Friday, October 06, 2006

Patricia Dunn's "In"credible Testimony

Here's the YouTube video clip of a part of HP's former Chairwoman, Patty Dunn's, testimony before Congress a few weeks ago.

I love how incredulous Greg Walden, the Rep. from Oregon, is, when Dunn asserts that she thought anyone can just call up the local phone company, request, and receive, anybody else's detailed message unit call information.

It is truly hard to believe that someone who could qualify as the Chairwoman of a major US company would be this gullible or naive.

The Wall Street Journal ran a piece yesterday discussing how Dunn's testimony has already "boxed her in," regarding her recent felony indictment over this case, in California. With this video available, what judge or jury is going to believe Dunn wasn't either lying under Congressional oath, or is lying in court if she testifies and reaffirms her belief about the availability of such private, detailed phone records?

Let's not even get into what happens if she changes her sworn testimony in subsequent legal proceedings.

It's just a very sad commentary on the caliber of senior leadership in large US companies, that Patty Dunn is either without scruples, and lying to cover up her knowledge of the use of questionable tactics by HP to find the board-level leaks, or she is truly so naive as to think your and my detailed phone records can be had for the price of a local call to our landline phone service provider.

Thursday, October 05, 2006

Apple's iPod & iTunes Overhauls: Schumpeter Would Be Proud

Walt Mossberg of the Wall Street Journal reviewed the new lineup of Apple's iProducts and Services in Wednesday's edition of the paper. He notes that, with the advent of Microsoft's Zune, and RealNetwork's Rhapsody, Apple has completely overhauled it's offerings.

Even if I did not own Apple's stock in my strategy's portfolio, I would appreciate the company's very aggressive product/market management.

Given the quickly-shifting sands of competition in this arena, Joseph Schumpeter would be very proud to see how Apple has rapidly cannibalized its own product line, in order to meet new competitive threats.

For instance, they have redesigned the low-end Shuffle, and pared the number of now mid-range offerings of the original iPod, and eliminated the iPod Mini altogether. Through a combination of pricing and product repositioning, the company has made room for new, higher-functionality entries in its iPod line.

It has also upgraded iTunes, the online entertainment content management system which is the companion to its iPod line, in time for the entry of the two new competitors' products.

The vagaries of consumer tastes may result in the loss of significant market share for Apple's products. Or it may result in the firm's continued dominance of the product/market. Either way, Apple won't lose share and growth because it stood still, became complacent, or milked the business.

It's a pleasure to see a leading company, like Apple, do such an admirable job in a key business, such as digital entertainment content, of moving ahead to change the competitive environment while it still can significantly effect that environment, rather than rest, and let new competitors control the terms on which competition will play out over the next few years.

New Pension Liability Effects: Bracing for Negative Shareholders Equity

In a story with potentially large effects on the financial services sector, the FASB recently ruled to require the charging of pension obligations directly to equity. This is, according to observers of the situation, going to result in some major companies having negative equity.

To read more about the changes, you can go
here. To quote from that site's article,

"That means huge liabilities could suddenly drop like a bomb onto balance sheets, putting any deficits squarely in the public view and possibly throwing some lending agreements into question because it may lead to sharp drops in corporate net worth.

Figuring out if any maneuvering is going on won't be an easy task. Investors will have to closely watch companies' assumptions for such things as health care and wage inflation that are used to determine the costs of defined benefit plans, which promise retirees a monthly check and often medical coverage.

For years, companies have gotten off easy by agreeing to such benefits without having to immediately set aside ample assets to cover them. Standard & Poor's estimates that the companies in its benchmark index offering such benefits held assets worth only $1.409 trillion in 2005 to cover $1.870 trillion in pension and other retiree-benefit obligations, resulting in a record deficit of $461 billion."

A Reuters article further noted,

"Investors may see some of the biggest changes in the balance sheets of companies like General Motors Corp., Ford Motor Co., Goodyear Tire & Rubber Co. and Exxon Mobil Corp., which maintain some of the largest U.S. pension and other post-retirement benefit plans.
Automakers, airlines, steelmakers and other manufacturing companies are likely to face the biggest obligations because of histories with unions and legacy costs, according to accounting analysts at Bear Stearns."

