In this weekly feature, FSA shows a potential investment that a firm has declined on the basis of ESG criteria. The purpose is to highlight firms that are actually putting into practice an aspirational ESG policy.
ESG assessment led by: AB’s US large cap growth team and Ryan Oden, dedicated ESG analyst.
Company assessed: A large-cap, US-based media and entertainment company
Fund: The company was reviewed for potential investment by the AB American Growth Portfolio Fund, which is authorised for sale in Hong Kong and Singapore.
Background: Video streaming companies have become attractive investments as disruption of the cable TV industry (“cord-cutting”) deepens and spreads globally. Netflix has been the dominant player, with a stock price up 5x in five years, but it is challenged by Hulu, HBO, Disney, Amazon, Apple and a host of other smaller players seizing the opportunity.
When AB’s ESG team evaluated a company that offers an internet subscription service for streaming TV shows and movies, the first red flag was company culture.
“Management reportedly uses fear to drive employee performance and supervisors feel constant pressure to fire their staff,” according to the AB ESG team report.
“Another area of concern was the fact that any employee, director-level or higher, can view the salaries of every employee. This treatment of employees, coupled with a relatively low proportion of equity in employee total compensation, exposes the company to talent-retention and overall culture risk.”
The ESG review also found that data security practices, an area of particular vulnerability for online businesses, were substandard.
“No evidence that the company uses the strongest forms of data encryption for customer financial data, no evidence of employee training on privacy/data security, and no evidence of a data security audit program,” according to the ESG report.
Looking at corporate governance, the team was concerned about the board of directors and shareholders rights.
“Management and the board refuse to engage with shareholders, shareholders do not have the ability to call a meeting, vote out a director, or change company rules. In fact, the board has failed to act upon multiple majority-passed shareholder proposals.
“The board is entrenched and overextended, with many members holding seats on too many public company boards, including the key role of chairman of the audit committee.”
Additionally, executive compensation and business performance were misaligned.
“Executives set their own pay structure and amounts, which for several executives is higher than the industry CEO peer median and is primarily awarded in cash with limited amounts of equity compensation that come with no vesting periods or performance requirements.”
The ESG team concluded that the company’s poor social and governance practices coupled with “uninspiring fundamental characteristics” led them to recommend avoiding investment.
AB said the would look at the company in the future, but several issues had to show significant improvement before granting a ready-for-investment ESG grade.
They would look for several indicators, including “board refreshment, a willingness to engage with shareholders, a returns-focused long-term compensation structure, an improvement in company culture, talent development opportunities and the implementation of ESG targets”.