Monday, December 26, 2005
It seems to me that anything Google really needs accomplished will be done on its own, with full control. For some time now, the mating dance by Yahoo, Microsoft and Google around AOL was seen as mostly to keep the latter's customer base out of one of the others' grasp. Just in case it turns out to be useful for something.
Watching Dick Parsons juggle his succession lineup and attempt to fend off Carl Icahn in the midst of this venture is amusing, when it's not sad. I owned AOL at the time of its merger with Time Warner. Then, as now, I thought the latter's board did a profound disservice to its shareholders by accepting AOL's offer, and not spurning it. It is hard to believe that a marquee name investment bank would not have found adequate grounds to reject the offer, protect the board's exposure on the "fiduciary duty" basis, and provide sufficient doubt of the longer-term value of merging with a temporarily-highly valued suitor like AOL.
Perhaps, more than anything else, this deal demonstrated, once again, that "synergies" are rarely realized post-merger, and that simpler business structures are frequently more consistently superior in generating market-beating total returns for their owners.
I don't envy the managers at AOL. Being the "partner" of a celebrity company like Google, and nearly publicly disowned by its management, can hardly be an appealing career opportunity.
Tuesday, December 20, 2005
If this doesn’t demonstrate the networks treatment of investing as primarily entertainment, what could?
The NYSE move to electronic trading, in order to minimize the egregious regulatory infractions of it’s specialist members, including front-running its customers when order filling, makes the trading floor an even less important place in the investing process then it already has been for some time. With the rise of managed funds, 401K plans, etc, institutional management has been the driving force in the market for quite some time. The trading floor is for order execution, but is not, in itself, the locus of investment decision-making that moves the markets.
Thus, CNBC seems to be moving to cover the sizzle, but not the actual “meat” of the capital markets. If you needed to understand what is going on in the markets, you can monitor any number of real-time ticker and index data feeds. Actually seeing the trading floor and filling of orders is superfluous.
However, if you simply want to portray an entertaining drama of market forces at work, I suppose having a program set located within earshot of the trading floor frenzy does that.
Monday, December 19, 2005
What struck me were the last two paragraphs. After describing the agony PepsiCo has gone through to produce enough potatos in China to drive Lays’ market share to 40%, the piece noted that Wal-Mart (in China) complained about shortages of Lays on its shelves. The article finishes with these lines,
“….The chip-production goal has been increased again to meet rising demand. Mr. Shi’s shoulders slumped.
“We’re under a lot of pressure from the sales guys,” he said. “It’s growing too fast.”
This reinforces my thesis that the best way to buy successful growth companies is to buy those who have already demonstrated successful growth. That is because sustained profitable growth is so hard to achieve.
Isn’t it interesting that a world-class company like PepsiCo, with so many resources available, has to struggle, as the article depicts, just to introduce and grow the Lays potato chip brand in the world’s most populous country? You would think this would be child’s play. But evidently it is not.
PepsiCo has only attained a cumulative 20% total return for the past five years. By comparison, the S&P500 is slightly under a 0% return for the same period. That means that PepsiCo has had an average out-performance of only 4% over the S&P for the last 5 years. Clearly, it is by no means currently successful at turning whatever top-line revenue growth it has into consistently-superior total returns.
However, my portfolio strategy has selected a host of companies over the years which have consistently performed much better than PepsiCo. Thus, my preference for owning companies that have actually demonstrated consistently-superior performance over time, rather than those who one would believe should be able to do so. And the wisdom of my strategy’s approach is evident in the portfolio’s consistently superior returns over time.
Friday, December 16, 2005
What I found upon reading Collins’ methodology was an odd mixture of quantitative and qualitative bases of analyses. There are a variety of problems with his methods, which I will address both here and in subsequent posts.
To start with, Collins uses cumulative returns over long periods of time to judge a company as “good” and/or “great.”
However, my own research on large U.S. publicly-held companies reveals that among companies which outperform the S&P 500 average total return over a period of years, firms which consistently outperform the S&P index, on average, create shareholder wealth at a much higher rate than companies which earn most of their total returns with a few years of outstanding performance.
This is a very non-trivial issue. If, as CEO, your decisions are guided by the desire to “maximize the present value of the firm”, how do you choose when to maximize that value, which in turn maximizes shareholder wealth? Will the decisions you make enrich some shareholders at the expense of others because they own your company’s stock at different points in time?
It is highly likely that a consistently-superior firm’s great wealth creation is a reward for not forcing investors to be market-timers. Collins completely misses this distinction in his work. Since it is the first screen by which he typifies companies, it therefore compromises the entire remainder of his findings and body of work as described in the book.
I must admit, I was rather shocked that such slipshod and simplistic quantitative definitions of “good” and “great” performances would exist in a book so seemingly well-regarded in the business community. Perhaps it is yet another case of the broad class of mediocre managers and leaders being unable to distinguish “great” work when they see it.
As I read more of Collins’ book, I will post additional comments on the differences in approach and findings between his work and my own.
Tuesday, December 13, 2005
Yesterday's downgrade of the company's debt by Standard & Poors may now give these parties the "cover" they seek to express their true feelings. According to today's Wall Street Journal story on the subject, S&P's rating of GM now places it in a category in which 5.7% of whose companies typically default within a year. So, now we have at least one quantitative estimate of GM's viability over the next twelve months. Since GM is involved with the Delphi situation, I stand by my belief, expressed many weeks ago, that the former will be merged, acquired, or in bankruptcy at the end of two years from now.
It is noteworthy that S&P, perhaps a more "neutral" analyst than many brokerages, is quite clearly concerned about the revenue and market-share dilemmas facing GM, rather than the company's self-diagnosed cost-control challenges.
What I now wonder is how much value in investors' portfolios has been destroyed by GM's roughly -19% return from October 18th until yesterday's closing price? How do the sell-side analysts defend their silence then, given this recent loss in GM's value? I don't track how many downgrades were issued, or when, by various analysts since mid-October. What I do know is that the media and analytic climate two months ago was one of relative silence in the face of what seemed pretty obviously the beginning of the end for GM.
Most portfolio managers trade more frequently than I do. My twice-yearly trading allows my positions to quietly run their course, often amassing substantial returns while others would “rebalance” away profits. This half-year has been no different in that regard, with energy issues earning double-digit returns.
I have, however, come to terms with the steady drumbeat of sell-side analysts and media pundits, such as Jim Cramer. Daily volatility is now something I expect, as it represents other investors and traders entering and exiting the market on any particular day. These daily price fluctuations assure smooth and liquid trading on the two days per year I will trade. With few exceptions, the actual movement of the market over a few hours on any given day is not that large.
So I now “go placidly”, holding my positions patiently while observing the daily frenzy. No matter how volatile the daily price moves, the monthly volatility is less affected. And so are even longer-term moves of prices and indices. My portfolio may experience some volatility due to short-term market exuberance, but in the longer-term, the superiority of the portfolio’s selections typically reappears. The key is to not succumb to daily or weekly concerns due to traders’ constantly-shifting valuations, but maintaining the discipline of my investment process.
Friday, December 09, 2005
"… This ignores the fact that American auto makers and other traditional manufacturing companies created a social contract with government and labor that raised America's standard of living and provided much of the economic growth of the 20th century. American manufacturers were once held up as good corporate citizens for providing these benefits. Today, we are maligned for our poor judgment in "giving away" such benefits 40 years ago…."
Waggoner is saying that GM and other large US corporations privately monetized future promised benefits as a form of currency to lubricate and drive US economic growth. He implies that they promised wealth in order to drive more consumption on the part of the workers. He seems to be arguing that making false promises which accelerated US growth in prior decades is defensible on the basis of the end, namely, falsely promising undeliverable benefits.
Is this amazing, or what?
First, Waggoner effectively admits that corporate America has been privately creating money by issuing dubious pension promises. As if GM hasn’t had enough difficulty just being a consistently-good investment for its shareholders, it apparently dabbled in monetary policy, too.
Then, with unmitigated gall, Waggoner goes on to suggest that making pension promises which have turned out to be unaffordable was justified, because it caused workers to feel wealthier, spend a lot more money, and drive economic growth.
Maybe Rick Waggoner would be better off not speaking or writing anymore, and trying to find a merger partner for his wreck of a company, while it still has some cachet with a few buyers in some of its customer segments.
