Friday, August 25, 2006

The New Investment Banking vs. The Old

Yesterday, The Wall Street Journal had a review of "The Accidental Investment Banker," by Jonathan Knee. I have not read the book, nor do I plan to. This post is based upon the Journal's review, written by Dennis Berman, a reporter for the paper.

I have to say, in my opinion, the joke is on the author. He may suddenly have grasped the crass avarice of investment banking, but I think most of the rest of us in business, over the age of, say, 45, have always known this about investment bankers.

There are two themes to the review. One is about the author's route into the business. The other is the author's apparent embrace of the "old style" of investment banking. This, one suspects, is suppose to have been sometime in the pre-history of time, or at least the youngish author's experience- perhaps the 1970s?

On the first point, let me just say that it confirms something I've long suspected. There's very little actual unique value or talent resident in investment bankers, in general. Much of their eventual value is, like many bond traders, the result of proximity to deal flow and information, rather than their own latent talent, per se. Knee apparently joined Goldman because a friend "recruited" him after he finished some work for UAL. Some recommendation, that, eh? You finish helping gum up a major, failing airline, so you are now Goldman material.

This brings me to the second theme. The trend toward "short term greedy" investment banking started because Knee's employers got greedy themselves, and took their firms public. If they hadn't, the old ways of "long-term greedy" would have continued. But the sector had to provide for the growth it wanted, and partnerships become unwieldy and cumbersome to manage. Basically, investment banks and large consultancies used to function similarly. A few partners got rich billing out Ivy-graduated kids at inflated prices, paying them much less, and pocketing the difference. Witness Lehman's dissolution decades ago over the fight between Glucksman's traders and Petersen's bankers.

As capital and capital markets activity began to mushroom unexpectedly in the early 1980s, investment banks scaled up massively to take advantage of the deal/money flow, and not be left behind as market share midgets. Not only did old wire houses end up as public entities, but so did firms like Salomon Brothers. As this type of growth accelerated, senior partners took their one-time windfall and went public, culminating with Goldman some years ago. In the consulting world, the same thing happened with the old "Big 8." Andersen Consulting eventually became the publicly-held Accenture.

Since public companies can't really have private partners, that model went out the window. And with it, the ability of the firms to internally manage through soft periods with their own plentiful capital. So, welcome to the world of management by objectives, or, as the author phrases it, "short-term greedy."

So it seems that the sector chose to change the way it did business all on its own. Mostly, as is typical with human nature, due to profit motives of the guys at the top who stood to reap fortunes for the one-time conversions from private partnerships to public entities.

But is this necessarily a bad thing? What if, instead of accepting Knee's contention that the old ways were better, we reverse his hypothesis? What if today's mores are, in fact, better? Why could this be so?

Perhaps it is actually better now because everybody has greater liquidity at lower prices. If you, as a private business owner, wish to be "long term greedy," so be it. Hold on for longer, don't sell out. If you are the manager of a privately-held business, don't you still have to earn comparative returns on equity, at comparative growth rates, to merit continuing to run the firm, rather than your owner selling it with the help of a "short-term greedy" investment banker?

If you are the CEO of a public company, it's the same, only simpler. If your total returns aren't up to par, why should anyone give you years to 'turn things around?' Why not allow someone else to pay for the right to do what you can't? If shareholders want to give you more time, fine. If, however, sufficient numbers wish to cash out, why not, again, allow a "short-term greedy" banker to facilitate the transaction?

So, maybe this is all to the good. Everybody is aware of how mercenary, merciless, and amoral, investment bankers are. If they can convince sufficient numbers of shareholders to sell, or buy, a company, or a private owner to succumb to outside offers, who's to say that is wrong?

Maybe "long-term greedy" is, in reality, now a succession of intelligent "short-term greedy" bets? In today's Schumpeterian world of fast-paced technological change, can anyone expect a single sector of company to remain steady and unaffected in its ability to add value anymore? It's doubtful.

Perhaps investment banking's changes, along with those of the parallel universe of private equity, have evolved in such a way as to facilitate faster, more accurate value recognition in our modern financial and technological world.

Market forces are now more easily able to influence decisions such as type of ownership. Chances are, it's a good thing, not a bad thing.

Thursday, August 24, 2006

The New Bell Labs at Lucent: Is Basic Research Really Dead?

Monday's Wall Street Journal featured an article about some major changes underway at Bell Labs, a unit of the soon-to-be-acquired Lucent. The headline is that applied research is in, and fundamental research of the type that made the Labs famous, and won so many Nobel prizes for its staff, is out. Or, at least, greatly diminished.