Let me note that all of this harks back to one of my
earliest posts, from last September, about the long-lasting effects of the mutually-flawed bargains struck beginning 50+ years ago between American corporate and labor union leaders.

If the companies in question see their stock prices change materially from this FASB decision, then it suggests that the analyst corps was never doing an adequate job of understanding the true financial positions of these companies. If, on the other hand, the stock prices do not change materially, then it suggests that the existing measures weren't really all that useful to begin with, because they were in error, yet still in cited.

Analysts can't have it both ways, can they?

Late last week on CNBC, in an interview with an equity analyst, the first effect mentioned was that of screwing up traditional stock evaluation measures.

My own early work on valuation taught me about the inadequacy of measures such as Price/Earnings and Market/Book ratios, and other point-in-time balance sheet or income statement measures.

Now, it appears that those measures will have a permanently disjointed history that cannot be smoothed or calculated away. Furthermore, their future behaviors may now result in calculation-inhibiting values. This was always the case with using earnings, which can dip below zero, making growth calculations effectively insoluble. Now, even some balance sheet staples like basic Shareholder Equity will be unusable.

This is why I use simpler scalers with a time dimension in my analysis of companies' performances. Specifically, revenue growth and total return. No ratios.

I learned years ago, grappling with the more conventional ratios and snapshot measures, that they are subject to incomprehensible results, and, sometimes, literally incalculable ones.

By focusing on the quantitative expressions of a company's ability to consistently acquire and retain customers, at appropriate prices for the products and services they sell, i.e., revenue growth, and matching these values with investors' judgments on the adequacy of the resulting financial results, i.e., consistently superior total returns, my methods free me from the risk of accounting distortions.

Rick Santelli of CNBC Gets Even Smarter: The Impact of Derivatives On Spreads

This morning, as I was reading the Wall Street Journal and watching CNBC's Squawkbox, Rick Santelli was debating the recent confusion in the debt markets regarding inflation, interest rates, and economic growth.

Joining the debate were Joe Kernan, Steve Leisman, the show's under-educated 'senior economic reporter,' and a guest host.

Kernan is always a level-headed, sensible, and smart commentator. Leisman is typically self-impressed, and blind to his own lack of basic economic education.

Santelli, the network's Chicago-based reporter from the options pits at the CBOT, is among the most intelligent, informed, educated, and plain-spoken bond market reporters that I have ever seen on television. Bar none.

This morning, Rick gave the most lucid example I've ever heard of how the existence of credit derivatives affects, and has permanently affected, bond market spreads. He explained how, when one can buy protection for the drop in value of a bond, it necessarily puts upward pressure on the price, because the lowest value it can now attain is much higher than it otherwise would be.

He then went on to note that many people have missed this important development in the bond markets. And that even Fed officials might be misinterpreting the meaning of the now-closer spread relationships, versus their historic wider margins.

Leisman asked, to paraphrase,

"can it now be that, and I don't really understand this, that the bond markets are existing on one plane, setting rates, and the Fed is on another plane, or level, with its rate setting views?"

Santelli responded that, yes, the two might not agree contemporaneously, but in time, would gravitate to the bond market's view. Kernan laughed, and Leisman sort of looked puzzled, which was to be expected. But Santelli clearly meant that, over time, the closer spreads for yields between various debt instruments are here to stay, and the Fed will have to adjust to this. The money markets will overwhelm the Fed's interest rate manipulations every time, until the Fed takes the market's judgments into account.

What really impressed me is Santelli's matter-of-fact command of bond market reality, and its impact on economic theories that others believe are governing that reality.

He is one CNBC correspondent who I could watch all day, and probably never feel I'd learned everything I could by listening to him.

Wednesday, October 04, 2006

Monday on CNBC: The Conflicted Trader

I saw interviews with two 'traders' on CNBC Monday morning which yielded diametrically opposite views

First, Art Cashen, the florid-looking mossback from UBS, said that interest rates and Bernanke govern the market now. Period. Nothing else mattered.

Then a trader for another large broker was similarly questioned. He waffled on every question, giving no solid opinions whatsoever, except to say 'it all comes down to earnings'

So, there you have it. It's all about interest rates. Well, except when it's all about earnings.

Gee- thanks guys. I didn't think about either of these.