Tuesday, December 06, 2005
Waggoner first makes a dismissive nod to the need for producing vehicles which people actually want to buy, rather than stuffing GM products with various features that still fail to address the overall demand of the driving public. The extent of his solution is found in this passage, “We will step up our performance in this regard.”
Wow. And all this time, it was so easy. Just write that you will ‘step up …performance,’ and you have it covered. No details as to how your entire heretofore ineffective creative design staffs will change overnight. Or how these people, or perhaps their replacements, will quickly produce newly-interpreted solutions for the vehicle-buying public. No, just tweak a few knobs down in the design department and you are back in the black!
But the really sad part of Waggoner’s article is the roughly one-third of it which wraps his company in the American flag. This tactic sent me to Bartlett’s for this line:
“Patriotism is the last refuge of a scoundrel,” is attributed to Boswell in his Life of Johnson.
According to Waggoner, while GM freely entered into its pension agreements with its workers and their unions, they did it because “….(American manufacturers) were once held up as good corporate citizens for providing these benefits.” He goes on to say that these same companies are now “maligned for our poor judgement in ‘giving away’ such benefits 40 years ago.”
What Mr. Waggoner fails to realize, as apparently did his predecessors, is that his and their fiduciary duty is to GM’s shareowners, not to a faceless holder of opinions about whether a company is a “good corporate citizen.” He takes the easy way out, pleading that GM’s prior and current managements must bend to the will of public opinion regarding their status as corporate citizens.
Never mind their option to make their own case to these same opinion-holders regarding the long-term financial inviability of the agreements GM freely made. Instead, Waggoner effectively blames the social environment of the last 40 years for his company’s plight. I would opine that, if anything, this displays how inept the GM management has been for years at correctly assessing its own costs of business, and putting its shareholders first.
If this kind of scapegoating and avoidance of responsibility is how Waggoner plans to lead GM, I continue to predict that he will have a short tenure.
Joseph A. Schumpeter
Capitalism, Socialism and Democracy, 1942
This morning on CNBC, the Squawkbox crew debated recently-revised “productivity” data for the US economy. I use quotes because I have my doubts that the popular use of the term promotes clarity of thinking, as I hope to demonstrate in this piece.
Steve Liesman spent a considerable amount of time discussing how the improved physical output of a machine would improve productivity of its worker, and also profitability of the firm using it. If only life were that simple.
As my old boss and mentor, Gerry Weiss, SVP of Corporate Planning & Development at the old Chase Manhattan Bank used to say, producing another poorly-selling Cadillac Cimarron more efficiently adds little, if any value to the US economy.
Simply put, there is a major difference between efficiency and productivity. I find most classically-trained economists make this mistake, Schumpeter’s passage notwithstanding. To understand the difference, we need to understand the “background,” as Schumpeter stated in his 1942 book.
Liesman made a common mistake in assuming that whatever that machine was producing could be sold at a market-clearing price, thus improving overall profitability and margins. However, this isn’t correct. Productivity didn’t improve from that machine’s added output- efficiency did. We only know about the physical output of the machine per unit of time or other resources- workers, maintenance expense, etc.
We know nothing about the sale price of the product into which the machine’s output goes, nor the price elasticity of the product, the demand for it at various prices, etc. These elements affect what I call the product’s, or sub-component’s “resource value productivity.” This would be the value-added to the firm of that component or product divided by the particular resource, in this case, a more efficient machine.
Confusing efficiency of output with the ability to create more value-added per unit of resource shows a lack of understanding of how economics is morphed in a company into marketing.
For example, what if the management of the firm in question has mis-estimated demand, and the newly-efficient machine is producing unwanted product? Think this is rare? Look at GM, Ford, Merck, or even a Hollywood movie studio. If GM more efficiently produces an SUV that will sit on a dealer’s lot, to be sold at deep discount, was there any productivity gain? Or was an unwanted, little-valued product made more efficiently?
It strikes me as odd that reporters on a leading business program can be so well-versed in economic theory, but miss the major difference that an advanced, consumer-driven market economy has over a production-driven economy. That difference is the need for producers in the former to get product development and price-points right, in order to sell highly-valued merchandise and services to a demanding and selective market. Once you grasp this, you immediately can grasp how production efficiencies are not at all the same thing as resource (value) productivity.
Schumpeter’s observations about the perennial gale of creative destruction makes this so. Too bad so many business people and economists recall the two-word phrase, but not the author’s deeper analysis of its implications.
Sunday, December 04, 2005
However, what really made me sit up and take notice was Icahn’s pointed comment regarding the modern large-cap American CEO. He feels that, on average, and as a group, they are seriously disadvantaging US business relative to foreign businesses. This is a fascinating viewpoint. It echoes my own research, writing and feelings, some of which are found elsewhere on this blog.
Icahn specifically voiced concern that today’s CEOs are so over-compensated that they simply do not pay sufficient attention to maximizing ongoing shareholder wealth. In this, I totally agree ( see my recent post regarding pay-for-performance for large-cap CEOs). He feels that if this trend continues, American business will lose its competitive edge and, over time, fall victim to hungrier, more attentive foreign competitors.
With GM, Ford, UAL, Merck and TimeWarner as examples, it’s hard to argue with him. It is possible that Ricardian economics is responsible for the leadership in steel, airlines and autos going overseas.
But couldn’t these firms have accomplished what Intel has around the world, and remained competitive via global facilities and globally-sourced talent? My suspicion is that Icahn is onto something here. As superior innovative talent in other countries becomes more globally accessible and able to be leveraged, it may signal another round of American industrial restructuring to come on the order of that which we saw in the 1980s and early ‘90s.
Thursday, December 01, 2005
The piece, entitled, “It’s the Purpose Brand, Stupid,” advances the apparently-novel notion that products (and services) should be focused on customer needs.
Really? Do tell!
What struck me as I glanced at this piece is how low the Journal’s staff must be aiming to waste space on this type of pablum. And, thus, how uneducated the staff must feel their average reading audience is.
But there’s more shocking news. The piece is an exerpt of the authors’ upcoming article in the Harvard Business Review. One of the co-authors is a member of that college’s business school faculty.
The notion of developing products to satisfy customer needs is literally as old as marketing itself, and covered in an introductory marketing course at the undergraduate level. Why this would need to be re-stated as a special topic in the world’s leading business daily makes a sad statement about the state of mediocrity among business executives in general.
Perhaps this is because the MBA as an educational program is insufficient to impart the necessary knowledge in depth to lead and manage businesses effectively. With less than 24 months duration, and the last 6 of those typically wasted on job search, the educational program may be too short to really imbue its students with effective managerial tools. In my opinion, it seems to have become more of a financial- and other functional tradecraft certification, and much less of a management degree.
If this were not true, would an article such as the one mentioned in the beginning of this post be appearing in the leading business daily paper, as well as a well-known business monthly magazine?
There seems to be an irreconcilable conflict in many sectors between a company’s growth objectives, its profitability, and the real constraints to satisfying both of these. It is especially obvious with airlines.
As a business with large fixed capital assets and varying customer demand levels, both in unit volumes and revenues, airlines have always been management challenges. Factoring in the relevant economic attributes of the typical airline- low barriers to entry, relatively high capital requirements, unionized labor, lack of control over the system in which it operates, tendency towards costly evolution to multiple plane types, underlying derived demand for travel- suggests that there are probably very real limits to profitable growth.
In Southwest Air’s case, when I read about the airline changing its operating model to accommodate growth, I expect financial doom to be in the offing. The stock is down over the last five years as it is, and even under-performs the S&P500 during that period.
Similar to the “wheel of retailing,” about which I have written in an earlier post, budget airlines beg for trouble when they depart from their original low-cost, no-frills, or limited-geographical service model. It does seem that historically financially successful airlines were regional carriers who had identified a fairly self-contained segment of fliers whom they could serve at lower costs than larger airlines could do so. So long as such airlines expanded within a region that provided high load factors while the airline grew service points and passenger volume, there was no problem.
What seems to sound the death knell for these regional carriers is their eventual desire for passenger and revenue growth which requires them to outgrow their original, self-contained market segment of travelers. Just because an airline wishes to profitably continue its growth does not mean it should, or will, happen. Thus, Southwest’s dilemma.
It is pushing for growth while its total returns over the last five years are already penalizing its shareholders.
Hard as it may be to accept, many companies simply run out of profitable market segments in which to grow, and then their days of consistently superior returns are over. Airline total return performances seem to reinforce this conclusion with stunning regularity. So much for learning by example, or even from their own mistakes.