As I read the article, it occurred to me that, although pure research was a good idea in the era of large industrial utilities, perhaps it no longer is. With such widespread use of many current technologies enabling smaller firms to innovate, perhaps "pure" research is an appropriate relic of a bygone era.

With ample venture capital, seasoned managers and smaller-scale tools, perhaps "pure" research can sprint off the test bench and into application and production so fast that perhaps it no longer makes sense to treat it separately commercially.

There will still be scientists at universities, researching and publishing for tenure, etc. It's not like all pure research is ending.

Rather, a smart scientist with a basic invention can now have a start-up formed around him, including funding, management, and, if necessary, regulatory acumen. Somehow, I sense handwringing for a bygone era that, in fact, was less productive than might have been.

Think about this. Has your life changed at a faster pace, been delivered more valuable innovation, in the last 20 years, or the period from, say, 1950-1970. The vaunted Labs did produce the transistor, and other basic discoveries. But, realistically, who would question that the pace of innovation has increased, not slowed, since the breakup of the old Bell System over 20 years ago that led to this crossroads for Bell Labs.

In fact, I often suggest to colleagues that, if the Bell breakup had never occurred, we probably would be far behind where we are today, in terms of technological innovations such as: cell phones, Blackberrys, the internet, and the now-burgeoning world of video content on demand.

Perhaps what's gone missing is basic research of the kind that shareholders pay for, but for which they fail to see results. I think basic research is alive and well, but its half-life is considerably shorter now, before it's applied to commercial enterprises.

Wednesday, August 23, 2006

Objective Equity Commentary Goes Biased: WisdomTree's New Hires

Last June, I posted a piece on Jeremy Siegel's Wall Street Journal editorial concerning "new" index funds. At the time, he simply noted that he developed them 'with' private concern WisdomTree Asset Management. According to the ad I saw on CNBC this afternoon, Siegel and former hedge-fund manager Michael Steinhardt have joined the firm.

For what it's worth, I recall Steinhardt liquidating his fund because he was having trouble generating performance for his investors, and preferred to spend more time on his coin (?) collection.

In any case, back to WisdomTree. From the WSJ piece back in June, it seemed that what Siegel has decided is that you can decide for yourself what features you want in a fund, tweak some existing benchmark to be more like that, and then call that group a fundamentally-based index. Siegel's apparent objective is to reduce index volatility.

That's nice, but it still misses the point. Indices have as their objective the descriptive measurement of a specific group of equities, usually representing the economy, or a sector thereof.

In fact, what Siegel and his colleagues have done is simply created some new, quasi-passively managed mutual funds. They are trying to position them as "indices" in order, I suppose, to compare their return/risk with an index such as the S&P500, and look better. There's nothing wrong with forming a new mutual fund company and launching a new, cleverly-designed fund approach. But let's not call it indexing, when it's apparently just passively managed.

I guess this means it's the end of Jeremy Siegel as an objective observer of equity markets. Everyone has his price, and WisdomTree finally must have met Jeremy's.

Tuesday, August 22, 2006

Amazon's Marketing Missteps in China

Today's Wall Street Journal's Marketplace section carried a wonderful little piece about a Chinese couple whose online retailing business is beating US giants in China.

The company,, was founded by Peggy Yu and her husband, Li Guoqing. You can read the details on the WSJ website, or in print.

What drew my attention was this gem, about a third of the way through the piece,

"...But equally critical to the success, analysts and executives say, is the ability of domestic companies to understand and adapt to some of the other peculiarities of China's market. Ms. Yu says Dangdang had to make adjustments to the model pioneered by and others. For example, the vast majority of Dangdang's Chinese buyers of books pay cash on delivery- a result of the fact that credit cards are still relatively uncommon in China.....Edward Yu, president of Analysys International, a Beijing-based technology research company, says foreign Internet companies sometimes don't give local managers enough leeway to adapt their businesses to local customs."

Further on, Ms. Yu is quoted as restating a time-honored marketing principle,

"Don't try to change consumer behavior. If consumers don't want to pay with credit cards, then ask them how they want to pay. If they want to pay cash, then figure out a way to get their cash."

Of course, sometimes marketing success comes from changing consumer behaviors. But typically, that is with some technological 'must have,' like a Walkman, iPod, or VCR. And that may involve changing usage habits, not purchase habits.