Once again, this anecdote of the conflicted floor traders shows how inane talking to brokers is. For the most part, they trade for clients- insitutional managers, other houses, and large private accounts. For the most part, all the brokers really 'know' is instantaneous order behavior.

Of course, they like to personify the 'market' because it adds presumed value and glamor to a business going totally electronic. Seriously, how can "the market" really know or care about the level of a single composit index, and truly behave differently as that level's old, nominally-valued maximum is exceeded?

One thing the piece did demonstrate- it takes different views to make a market, and even interviewing only two brokers already did that.

Tuesday, October 03, 2006

Professional Fund Manager's Erratic Behaviors

Saturday's Wall Street Journal featured an article about a Lehman fund manager, Jon Brorson, fretting over the recently monthly performances of the market indices, his fund, and what can be gleaned of US economic activity.

The article states, in part,

"Mr. Brorson's worries served him in May. Then, he shifted toward "defensive" companies whose sales tend to hold up in all kinds of economies, such as drug makers, food producers and electric utilities. His May move was gutsy -- and right. The Dow got to within 81 points of its record and then fell 8% into July.....Now, as it rises, he's fighting the trend again. .... His travails over the past two months show just how hard it is even for dedicated pros to call the turns. It's especially hard at times like these when investors are debating whether a shifting economy will change stocks' direction."

I see in this echoes of 'the broad market has it wrong' attitude, as he holds and waits. In fact, I can identify with the sentiment.

However, I also note how Brorson makes snap calls on fuzzy, unclear economic information. In effect, betting on the come. Then people judge his guess for the month.

If this is really the stock in trade of the average fund manager, I wonder how any of them develop consistent track records.

Wait! They don't, for the most part! The number of public fund managers who consistently beat the S&P is incredibly small. Forget doing it every year- even most years, it's unattainable on a consistent basis. Maybe this monthly micro-managing suggests why that is the case?

I would imagine that the kind of guesswork, based upon shifting, often wrong economic insights and confusing data, cannot be sustained for more than, say, a year. That is, if it is just a string of lucky guesses.

For instance, recently, many investors seemed to be worried that softening home prices will drag the economy into recession. However, just a few days ago, the Wall Street Journal carried an article by one of its reporters, Greg Ip, which noted the following,

"The overwhelming majority of mortgage debt and home-equity loans are held by Americans in the upper half of the income range. Households in the top 10% of income hold 42% of the value of home-equity lines of credit."

Thus, much of the risk of real-estate-related bad debt is overstated. This is the type of economic information that seems to go unnoticed or misinterpreted.

It's one of the reasons I don't buy and sell portfolio positions every month. Even supposedly firm economic data can mislead, e.g., the infamous, but nonexistent, spring 2005 "softening." Now, it is the 'recession,' or imminent 'soft landing,' in the face of continued economic data suggesting continued healthy growth.

Jon Brorson's concerns are ones I share. But I just don't see how changing one's strategy and spontaneously attempting to take advantage of a short-term economic will o'the wisp can lead to consistently superior total return performance over the long term.

Monday, October 02, 2006

The Rush By "Old Media" To Offer Online Video

Recently, I wrote, here, about Apple's iTV announcement, and its probably effect on cable TV providers going forward. Subsequently, I wrote about the recent Goldman Sachs media conference, here, discussing the rush of existing content library owners to deals for the distribution of their libraries to any and all digital channels while they still have value.

Then, last week, the Wall Street Journal ran an article in the back pages of the second section discussing the rush by all sorts of companies to offer online digital video now. The piece was entitled, "As Internet TV Gains Popularity, Cable Firms Bulk Up Offerings."

A nice idea, but a little late, as indicated by this line in the article,

"Video Web sites now draw users in numbers that rival those of cable or satellite companies. YouTube, the country's No. 1 online-video site, had more than 34 million unique visitors in August, according to Nielsen/NetRatings. MySpace was second with 17.9 million unique visitors. In comparison, Comcast, the country's largest cable company, has 24 million subscribers, and DirectTV, the largest satellite-TV provider that is owned by News Corp., has 15.5 million U.S. subscribers."

So the hi-speed access that came along with cable-TV has now grown to undercut the latter by allowing free, independent production and distribution of video content which is growing to rival the paid content on the original cable pay-TV systems.