Sunday, November 27, 2005
Ironically, my old boss, and SVP of Corporate Planning and Development of the “old” Chase Manhattan, Gerry Weiss, predicted back in 1986 that eventually the major money center banks of Manhattan would merge into one or two giant mediocre financial services companies. He was eerily prescient.
What Gerry saw from his unique vantage point was how difficult it was to effectively manage such a wide range of types of businesses at these banks, in conjunction with the lack of adequate managerial talent. Financial services has never attracted good managers.
Traders, deal-makers, and financial products innovators, yes. Consistently-effective managers, no.
My original research at Oliver Wyman & Company, now Mercer’s financial services consulting unit, confirmed this. Money center banks and large investment bank/brokerages never enjoyed consistent superiority in their shareholder wealth creation. They were out-peformed by single-line firms in credit card lending, mortgage banking, private banking, asset mgt, etc.
Empirical research of over a decade of company performances confirmed my old friend and boss’ hunch, and added a new finding. Not only were and are these financial leviathans simply too complex for the executives that are typically drawn up through their ranks to successfully manage. By being so broadly diversified, and large, they are sure to experience every major financial calamity which befalls the sector- be it real estate lending, sub-prime credit, risky proprietary trading, or, as in the Enron case, over-zealous complex financial products marketing which apparently crossed the line from finance to abetting financial fraud. The result is that consistent total returns prove to be an elusive goal, as these huge financial behemoths are beset with every market excess which occurs in the industry.
That is no doubt why these companies are rarely, if ever selected by my portfolio strategy. Revisiting my original sector research, and Chase’s and Citigroup’s recent performances, is a comforting reminder that my strategy’s bias in favor consistently superior performance is based on sound empirical research. Size for its own sake is of no value when you want to out-perform the market, despite what analysts may believe.
I suppose an indication of how useless the resulting “vision” was is that Chase was acquired by Chemical bank within just a few years of the company-wide project’s conclusion. As I recall, it was that, or have Michael Price, then a hot mutual fund manager, force the bank’s senior management to dismember the firm in order to wring more value from it. Either way, Labreque's hand was forced, and he lost control of the bank he had labored so hard to finally "lead."
Today, Chase is a combination of Manufacturers Hanover, Chemical, and JP Morgan with Chase. The only significant US banks on the island of Manhattan that didn’t merge into it were Bankers Trust, which was snapped up by Deutsche bank after its ill-fated derivatives moves later in the decade, and Citibank.
Maybe the lesson here is that clueless white senior managers shouldn’t try “vision quest” –ing on their own, or with conventional management consultants.
Perhaps if Chase had actually retained an American Indian consulting group, complete with hallucinogenic substances, their efforts would have met with more success. It's arguable that the results of such a "vision quest" could have led to any worse results than those which followed from the erstatz process the bank actually employed.
Monday, November 21, 2005
You see, I worked for the “old” AT&T. The one prior to the spinoff and deregulatory shuffles of the mid-late 1980s. Sadly, Whitacre’s vision is just about exactly the same one that Charlie Brown, AT&T’s then-CEO, had more than twenty years ago. Once again, smaller, nimbler, more experienced competitors have already staked out turf and begun operating in the areas that the new AT&T is still planning to conquer.
It is inexplicably bizarre that one corporate name should be retrieved to brand yet another headlong lunge into a new, complex technological battle of precisely the same type that destroyed its first incarnation. When I arrived at AT&T in 1979, it was rapidly girding for a deregulated operating environment. And immenses riches were planned to flow into the corporate coffers from dominating voice, data, text and video communications. We had nascent private quasi-internet projects, like ACS, as well as new multi-media digital processing products. What we didn’t have was credibility in designing and marketing the new products and services, much less sufficient customer behavior information to drive their design and integration.
I don’t see much difference this time around. Once again, the guys with the AT&T logo are claiming that they will swamp existing competitors with multimedia services, delivered in unrivaled volumes and combinations, and with technological superiority. Forgive me for being cynical, but I not only saw this movie already- I was actually cast in it. Believe me, when you are inside a behemoth like this, bent on implementing its market-conquering view, no amount of realistic advice will change anything.
Can one firm, one corporate name, endure a second trip to the ash heap of corporate history? Maybe, like large killer hurricanes, corporate names from spectacular disasters should be retired, never to be used again. I think the “old” AT&T deserves at least that much respect.
The original research which drives my large-cap equity portfolio strategy has shown that turnarounds such as this one are fraught with risk, and, thus, rarely return a company to a path of consistently-superior total returns. Even if expense levels are cut, the ability to regain healthy revenue growth rates seems to be a very rare phenomenon. In short, shareholders will continue to wish they had simply bought the S&P500 index for the long term, rather than continue to hold GM stock.
I knew for sure that GM is still in trouble when Waggoner attributed this newly-announced initiative to “our smartest people.” Translation: ‘Look out! The best minds who have assisted me in bungling the management of this former market-leader over the past few years have conspired to bring you another page from the same book.’
Don’t hold your breath for the return to health of this industrial wreck. At best, Waggoner will perhaps engineer a merger of equally-unhealthy auto makers before GM runs out of time and money.
Saturday, November 19, 2005
The notion of counterparty risk, usually found in financial enterprises, has recently become much more widely understood, albeit under a different name. GM’s pension liabilities, for example, are now realized to be at risk of being unpaid, as its debt yield exceeds that of at least one South American country. The reason it’s finally a hot topic, as evidenced by CNBC’s week-long focus on “lie now, pay later,” is that a major industrial firm is now judged to be an unreliable counterparty in the pension arena.
Truth be told, this is not really news. The topic was very au courant in the early ‘80s, when I was fresh out of graduate school. During the roaring inflation of that era, and subsequently, FASB introduced the first changes in pension liability accounting, to begin to accurately portray these unfunded obligations.
But before concluding that GM and its ilk are lying, cheating and despicable pension thieves, let’s revisit what actually occurs in an employment situation.
Imagine someone offers to hire you for $100,000 per year of compensation, but they will only pay you $80,000 in cash. For the remaining $20,000, they promise you that they will pay the cumulative amount at a time in the not-so-near future. No escrow account, promissory note, bond, or anything like that. Just a written promise. So, in effect, you have bought, or in financial parlance, “gone long,” your employer’s counterparty risk- the risk that they might not actually be able to deliver on their financial promise.
This is typical behavior of employees in the US. Thanks to the federal government’s expansive pension benefit legislation, what individuals would ordinarily consider too risky is judged safe because of governmental policy. But the truth is that because of governmental meddling, people take far more risks, as well as leave of their senses, when agreeing to accept unsecured future payment promises from companies whose legal resources are so vast as to nullify any possible means an individual realistically has to make said company satisfy its pension obligations.
I find it ironic and sad that, thanks to governmental interference, yet another area of compensation has been mucked up. Rather than mandate a company cash contribution into individual retirement accounts, our government allows companies to run the private equivalent of the Social Security mess- undivided, massive pools of pension funds which are unequal to the claims against them.
In all probability, Congress probably thought it was “protecting” workers from their own naivete in managing their pension savings. But do you really think most individuals would have done this bad a job on their own? Winding up with their entire pension held hostage to the probable bankruptcy of a once-large manufacturer, GM?
Who can afford much more of this kind of “protection” by our federal government?
Friday, November 18, 2005
Some wags refer to GM as a company ‘run for the benefit of its retirees’ health care expenses.’ Perhaps so. According to information mentioned on CNBC yesterday morning, a significant portion of the stock is owned by employees and retirees. So maybe it’s justice that the firm seems to now exist to pay their medical expenses.
Seriously, who in their right mind would hold or buy this stock now? Does anybody really feel it is a comparatively attractive equity play? GM’s situation has gotten me to muse about why people still hold a stock like this. And that, once issued, someone has to own the shares. How odd. You could have all this equity out there in one company being used in a gigantic game of pass the financial trash.
And what about the board endorsing Rick Waggoner in his role of presiding over the slide toward bankruptcy of what was once the world’s largest automotive enterprise? Are they sticking with the devil they know, simply because a new CEO would take even more time to sort this mess out? Or because, embarrassedly, nobody else would take the job now?