In this case, it's clear that the local firm employed classically simple marketing concepts. Provide something familiar, books, in a new way, online, with a better value proposition. Taking care of details like payment methods, which Dangdang did not do immediately, made the difference between success and failure.

The article goes on to report that Dangdang's major competitor, Joyo, purchased recently by Amazon, grew sales at 50% last year. Dangdang's grew at a reported 175%.

Some things don't change. Size, as I have discussed in earlier posts (e.g., Starbucks, Intel, GM), can chill innovation and suck in mediocre managers who simply warm seats and "do their jobs."

It's refreshing to see a smaller company apply intelligent marketing principles, work hard, and outperform a larger, duller giant in the same product/market space.

More on Private Buyouts

I've written two posts in the past few months concerning private equity-financed buyouts, found here and here.

According to a piece in Friday's edition of the Wall Street Journal, something I mused about in the second linked post, from June, seems to be occurring already. It seems that VNU, NV, of the Netherlands, which owns the Nielsen ratings service, was taken private only after shareholders organized and demanded a higher premium for the deal. Mind you, these shareholders, some of them large mutual funds, overrode the board of directors' recommendation to accept the initial private equity offer, and extracted an additional 2.5% of the initial offer for their trouble.

According to the article, the premiums on some private equity deals is rising sufficiently to make them unattractive.

On a related note, I saw a fascinating little interview on CNBC yesterday. An analyst with a major commercial bank discussed Microsoft from a leveraged-buyout, private equity perspective.

Allowing that the firm is far too large to effectively be taken private like that, he went on to describe it as an ideal, typical buyout target. It has too much cash on its balance sheet to use productively. Its R&D spending is wasteful, producing little in the way of products or services which are driving total returns higher. And its staffing seems bloated, for the lack of value being created by the firm nowadays.

The only silly comment I heard was, as usual, the CNBC air-head interviewer. She asked how one "would fix Microsoft?"

There is no "fixing" Microsoft. My prior posts, here and here, discuss Microsoft's stagnant stock price and total returns for the past 5 years or so, as well as various mismanagement issues. It's a once-great, now-dormant tech giant, now being run more like a private bank account for Gates, Ballmer and perhaps a few other senior executives, than like a public company.

It's really a shame that this company is too large to be subject to the dynamics of our capital markets. How I'd love to see a one-time union of buyout firms like Texas Pacific Group, Blackstone, Carlyle, etc, to take Microsoft private, like a wolf pack cornering, bringing down and dismembering an aged bulk elk.

Now that would be something to see in the markets. Maybe not now, but perhaps in a few more years, such 'creative destruction' could come to pass.

Monday, August 21, 2006

Ford's Downsizing News: The "Final" Way Forward?

Last October, I wrote this post predicting one less major car company in Detroit by 2010. Yesterday's WSJ piece announcing Ford's "sweeping production cuts" seems to indicate the pace may have accelerated.

With all the hoopla surrounding GM's possible alliance with Nissan/Renault last month, the spotlight seemed to have left Ford. Now, with the former situation apparently in limbo, or dead, Ford's announcement of severe production curtailment puts it back in the limelight.

When I made my prediction last October, a full 10 months ago, I wasn't expecting the recent rise in oil and gasoline prices to cripple GM and Ford so quickly. I was anticipating something slower, more gradual. Perhaps an alliance or merger of Ford and GM a few years out, to consolidate the last US-based major auto producers.

With last week's announcement, though, I think Ford may soon no longer qualify as a "major" auto producer. Not quite the way I expected my prediction to come true, but close enough.

As Ford shrinks, it's reasonable to expect it to be picked up, either whole, or for the better brand names, by another, larger producer.

Between the "Way Forward" plan of some months ago, then the hiring of the outside consultant/investment banker recently, and now the sizable production cutbacks, one wonders how long Bill Ford is for the company which bears his name.

The article in the Wall Street Journal discusses how Ford should deal with the marketing of brands which it honestly doesn't expect to sell very well anymore, such as SUVs and pickup trucks. So, now we have sales of the most profitable autos slowing, no significant new models to take up the slack, a shrinking production base, and continued high gasoline prices probably modifying consumer behavior for longer than Ford has cash to ride out the unexpected changes.

Energy supply doesn't look to grow overnight, and demand isn't looking to slow markedly. Unless it's through a recession, which, again, is bad for the car companies.

It's now looking like, 10 months after my initial prediction of one less major auto company in Detroit by 2010, it may be more like 2008. A little less than 18 months is now probably time enough for either GM or Ford to merge, enter Chapter 11, or be acquired.