If this situation doesn't demonstrate Schumpeter's visions of creative destruction at the extreme, where a firm's own success creates the undercurrent that hollows out its competitive position's strength, what does?

In this case, though, I think cable companies are myopic. Consider this closing quote from the WSJ article. The source of the quote, Steve Burke, CEO of Comcast, said, in reference to his own idea of

"creating an extensive viewing guide that would aggregate Comcast's TV schedule with online clips and video-on-demand options, giving people a mega portal for one-stop viewing shopping,"

"We're not alone in our aspiration to be that one place."

Now, I think that's the problem with old media's viewpoint.

There is, in my opinion, no "one place."

YouTube is 'one place,' alright, but hardly the "one place." It may not even be king of the hill in another year. That, of course, is the risk a potential acquirer will have to take.

The essential concept of internet-based, free video content sites almost guarantees no single site will be "the" site. Wherever a critical mass of video content may be gathered and offered, a viable site may be created. The company that has really missed the boat on this is, of course, Amazon.

Amazon, with its broad array of storefronts for independent book sellers/shippers, could easily have offered the same type of home to indie video producers, becoming the internet's video 'general store.'

Not anymore. That opportunity is gone, and, with it, Amazon's ability to capture anything beyond "me too" traffic and revenues.

It's simply incomprehensible to me how, having seen the future, a la YouTube, the CEO of Comcast still doesn't "get it," and is throwing money at an attempt to create, much further down the road, an omnibus, ostensibly partially-paid video site, to challenge a free one. Between Comcast and TimeWarner, one wonders if any old media companies will be worth more than a fraction of their current market values in a few year's time.

Kerkorian's Bold GM Gambit

You can't say Kirk Kerkorian isn't a bold poker player.

Friday's Wall Street Journal details his bid to buy an additional six million shares of GM, and plans to perhaps buy another six million. These stakes, if purchased, according to the Journal article, would make Kerkorian the second-largest GM shareholder, with a 12% position.

Although it looked like a losing position this summer, Kerkorian's original investment has now gained about 14%, thanks to GM's recent stock price rebound, on the basis of cutting deals with its unions over buyouts and layoffs.

The Journal piece characterizes the GM situation as becoming a sort of show down between CEO Rick Wagoner, who wants to slowly rebuild the company, if there's time, and Kerkorian, who wants a much faster, thorough restructuring, including a three-way alliance between GM, Renault and Nissan.

My recent thoughts on the GM situation can be found
here. Suffice to say, I don't think GM is a viable performer, in terms of consistently superior total returns, without some sort of outside help or alliance.

Kerkorian is certainly playing a bold game, though. He could take his winnings off the table at this point, and have outperformed the S&P for the period. However, he chose instead to double-up, indicating he's after a much bigger gain, and prepared to invest the time and effort to secure it.

By moving to take a larger position, the betting is that, in the language of his SEC filing, "there should be strong GM board involvement" in assessing potential alliances. Meaning Kerkorian wants to outmaneuver Wagoner's internal attempts to scuttle the alliance, and get it approved by the board, out of Wagoner's direct reach and control.

It's hard to guess what the outcome will be in this case. There are so many options for Kerkorian, and the rest of the GM board. However, I don't recall Kerkorian leaving a situation like this with a loss. If he's prepared to add to his GM stake, then he must feel very confident that he can force the alliance, and reap the gains he expects from a resultant higher GM stock price.

In a sense, he can't lose, in the long term. If Wagoner's alleged "turnaround" really is more than short-term cost cutting, then the shares will rise, and Kerkorian makes more money. If Wagoner is wrong, Kerkorian, as the second-largest shareholder, through his employee, Jerry York, can probably force Wagoner's departure, and proceed with an alliance for GM. The only question at that point is whether or not Ghosn's Nissan is still open to the alliance, or has already tied up with Ford.

Could it be that Ghosn, watching from outside, could now hold off from a Ford alliance, and simply wait Wagoner out, knowing that Kerkorian will eagerly come calling, with less onerous terms than Wagoner has demanded?

It continues to be a phenomenonally interesting end-game for GM and Kerkorian, as the time to demonstrate a believable, lasting reversal of GM's fortunes grows shorter.