I saw an interview with one portfolio manager who actually holds a lot of GM stock. When asked by CNBC interviewers what he hoped would happen, he kept saying he expected the board to “step up” to the task. This was echoed by a corporate governance pundit as well. When pressed, neither would elaborate.
Do they really mean that Waggoner should “step down?”
Friday, November 11, 2005
After reviewing my portfolio strategy’s selections over the past fifteen years, a pattern does become clear. Companies that sell discrete items or services that are not considered “technology” may regain the characteristics of consistent superiority, i.e., consistently above-average revenue growth and total returns. Retailers, white goods manufacturers, apparel makers, pharmaceutical companies, financial services companies and other producers of discrete products and services are examples of this. Software makers are not.
If you think about “technology” companies, many of them, by their very nature, will only have at most one significant period of consistently superior performance. Various generations of computing platforms, such as mainframes, minicomputers, and, yes, even personal computers, seem destined to experience only one explosive period of superiority. After that, either growth rates fall with saturation, or the investment community learns to expect appropriate performance from the maturing firm, and returns no longer out-perform the market.
Software is even more prone to obsolescence. It creates the “installed base” or “legacy” problem, even as it provides a convenient price/performance target for the next generation of solutions to exceed. I first became acquainted with the installed base issue while at AT&T. While electro-mechanical telephones did not have software legacy issues, the time and expenses involved in servicing its vast installed base of older telephone equipment caused AT&T to carry a burden for years. Due to regulatory constraints, the firm was unable to recapture competitive profits on the expensive older base. Yet, early termination of the equipment would have thrown huge numbers of existing customers into the market at a time in which AT&T’s market share was slipping, causing its cashflow to shrink just as it had to fund new digital communications products.
For a firm like Microsoft, the legacy challenge is perhaps even more daunting. The firm must provide reasonable portability between generations of its products for its customers, even as it attempts to remain competitive with new entrants on performance and price/performance bases. This probably accounts for much of Microsoft’s slowing new product introduction rate, as well as the lack of significant new “killer applications”. Worse still, eventually moving to a web-based access model competitively priced to rival new entrants such as Google is likely to force it to devalue its own core products without additional new sources of revenue.
But let’s return to the initial focus of this piece. Actually, retailers like Home Depot, Wal-Mart, Kohls and Bed, Bath and Beyond have a greater probability to return as consistently superior portfolio selections in my strategy, after falling out of the group, than many other companies. This is because they satisfy frequently recurring customer needs, yet they don’t have to design or manufacture their products. As end-distributors, they simply need to continually offer the best choices of relevant products, and be well-managed. This is not to say it will happen all that often. Dysfunctional cultures and myopic management are still the rule among most US large-cap corporations. However, since consistently-superior revenue growth is the single hardest business phenomenon to create, these companies have the advantage of serving recurring needs of fairly large sized customer bases.
As I observe this week’s continuing business media fascination with Microsoft, it baffles me that they can’t grasp the fundamental nature of technology companies. The latter compete to solve specific customer needs with a (typically) proprietary or unique technical solution. The solution requires substantial resources dedicated to a particular methods, technologies and capabilities. When another company eclipses their solution, why would any intelligent person think that the once-successful vendor should be able to simply technologically leap-frog new competitors to reclaim its past pre-eminent position?
Wednesday, November 09, 2005
Jobs has demonstrated a talent for successfully implementing two, perhaps three, business visions. However, to do so, he started Pixar separately from Apple. He didn’t attempt to create it as a division of the latter. Rather, Pixar is about entertainment technology. Who knows how warped its development may have been, were it to have been birthed within a personal computer maker. It seems to be in the nature of human behavior, especially for leaders of previously successful enterprises, that these people seldom lead those organizations to long-term domination of a product/market across technological divides.
It’s interesting to consider that Job’s, and Apple’s, latest and greatest invention, the iPod line, occurred after Pixar. Perhaps Jobs appreciated the needs and solutions for personal entertainment better after having created and successfully run an entertainment-related company. The iPods are a far better concept and implementation than the Apple Newton was in its day.
However, contrast Jobs and Apple with Gates and Microsoft. The former created a radically new business by starting from scratch. The latter are attempting to recover from several product/market defeats with a biased, existing culture. Even Ray Ozzie, Microsoft’s new visionary team member, is on at least his third organization. To him, it’s a new culture and environment, so he isn’t limited by Lotus or Groove Networks.
However, Bill Gates is still at Microsoft. Despite Ozzie, whatever Microsoft does to compete with Google will look a lot like, well, how Microsoft would do online/internet services.
For an example of how wrong this can go, consider this. In my youth, when I joined AT&T, I met veterans from the company’s first large-scale digital PBX development team. They described how Bell Labs product developers had originally provided access to computer software on the product via four-digit numerical access codes. While everyone else in the world was using computers via full keyboards, these guys were going to give their users access via numeric touchpads on a telephone. It was simply the world they knew.
I think Gates will have much more success by simply putting Ray Ozzie in charge of a new company, funded by Gates/Microsoft, to pursue the latter’s latest visions. It will bear none of the cultural burden and ponderous size of Microsoft, both of which are sure to be handicaps in the race to compete with Google, Yahoo, et.al. You can’t really believe that Microsoft’s employees feel totally free to change direction with Gates’ personality still in resident. That’s not to say Microsoft can’t develop online service versions of their current product portfolio. But at this point, who cares? Nobody else is competing in those now-commoditized and basic niches anyway.
Mind you, I don't think this takes away any credit whatsoever for what Bill Gates did with Microsoft. He performed a very successful wealth-creation job. Nobody should discount that. It's just that now, Microsoft's time is over- like GM's, IBM's, AOL's, etc. These companies have already seen their most creative, consistently-superior wealth-creating days. They are now simply large, slower-growth, mediocre remnants from once-hot product/markets.
When I began these two latest posts, I was focusing on Bill Gates and his belated attempts to not just change the direction of his supertanker that is Microsoft, but actually rebuild it in the water en route. What I have concluded, surprisingly, is that the really great role model for radical corporate change is Steve Jobs. He had the courage to found an entirely new company (two, actually, if you count Next) in order to implement part of his digital vision. And probably used that to pollinate Apple with ideas that led to the iPod line and iTunes.
Bill Gates’ new manifesto won’t work as imagined. At best, Microsoft may develop several competitive offerings for web-based services. However, the days of the desktop operating system being a gatekeeper are now over.
Gates and Microsoft are fortunate to have picked up Ray Ozzie, but I doubt it will really make a difference in Microsoft’s ability to dominate a significant software product/market niche again. Ozzie’s success with LotusNotes demonstrates that he just sees the world differently than his employers at Microsoft have, do and will. So it’s unlikely that the full value and intent of his thinking will be executed at his new corporate home. It’s too late in the game now. MSN Messenger, the web browser, multi-platform operating systems, a search engine, all were nascent at Microsoft while someone else succeeded with them as a business model. This was no accident.
This is why, to me, Microsoft now looks a lot like AT&T did when I first joined it in 1979. It was a large company by virtue of its position in a soon-to-be obliterated competitive landscape. The guys who ran AT&T thought they could control how they would allow competition to affect their very large organization. We had tons of meetings and projects, always infused with the top-down attitude that when we were ready, when AT&T really hit back, then the market and competitors would be stunned with our offerings and success. Well, it never happened, because those senior executives simply could not comprehend the magnitude of the environmental change coming over them. AT&T was first with the transistor, multi-media telephony communication, data switching and processors in the network. At one time, its subsidiary, Teletype, completely controlled the terminal market. To what end?
It looks like the same thing has happened to Bill Gates. Rather than spend weeks alone in some lakeside cottage, sipping sodas and reading a lot of navel-gazing papers from his own employees, he should be out among consumers, watching what they do, listening to what they want.
These personal observations are reinforced by my extensive research on corporate performance. It is astonishingly hard for one company to accomplish what Microsoft did in the 1980s and ‘90s. The firm hasn’t been in my list of consistently superior return generators in this decade. For a technology company to return to the list is virtually impossible. What made it great, its focus on its then-crucial competitive advantages, virtually guarantees that it will find those advantages blunted by later competitors. So long as the firm remains even remotely attached to its earlier product/market strategies, it will not return to its prior success in the equity markets.
Frankly, so long as Gates remains the leader of Microsoft, whether chief technical officer or not, it has virtually no chance of returning to its former status as a consistently superior total return creator.
