaping companies, Operations, IT/Systems Integration and key initiatives. Return on Efficiency, LLC specializes in those companies and initiatives where technology is the primary means of service delivery and revenue creation.  He can be reached at richard.eichen@growroe.com

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