Hitting the Jackpot
How Align’s CEO pocketed an extra $27.6 million by sheer luck
Here’s a story that has never been told, but should be...
It’s the first thing I thought of when I saw the stock of Align Technology sink 23% in a single day on bad earnings news last week.
I’ve written about Align on and off since its public debut 22 years ago, often with a cautionary tone.
But I had stopped paying close attention...
After all, this was a stock that had a history of steamrolling critics, thanks to the popularity of its Invisalign tooth aligners. It had done so well that in 2017 Align was the S&P 500’s best performer, with a gain of 131%... to finish the year at $222.19.
Nothing came close to what happened in the second quarter of 2021...
It was like fireworks had gone off, with revenue leaping by an astounding 187%. That was roughly nine-times its pre-pandemic growth, which had been declining.
Shares Skyrocketed
At their peak, shares responded by roughly doubling from where they were a year earlier to more than $700 a share.
This was when seemingly everybody was getting their crooked teeth fixed so they could look better on Zoom… which coincided with the peak of the zero interest rate-driven, post-pandemic stock market mania.
Align’s good fortune, of course, was unsustainable, with revenue growth ultimately turning negative against ridiculously tough comparisons.
Even so, the stock had hung in there. The last I had looked at it was a few months ago, when shares were hovering around $350. And while Align has beaten the market by an enormous spread over the past 10 years and beyond....
... When I checked back after last week’s pummeling, with shares under $200, I was surprised to see that it had underperformed over the past five years, and not by a small amount.
That’s when all sorts of alarm bells went off in my head...
Now for the Fun Part…
I immediately flashed back to something I had written in 2019 while doing short-biased research...
We had been raising concerns about Align since early 2018. Our focus had been the growing threat of competition in the market for clear teeth aligners.
We were right, and the stock had several big roller coaster moves along the way, until pandemic-fueled demand caused the stock shoot into the stratosphere.
That’s where this story gets interesting, and to the best of my knowledge, a story never told – certainly not in the media.
Checking out the Proxy
While going through Align’s 2019 proxy as part of our routine research, I noticed that CEO Joe Hogan’s total compensation for the year had nearly quadrupled to $41 million.
When researching companies, it often pays to check out the proxy statement...
That’s where you can see how much the top executives are paid, including bonuses and incentives.... and if financials are funky, the motive.
Funky financials were not an issue with Align, but if a CEO’s incentive is egregious, it might be a reason to pay special attention to financials going forward.
Hogan’s was off-the-charts...
A closer read of the footnotes showed that he had received “a special one-time MSU award with a grant date fair value of approximately $27.6 million.”
‘Special Grant’
An MSU is a market stock unit, which is an incentive stock option tied to the performance of a company’s stock. Billed in the proxy as a “CEO Special Equity Grant,” Hogan was receiving this MSU award “in consideration of his exceptional service to Align during his tenure and the desire to retain the executive talent necessary to drive toward the achievement of our global strategic initiatives.”
The board knew this would be a perceived as an egregious payout – so big, in fact, that it made a point to acknowledge it, saying...
While this grant is significant, it is 100% performance-based.
In other words, the stock had to rise by 80% over a three-year period from the time of the grant, with its total shareholder return landing in the 80th percentile of the S&P 500...
That implied a stock price of $500, which at the time was no small feat, given that the stock was $330...
Large Investors Balked
Since this was in the proxy, which few people read – and since Align is a company that tends to say out of the limelight – the size of the payout never made headlines. But it clearly caught the attention of the company’s large investors, who balked.
At least that’s my interpretation after reading the company’s comments in its year-later proxy, when it said it needed to “clarify some misconceptions about the award expressed during our shareholder outreach.”
The filing then spent a full five pages explaining why it believed Hogan deserved such a big incentive. It then went on to say that as a result of the feedback (emphasis added), “we determined that we will not make similar awards in the future except under extraordinary circumstances and only following stockholder outreach. We have not made any such awards since 2018 and we do not have any plans to make any such award in the future.”
The company also made clear that at the time of the filing – almost two years in – that Hogan “has yet to benefit… because stockholders are not benefiting from Align’s continuing strong performance.”
Enter the Pandemic
Then along came the pandemic and everything changed...
After a brief pause, Align’s business skyrocketed, the stock zoomed past $500 – rising 91% in 2020 alone – and Hogan hit the jackpot.
As the company disclosed in its 2022 proxy (emphasis added)...
During the performance period of the 2018 MSU, our stock outperformed the NASDAQ Composite Index by 111.6% and surpassed the $500 per share highest stock price performance hurdle under the 2018 MSU by $89.53 per share. As a result, Mr. Hogan also earned the maximum allowable payout under the MSU of 300% of his target award.
He wound up with 129,300 shares, and unlike some MSU plans, this one didn’t have a holding period. Within days of vesting, Hogan sold nearly half the shares at $582.35 a share… much of that tied to exercising the units.
Two month later as the chart below from his filing with the SEC shows, he top-ticked the market by selling another 75,000 shares at prices ranging from $686 to $705, just below its highest price ever.
Not only does it turn out that Hogan is a good CEO, but he has impeccable timing on when to trade the company’s stock... which started to tumble a mere two months later.
Gravity Takes Hold
In the following two months, the stock had slipped back below $500... falling fast to where it is today, which is less than half the target the stock had to reach for Hogan to get paid.
The reality is that the only reason Align hit $500 in the first place was because of something totally out of Hogan’s control – an exogenous event like none other, which paradoxically created an unsustainable boom in demand.
Put another way, sheer luck spelled the difference between an exceptional payday and one that was exceptionally incredible.
If there is any doubt, look no further than these comments by the head of the company’s scanning division at Align’s Investor day less than two months ago…
Up until a couple of years ago, we did not see a lot of competition either in the clear aligner space or in the scanning space. But today, you see a lot of competition emerging. Why? Because they see the opportunity, the massive opportunity ahead of us in this transformation and a lot of people are coming in.
With that, you will also see a big pressure on pricing. More competition, pricing is going to go down. And the only way to survive this game is through differentiation. And this is why we talk about comprehensive dentistry and how we go after this unique opportunity with the two million dentists out there.
This was part of a broader presentation about where Align is on the “maturity grid,” as the aligner and scanner businesses mature.
I intentionally took it out of context, because no matter how it’s spun, these were comments coming from a company that has been viewed as having a near-monopoly on an industry it created.
When a company like that starts talking about “a lot of competition emerging” and “pricing going down,” the implication is that whatever moat it may have had has been breached. You can see that very clearly in the way investors reacted, with the stock sliding the day those comments were made…
All of which gets to the moral of this story...
I always say there’s the company and there’s the stock. In this case, as good a company as Align has proven itself to be – it has no debt, generates gobs of extra cash and spews loads of free cash flow – the stock got well ahead of the company.
That’s the problem with relatively short-term stock-based performance plans like this, especially if there’s no holding period of at least several years…
They very well can wind up rewarding luck rather than skill. It’s supposed to be the other way around.
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DISCLAIMER: This is solely my opinion based on my observations and interpretations of events, based on published facts and filings, and should not be construed as personal investment advice. (Because it isn’t!)
Feel free to contact me at herbgreenberg@substack.com. You can follow me on Twitter and Threads @herbgreenberg.
Love it!
Great piece!