To be continued…………
Tuesday, November 08, 2005
I’m referring in particular to the video iPod and the recent deals to allow network TV programs to be downloaded onto them via iTunes for 99 cents, as well as this week’s announcement that Comcast will allow on-demand viewing of network programs for the same cost.
The final major transformation of consumer content control is underway. What the big three networks will do with all that now-redundant delivery bandwidth is beyond me. Sure, you can still tape what you want and watch it when you want. And you can still get the default airwave schedule for free. But you can see the new model very clearly now. All content will become available on demand for under a buck.
The real question is what you’ll use to view it. Except for some teens and 20-somethings, I don’t think it will be your cell phone or iPod. They can technically support some programming, with special modifications, but I don’t think most people want to have to hold and view a device that small to see, say, an hour program, much less a movie. And let’s not discuss how long it takes to download even short video clips.
Many years ago, a friend bought me a Sony Watchman portable TV as a gift. Very small screen with a sharp picture. However, it was so tiny that it became tiresome to hold and view it for much more than a few minutes. I don’t see the video iPods or today’s cell phones being used for serious viewing, either, other than perhaps short music videos. Of course, you miss a lot of the action and atmosphere on those small screens.
That leaves a very attractive market for publicly-accessible viewing devices which are cabled up to the internet. Since nobody probably wants to carry a 21" viewing screen with them for idle moments of entertainment, it's logical to assume that various locations where people now wait (airports, coffee shops, etc) may have swipe-card operated viewing devices.
I have suspected for a few months, like the staff on CNBC’s SquawkBox concluded this morning in their discussion of this topic, that the end result of this will be personal content accounts accessible anywhere, anytime. But not through small personally-owned devices. Rather, think web-accessed accounts- networks, private producers, old movie library websites, etc. Or viewing a just-released movie, courtesy of Bob Iger’s new Disney plans, in your hotel room, for only a few dollars, by accessing your personal account on a website using the hotel’s high-speed connection.
It’s ironic that the same digital format that is going to take out the telephone companies is also going to remove a huge chunk of value-adding services from licensed broadcasting as well. Which do you think will implode first, Verizon and AT&T, or NBC and CBS?
Monday, November 07, 2005
It strikes me as more hypothetical than practical that an already-wealthy CEO will still behave like a hungry decision maker who is straining to earn every last nickel of total return in the equity markets for his shareholders. How many of us would still feel the need to take chances when we already had more money than we reasonably required to live comfortably thereafter?
In my opinion, once a CEO has earned in the neighborhood of $10-15MM in compensation from a company’s shareholders, s/he should be given a new performance target: exceed the S&P500’s total return in each calendar year, or over an average of a few years, or face immediate dismissal.
My equity performance research confirms that it is a very rare company that can consistently outperform the S&P500 for more than a few years at a time. So many things can befall a firm that it takes quite a bit of effort and competence to accomplish this feat for even five years. As a shareholder, I would be suspect that a wealthy CEO with more than five years in the job is going to take appropriate risks, should hard times arrive on his watch.
Therefore, putting a wealthy CEO on notice that perfect performance, relative to the market, is now required, would be likely to return his behavior, and that of the firm, to that of a hungry, focused enterprise actively striving to be the best purveyor of customer solutions in its chosen markets.
If a CEO could not do this, what have shareholders lost by replacing him? He hadn’t achieved a superior return for them, relative to what they could earn in a market index fund. Any other viable candidate would be preferable. Should the incumbent CEO revive the firm’s fortunes, then he is, again, worth his compensation for having created even more shareholder wealth at superior rates of return.
Either way, it begs the question of why shareholders should tolerate the employ of CEOs whom they have made wealthy, but who cannot return the favor at an above-market rate of return.
Sunday, November 06, 2005
The last 6-8 weeks of US equity market activity bear this out. No efficient market could have so many violent updrafts and downdrafts on the basis of so few pieces of genuinely “new” information.
We have, basically, five pieces of information which have been disseminated to the market: energy supplies, energy demand, inflation, consumer spending and economic growth.
Yet, going back to the second week of September, after hurricane Katrina tore through Louisiana, we have had 10 days in which the S&P500 Index rose or fell by 1% or more. There have been at least twice that many days in the same period in which it rose or fell by more than half that amount.
How can an “efficient” market display this many jarring price adjustments to essentially only five data inputs? My contention is that the vast army of mediocre, herd-following analysts and institutional investors are the source of this inefficient market behavior.
Failure of most participants to carefully piece together the puzzle pieces and see that energy demand had not been “destroyed,” and that consumer spending was not permanently crippled, as energy price increases abated as supplies returned to the market, was the cause of some of this market volatility. The practice of business news organizations to ceaselessly flail at all potential outcomes of any breaking economic story is probably another cause.
The truth is, two months after the hurricanes hit, economic growth in the US has been measured at being incredibly robust, while consumer spending continues with the help of increased total wages. It would seem that there was much short-term asset price movement on the basis of incorrect assumptions and expectations.
Yet another reason why my own portfolio strategy patiently holds its positions during periods of confusion and volatile asset pricing such as we are currently witnessing.
Friday, November 04, 2005
What is comforting to me, however, is that by persevering with my positions throughout the post-hurricane rise and fall of the market, my return for the year is almost back to its peak at the end of September. At that time, its gross return was roughly 12.5%, while the S&P500 Index was at roughly 1.2%. At the trough during October, my portfolio had lost about 10%. It subsequently recovered to only a –5.4% return for the month. At yesterday’s market close, my portfolio had a year-to-date return of 11%, versus roughly .5% for the index. So sticking with my positions throughout the October sell-off was handsomely rewarded.
It would seem that, since the hurricanes hit the US Gulf Coast, economic growth was not that badly damaged, and energy prices and availability are not going to cripple demand after all. Listening to a wide variety of pundits and analysts, I was struck by how many sell-side analysts overlooked the macroeconomic forces at work to drive demand for energy. Thus, as energy companies began to be valued as if they were simply oil tank farms or natural gas tanks, rather than producing enterprises, I felt they had become undervalued and would recover. I did not sell my positions. They now have recovered.
Last week’s third-quarter GDP number, combined with this week’s retail sales results, indicate that all the hand-wringing over an economic slowdown was simply wrong. Oh, well. At least the brokerages made money by facilitating investors’ moves out of, then back into, the retail and energy sectors.
It brings to mind a favorite quote I read a few weeks ago by John Bogle, erstwhile head of the Vanguard Group. In an interview in the Philadelphia Inquirer, he opined that in most situations, an investor’s best guide in the face of volatility and uncertainty is, “don’t do something, just sit there!” I have, and it’s worked. Again.
Tuesday, November 01, 2005
Dr. Urban, an MIT decision science/operations research professor, has allegedly pioneered a new form of customer relationship. It involves not merely understanding and meeting customer needs, which has typically been the province of marketing. Rather, he now espouses “advocating” for your customers, within your organization.
Sounds great, doesn’t it? Let’s review the list of companies the review in the alumni magazine provides as apparently shining examples of this method’s success:
-GM (wow- can you believe this one? Someone would actually list GM as a paragon of anything but failure in marketing?)
-Qwest (another paragon of clear-sighted marketing. Their very future is now in question after losing out in the bidding for MCI)
-Intel (great chip manufacturer, but not a great producer of consistently superior shareholder wealth)
-John Deere (again, a famous name, but hardly a consistently superior producer of shareholder wealth)
Maybe I’d rather see the list of companies who refused to pay Dr. Urban’s firm, Experion, for consultation on this important new customer management philosophy.
I recall reading Dr. Urban’s work as a graduate student in marketing some years ago. My belief then, as now, is that many operations researchers have much less understanding of the marketing discipline they seek to influence than they realize. Thank goodness.
For instance, I read in the book’s review in the aforementioned alumni magazine, “He draws on new case studies to show how to align culture, metrics, incentives, and organization, driving effective advocacy throughout entire organizations.” Now, that is a chilling concept indeed. Are we to understand that GM’s current situation is a showcase of this method writ large and successfully? Or did GM not fully embrace it yet, “throughout (the) entire organization(s),” and, if not, why not?
The concept of this being totally diffused throughout an organization leaves me with one thought- who’s minding the mint? Doesn’t at least one senior executive need to be left weighing the satisfaction of customer needs by new and existing products and services with the company’s long-term profitability and return to shareholders?
I confess to being embarrassed that one of my alma maters has become so myopic. What does it matter if a company profits, and fails to provide shareholders with an attractive, competitive return? At least I’m comfortable knowing there are very few hardcore OR types in the pantheon of academic marketing gods.
No need to take advantage of my alumni discount on this soon-to-be-classic volume.
I think that the two guys who founded google are very smart. They built a better search engine, but they realize the next great search engine is likely to surpass them, just as they dethroned Alta Vista. Yes, there actually were search engines prior to Google. A friend mentioned to me a few months ago for how little Alta Vista was ultimately purchased by some European company. It was pathetic.
I believe that the owners- excuse me, senior executives now- of Google realize that their best hope for continued consistent value, and thus wealth, creation is to become so entangled in the online habits of their customers that Google is no longer perceived as a search engine. Otherwise, they face the ever present threat of rapid decline.
Consider this. The two founders of Google probably don’t spend as much time creating new and better search procedures as they once did. Further, current students at better engineering schools across the country now have something at which to aim. By virtue of its current dominance, Google probably can’t take advantage of the next smart search engine designer’s new twist. And, to be honest, using a new search engine is ultimately as simple as going to a new website.
Thus, the rapid expansion by Google into, well, just about anything online that can tie your behavior into their brand, rather than their search engine, per se. For example, email services, instant messaging programs, a whispered foray into the remains of AOL, wifi rollouts in San Francisco, and, now, a voluminous database of searchable literary content. They must be really worried. Because very little of these enterprises, by themselves, require integrated consumer behavior. Rather, a single company offering all of them hopes they can bend consumer behavior to their version of service packaging.
Not likely in this internet and information age, is that?
As to the book scanning effort, that is perhaps the most intriguing of Google’s current projects. It is disingenuously portrayed as a simple case of Google spending it’s money, and lots of it, I would guess, to provide, for free, a database of searchable texts. What could possibly be avaricious about that?
True, their promise to provide only the undefined “snippet” of any search result is itself a loophole. And their explicit attempt to avoid securing permission to copy in a manner which, for anyone else, would require a copyright owner’s permission is worrisome. One gets the sense that they realize they have no chance of affordably tracking down the owner of every book they may scan. So, instead, they appear to be generous, allowing publishers to “opt out” on the copyright owners’ behalfs. How accommodating of Google.
But all this, I think, misses the real sizzle of this business concept. While maintaining the searchable text database as free in perpetuity, the mere ownership of this valuable trove provides for many as-yet-unspecified uniquely profitable opportunities. This is the sort of dream situation the authors of the Clayton Antitrust Act had in mind- one product is inexpensive, but is tied to another that is monopolistically controlled.
In the case of Google’s searchable database, the other, monopolistically controlled products, or services, may include: links to book sellers; extensive bibliographies of authors; access to information derived from Google’s ability to search the database in ways that are different than those it provides to free users.
The underlying opportunity in all these examples is some unspecified value-added product or service which is not the database, but is derived from ownership of the database. Particularly important, I am sure, is Google’s ownership of, and control of access to, that database. For instance, you don’t see Google, at this time, offering to share funding and control with, say, Yahoo, Amazon and Microsoft. No, they, or some of them, are now purported to be in their own discussions with publishers, to accomplish similar ends to that of Google.
As a closing note, this is now reminding me of two other investment “opportunities” of the last 150 years. Those are, American railroads of the late 19th century, and airlines in this century. British investors lost tons of money buying equity in fledgling US railroads during the late 1800s. The net cumulative cashflow of the airline sector, from birth to now, I have read, is negative. Which is to say, just because seemingly smart, well-heeled corporations and people throw wads of money at a concept doesn’t actually mean it will profit them. You and I may well enjoy a phenomenal benefit of online text search and procurement in the years ahead, at absolutely no cost to ourselves. And several seemingly invincible, or at least pretty powerful, technology titans will be poorer for our pleasure.
Monday, October 24, 2005
Where is Carl Icahn when you need him? Too busy over at Blockbuster, I guess.
I recall Silverman articulating the wonderful opportunities for cross-selling among the various travel, subscription, buying club and other businesses he assembled through acquisitions and mergers. So much for that puffery.
Perhaps the object lessons to learn here involve leadership, creativity and scale.
First, it’s really difficult to lead a diverse group of businesses into some sort of group-think that spontaneously generates successful cross-selling the way a producer wants to market it. All too often, as with Time Warner and AOL, or diversified financial services, the cross-selling is in the mind of the producer, not the consumer.
Neither Sandy Weill at Citicorp, nor Henry Silverman at Cendant, could force consumers to behave in ways which provided the predicted integrated revenue and profit growth from their respective acquisition empires.
Second, creative marketing management doesn’t seem to lend itself to scale. Innovative product development and marketing positioning seem to be fleeting instances of genius. It’s not clear you can “best practice” it across a business, let alone across businesses. Empirical evidence on the lethargic total return behavior of most conglomerates seems to bear this out.
If anything, the recent decades of technological advances in computing and communications have lowered the effective size for successful creative management, not raised it.
Finally, this leads to scale. Grandiose visions of imagined consumer buying behaviors changed by conglomerating products and services usually fail to account for the sheer difficulty of managing scale.
One of the oft-missed effects of conglomeration is probably the loss of many of the most talented employees. From my own experiences at AT&T, then the largest private employer on the planet, Chase Manhattan Bank, and Andersen Consulting (NOT Arthur Andersen, thank you very much!), I can vouch for this. Large scale organizations inevitably have to be run by a middle class of talent at most, if not all levels. Innovation is hard to tolerate in a firm of large size. Management is typically routinized into a definable culture, so that the firm is more efficiently run.
When you put all these effects together, you get disasters like Cendant.
I’ll leave you with this little gem. Today, in an interview on CNBC, Silverman solemnly intoned something to the effect that his conglomeration was, ‘an artistic success, but a commercial failure.’ How nice of him to tell his shareholders now that all this time, he was dabbling in art, not commerce.
Rather, these other companies see a possible opportunity to scavenge some of AOL’s parts on the way to changing the terms of competition in the larger arena in which AOL once played a dominant role. None of the three suitors would likely care about the dial-up access business, nor, for its own sake, the content portion of AOL. What they all want is AOL’s customer base to which to market their own collection of internet-oriented services.
Their very interests in the remains of AOL’s customer base signal that their strategies have devalued this older business model. AOL is a faded brand in a growth industry. Further, the industry has changed so much that companies with concepts still in their infancy in AOL’s heyday are now dominating it.
Google creates its value in other ways, and is perhaps looking to deny a piece of AOL to a competitor. The same is true of Yahoo. The combination of Yahoo’s and MSN’s messaging services further devalues AOL AIM system, because all of these are free.
The current competitive situation in this arena finds AOL still in possession of a customer base which sizable and somewhat unique. Before that is no longer true, these newer entrants, and one old one, Microsoft, are hoping to capitalize on the value of that base. The incidental businesses which originally attracted the customer base are probably not all that valuable to anyone now. If they were, AOL wouldn’t be in the trouble it’s in today.
Wednesday, October 19, 2005
Perot was vocal about the poor quality of GM’s cars and its lack of decisiveness. How prophetic and right he was. I think it is fair to say that GM’s failure 20 years ago to heed his warnings marked possibly the last time it had a significant opportunity to avoid the fate that now awaits it - loss of independence and/or existence.
Lest you think that Lee Iacocca’s Chrysler experience demonstrates that a Big 3 automaker can save itself, let me remind you that it ultimately was acquired by Daimler-Benz. Iacocca didn’t save Chrysler, he merely delayed its day of reckoning by a decade or so. After his exit, the inertia of Chrysler’s Big 3 culture drove it once again to the brink of ruin, and forced it again to depend on the kindness of strangers.
I continue to believe that GM cannot save itself because its current leaders, beginning with Rick Waggoner, are products of the existing culture of 40+ years. It is not capable of creating lasting, profitable change for the long term, within two years, in how it designs, builds and markets vehicles. It may be acquired, or “merge,” to avoid an actual bankruptcy. But I still maintain that it will not be independent within two to three years from now.
Tuesday, October 18, 2005
But that wasn’t the bizarre part. He then went on to explain that when he screams “buy,” he does not, in fact, mean “buy.” He said that all he really means is that viewers must ‘do their homework,’ going on to detail just what that meant. Hours Googling company names, reading “every” article written about them, and buying transcripts of conference calls with analysts. He added that he was not any viewer’s ‘personal financial advisor.’
Wow! You could have fooled me! With that take no prisoners attitude toward buy and sell recommendations, Cramer sure seems to believe he is advising his viewing audience. Especially on those occasions when he promises to guide them in and out of specific stocks on a day-by-day basis, due to some unique market dynamics.
What I wonder now, though, is whether somebody has sued Cramer, and/or his producers, and the show, over some of his recommendations. Was this his attempt at some type of on-air disclaimer?
He makes a point of having run a hedge fund in prior years. How did that venture end up? Other "former" hedge fund managers who come to mind are Julian Robertson, Michael Steinhardt, and, more recently, Alberto Vilas. Unless I’m mistaken, none of them voluntarily retired until they had lost so much money for their customers that they had to close their funds. It doesn’t seem to be a business which many managers leave on account of too much success on their customers’ behalfs.
But, back to Mr. Cramer’s comments on Thursday evening. What came to mind upon hearing his sudden change in attitude was one of his programs a few months back. He was castigating some newspaper writers for criticizing his stock picks this summer. They alleged that his recommendations had performed poorly. Cramer, on the air, countered that the writers in question had missed the programs wherein he, Cramer, had recommended selling the positions.
And that is what piques my interest. If Mr. Cramer on one hand offered his program’s record of his buy and sell recommendation as a basis on which to judge his selections, how can he now allege that when he says “buy,” or, presumably, “sell,” on his program, he does not really mean that at all?
Not that I take him seriously. I am an equity portfolio manager with a completely different style than Cramer’s. When I tune in, it’s for entertainment. And perhaps to keep an ear open for the opinions of someone with whom I typically disagree, just to test my own reasoning.
His description of what he means by “buy,” the other night, however, reminded me that there is a big difference between making “lightning” fast recommendations on the air to viewers who call in, and actually managing a real portfolio with real positions. One seems to be for entertainment and ratings. The other is to make real money.
Watching Mr. Cramer last week brought back a memory from long ago. Does know what ever happened to a short-lived market guru from long ago- Joe Granville?
What has occurred to me regarding GM, though, is that this fallen automotive giant is still considered sufficiently potent, when it comes to spending money, that nobody will speak the truth to its power. Perhaps the best example of this was the reaction to today’s agreement between GM and the UAW which will lower benefit expenses for the latter.
Truly, as I have written in a prior post, this is simply not the company’s salient problem. GM cannot and does not design and produce vehicles which sufficient numbers of people will buy at prices which will sustain the company’s financial health. Period. It’s beyond me how lowering the cost structure of an inept designer and marketer of cars and trucks will suddenly create better designs.
You would not know any of this, to judge from the press’ reaction to the agreement. Or Wall Street’s reaction, for that matter.
I now wonder if GM, even in its last acts as a sustainably profitable enterprise, wields enough financial leverage to silence any significant, honest appraisal of its situation.
Do analysts worry that they will be shut out of conference calls if they point to GM’s revenue problems as insoluble? Do the bankers worry that they won’t get invited to participate in any subsequent last-ditch financings? Do the various media outlets worry that they will have seen the last GM ads in/on their medium, should they report candidly about the company’s prospects? Perhaps fund managers are concerned that candid remarks will lose them possible business with GM's pension funds or treasury functions.
It’s now beginning to seem to me that all these parties, “stakeholders,” if you will, literally have more to gain from a fatally bleeding GM than they do from a merged/acquired/failed GM.
Wednesday, October 12, 2005
As I sat composing this post in my mind this morning over a cup of coffee, I was gratified to learn I am in good company. Before I could reduce my thoughts to writing, I heard both Alan Greenspan and Mario Gabelli refer to recent events in the US business world using Joseph Schumpeter’s famous phrase, “creative destruction.” I guess that puts me in good company regarding the framework with which I observe and interpret the current foment in US economic activity of many types these days.
This week, we see the markets digesting:
-Delphi’s Chapter 11 filing
-GM’s fallout from the Delphi filing
-Fed rate increases affecting home building
-Energy prices affecting retail spending and inflation
-Conventional telephony providers being potentially upended within a few years by VOIP from cable providers using wifi distribution
-Cable providers being potentially upended within a few years by dsl-based video services from telephony providers
-Airlines continuing to struggle with mismatches of cost structures and customer demand
-Yahoo, Google, eBay, TimeWarner and Microsoft all reaching outside of their main lines of business to either form alliances or enter new business lines
Is this unbridled chaos we see in both the US equity markets and corporate operating environment? Yes, and that’s a good thing. This is what full-on Schumpterian dynamics, of which creative destruction is only an initial part, are about.
My own equity portfolio strategy is based in part upon Schumpeter’s theories. In particular, he expressed some valuable insights in several papers which he wrote during the 1920s. These views shaped much of my approach to large-cap equity portfolio selection and management. Creative destruction is actually a very small part of his overall theory, despite it being the best-known part.
First, this “gale of creative destruction,” to use Schumpeter’s own phrase, is a good thing for large-cap equity strategists like me. In change there is growth. The ‘90s, a period of sustained low inflation and favorable economic policies for change, and thus, growth, enabled my strategy to perform up to its potential, both absolutely and relative to the market index I watch, the S&P500. Rather than worry about ailing giants, my strategy’s focus is purely on sustained superior business performance. I have never been invested in GM or Delphi. Microsoft has been out of the portfolio for all of this decade. eBay is no longer in it, either.
Second, the existence of such strong gales of economic creative destruction mean, ironically, that focusing on each immediate event is a mistake. When there is great variability and foment on the economic landscape, that is precisely when it’s better to take longer-term positions, then batten down and ride out the daily storms. No doubt brokerage firms are making a bundle amidst the uncertainty over GM, the airlines, and energy prices. Meanwhile, my own portfolio has remained well-performing, without trading since mid-summer. An earlier post addressed the “addiction” to trading some managers and their customers have, and my thoughts about that addiction.
Seeing the looming demise of one or two airlines, an auto maker or two, and at least one of their parts suppliers, gives me hope for new business models. For growth to be sprouting in other areas which is currently overshadowed by all the hand-wringing over these antiquated companies and their now-outdated approaches to markets and suppliers.
What lessons may be gleaned from all this recent chaotic activity? First, you can’t control these events, so don’t worry about them. Second, look on the bright side- for every “problem,” someone sees an opportunity, and there’s a potential for investment in that opportunity. Don’t confuse the two, and focus on the second lesson.
Tuesday, October 11, 2005
I guess I don’t understand our brilliant Wall Street analyst corps.
GM and Delphi are two of the largest US firms in a very prominent economic sector. Delphi’s spinoff from GM is recent and very public. Both companies’ economic woes have been well-covered in the press, never mind by analysts, for months.
So how can it be that Delphi’s filing could cause a 10% drop on the open of GM’s stock by today’s market close? Isn’t the analyst’s job to divine these things a priori, by dint of her/his superior knowledge, skill and familiarity with the companies and situation at hand? Could the bankruptcy filing really have been that much of a surprise? Even CNBC’s “Squawk Box” reported that Steve Miller, head of Delphi, had explicitly warned of filing for Chapter 11 protection several times recently. This, they noted, was not something he had ever done when leading the turnaround at Waste Management.
It seems to me that this situation, the linked and troubled fortunes of GM and its one-time subsidiary, Delphi, illustrates how poorly the analyst community typically performs. I don’t see analysts as any better at covering this developing situation than the business media, such as CNBC or the Wall Street Journal. It reminds me of the oft-repeated quote attributed to Thomas Jefferson regarding a choice between government with no free press, or a free press with no government.
Give me the media every time.
Sunday, October 09, 2005
Why isn’t the market totally efficient? The topic, and the related, “is the market efficient,” have been the subject of numerous written opinions.
I’ve come to a tentative conclusion this week that one major reason for market inefficiency, contrary to longstanding theory, is that all market participants are not equal in their ability to use, or process, information. Some are simply mediocre, and they generate so much ill-conceived action that it swamps the volumes generated by their more-skilled colleagues.
While I’ve studied statistics for roughly 30 years, it is only recently that this aspect of efficient markets theory occurred to me. It’s as if the theory’s developers forgot one important assumption: not only must information be available to all in order to be correctly and rapidly priced into the market, it must be used with equivalent skill by all participants.
I suspect that much market activity is dominated by the broad class of average, that is to say, mediocre, analysts, money managers and fund allocators. Thus the apparent reason why some investors out-perform the market over time, while most cannot.
The same idea, of course, applies to the companies whose equities many of us trade. It has much to do with why my own approach works.
And, as educational standards in the US have slipped during my own lifetime, it’s reasonable to assume that mediocrity isn’t what it used to be. It’s probably getting even, well, more mediocre.
To be continued……………
Thursday, October 06, 2005
GM’s and Ford’s managements got themselves into the mess they are in, over time, all by themselves. And the mess didn’t start with healthcare costs, legacy or otherwise. It started with building cars for which people won’t pay the manufacturer’s list price in sufficient number to result in profitable operations.
So long as Rick Waggoner and Bill Ford continue to be in denial about this issue, their companies’ fortunes will continue to decline. Using smoke and mirrors to blame the UAW for their respective woes may seem clever. But big labor doesn’t design the cars at GM and Ford. Management does. And management also freely entered into the contracts which have saddled them with fringe benefits they now feel are unaffordable.
I’ve done quite a bit of research on drivers of consistently superior company performances, looking over long timeframes among many large-cap companies. The very best companies consistently grow revenues at high rates. This typically involves both repurchases by customers, as well as an ability to sustain price levels. This type of customer behavior, repurchasing and paying full price, is usually seen when a company adapts its offerings to evolving customer needs over time in a competitively-advantaged manner.
GM and Ford don’t appear to be able to do either one. That’s their real problem. Failure to solve this problem will overwhelm the resolution of any of their other apparent problems, including those involving workforce healthcare. Even if they did get resolution on the latter issue, they still are stuck with a management that continues to churn out unwanted cars that are unable to sustain their sticker prices.
It stems from losing their way with product design. Detroit just doesn’t seem to be able to develop very many new vehicles for which the market clamors in large numbers. And now, it’s ironic that the one class of vehicle for which they can get list, in large numbers, is suddenly losing value faster than you can say “SUV.” With current energy prices, this product class is going to be out of favor for a while.
Judging from where GM and Ford appear to be putting much of their energies these days, I’d say we’re going to be shy at least one major US-based car manufacturer before the decade is out. It may involve a merger among onshore rivals, if Congress is afraid to let so many UAW workers lose their jobs at once through a total financial failure of GM or Ford. But I'm willing to bet there will be one less automotive CEO in Detroit when 2010 dawns.
Monday, October 03, 2005
Then again, the interviews were given while Eisner was still in power. Iger was probably justifiably wary of going the way of many next-in-line or newly-minted CEOs who radically change their predecessor’s game plans while the old boss is still too close for comfort.
Iger is doing some much-needed and laudable thinking about tearing up his business model before it is decimated by forces outside his control. It reminds me very much, by contrast, of my first post-grad school employer, AT&T. The latter never really seriously reacted to its business model’s many threats until it was far too late. From my own internal experience in telecom with AT&T, I can vouch for Iger’s instincts. It’s much better to gut your own business first, your way, losing a portion of your revenues, than to see it siphoned off to competitors and lose far more revenues and customers.
It also reminds me of one aspect of the primary research which led me to create my knowledge base of the operating characteristics of consistently superior companies. Applied for both consulting and equity portfolio management, it provides quantitative descriptions of how consistently superior firms, in terms of fundamental operating characteristics and stock price performance, differ from lesser-performing companies.
My initial inquiry dealt with how long a large-cap company could remain consistently superior. Without divulging proprietary findings, I can say that it’s less than a decade. And at a certain point, the odds of maintaining consistently superior performance dwindle quite suddenly. Which means, in the case of Disney, that Eisner’s value to the company ended long, long ago. Thus, the need for such a radical shake-up now by Iger.
One can examine several US large-cap success stories back over time, and typically find some CEO who stayed too long at the party. Sears, GE (twice), IBM, GM. They all required significant changes after one CEO's business model grew decrepit.
I’m looking forward to watching Iger’s next few years. Maybe Disney will be in my portfolio before long after all.
Thursday, September 29, 2005
However, the reason I'm writing this piece is that Mr. Gomes mentioned the current TimeWarner-Microsoft talks regarding sharing control and ownership of AOL.
Can you imagine Bill Gates and Steve Ballmer settling for less than controlling interest in AOL? Do you believe Dick Parsons wants those two controlling one of his major assets? The one which most seriously derailed his company over the past five years? Why are these two companies even considering trying to share control of AOL? TW has mismanaged it since the merger, yet won't spin it off. Would Microsoft seriously pay billions to run AOL without control? This strikes me as a recipe for further disaster for all involved.
I find the whole idea of these two aged titans, TimeWarner and Microsoft, struggling over control of a faded name in the internet product/market space, to be demonstrative of mediocre management. Both Microsoft and AOL were in my equity portfolio of consistently superior-performing large-cap companies in the late '90s. But neither has returned to that level of performance in this decade. Microsoft became predictable and less dynamic. AOL chose its peak market value, based on consistently superior performance, to unload itself to TimeWarner for a share of the latter's more tangible assets, at least on paper.
Gomes is right to point out that rarely do a combination of lesser-ranked competitors in technology sectors ever dethrone a market leader. That is because second-best tech companies are just that, and no amount of critical mass of their products will make them better than the leaders in terms of features, performance, etc.
It didn't happen in mainframes (Sperry, Univac, Honeywell, et.al.). Nor mini-computers. Nor PCs (how could we forget Carly Fiorina already? Compaq/Dec and HP). Nor software. It is unlikely to happen in online networks.
The prospect should make for some entertaining business news and corporate comedy in the months to come. But I doubt it will create any business which has a chance of attaining the sort of consistently excellent performance we look for in our equity portfolio holdings.
All Politics is Local
First, let’s admit that US Representatives are about the most “normal” national-level politicians of the lot. They have to convince you every two years to let them go back to that hellish job they said they wanted, “representing” you in our lower Congressional house. Sort of like paying to be allowed into a kindergarten free-for-all every two years.
In the pecking order of Presidents, Senators, and Supreme Court Justices, these Representatives are most definitely the least polished, most unvarnished of the political breed. Everybody knows the seamy stories about US Reps from their district. All politics “is” local, and the same “constituent servicing” goes on in every district in every state in the country.
So What Else is New?
So I was bemused to learn that Tom DeLay allegedly was explicit in trading his support of a colleague’s son for a House seat, in exchange for the colleague’s vote on the medicare prescription drug benefit. This was evidently only one of a handful of times that the House “ethics,” and I use the word very loosely, committee has spoken out on Mr. DeLay’s actions.
I’m reminded that Texas has been most generous in delivering this type of political comedy to the nation. Remember Jim Wright’s heavily accented, “I will comply” with the House’s ethics committee’s demand that he come clean on his infamous book-buying-cum-campaign-financing scandal? Or Bobby Baker’s vegetable oil hoax?
By now, I'm old enough to consider the phrase "House Ethics Committee" an oxymoron. Who are they kidding? It's a political club with which to bash the other party's most effective leader.
We Get What We Deserve
Seriously, though, I think the true lesson in the Tom DeLay affair is the continuing stupidity in Washington with respect to campaign finance “reform” and regulation. When will we voters learn that these guys and gals we elect are just using our money to try to hamstring each other with so-called “campaign finance reforms” as they attempt to remain in office forever?
Let’s just admit that money is fungible. What DeLay and his colleagues evidently did seems perfectly sane and reasonable, given funding regulations. They took donations which were apparently illegal in Texas, sent them to their National Committee, and received funds back from said Committee. It may be laundering, but I can’t see how you could possibly write legislation that would make all and only such transactions illegal. If the people we elect to the House and Senate weren’t this clever, would we even want them there in the first place?
A Better Idea
You and I, as taxpayers, would be far better off if the pols we send to Washington would rescind all the current campaign finance laws and replace them with one. It’s a great idea which I read in the editorial pages of the Wall Street Journal during the Clinton years. Simply require that any funds donated to a campaign must be publicly reported, both at an electronic/internet site, and in a paper-based document, within 24 hours. The information required would be the amount, the donor, and the donor’s contact information. Then let the press have at it. I frankly don’t care if the head of the Chinese army donates money to Bill Clinton (wasn’t that rumored during his campaigns?), Tom DeLay or John Kerry. I just want to know about it. It would say far more about the candidate than many of his or her words and actions ever could.