Saturday, February 24, 2007

H-P's New Direction: Software

Last Tuesday's Wall Street Journal reported that H-P is planning to boost growth by bundling its various software offerings, including those of Mercury Interactive, and Bristol Technology.

The software in question is corporate-oriented systems management software. Allegedly, the effort didn't work well prior to this because it was not sufficiently important to merit H-P's full support.

Now, H-P has hired Thomas Hogan, former CEO of Vignette, a software firm, to lead the new effort. Focus is being placed on sales force training and compensation, to facilitate the success of the new endeavor.

Even with all this, I doubt this effort will re-ignite H-P to be a firm with consistently superior total return performance over several years.

First, while Mark Hurd has led H-P through a recovery from its malaise under Carly Fiorina, I don't think that the firm has, by any means, locked up the consumer laptop and personal computer market. It has enjoyed a short-term bounce in its stock price thus far, but I'm not sure it is poised to continue that consistently going forward.

Second, the Journal article notes that corporate customers are already migrating to online, "on-demand" software services, rather than the traditional type that H-P envisions selling.

Third, H-P is coming to the corporate software market long after many competent competitors have already settled in, such as IBM.

Fourth, there is the issue of credibility. I would think that commitment to a software vendor is a very serious issue, and H-P isn't really much of a presence yet in that world. This could take quite some time to pay off.

Overall, I think this new direction probably won't change the fortunes of H-P, which are heavily wedded to selling commodity computing and related hardware- laptops, printers, etc. Hurd has fixed some of the firm's earlier problems, but I do not think this necessarily presages a return to H-P's former days. As the Yahoo-sourced chart on the left depicts (click on it to see the larger version), over 40 years, the company has had some runs of clearly consistently superior returns. For much of the 1990s, and the early 1980s, the firm appears to have outperformed the S&P500. However, beginning in the mid-1990s, H-P's performance began to revert to average and/or inconsistency.
Over the past 5 years, as shown in the chart on the left, H-P hasn't really outperformed the index until the last 20 months or so. Hardly a long-term return to consistent superiority. Based upon my proprietary research findings, H-P's recent performance is far from sufficient to merit ascribing to it long-term outperformance of the index. Even three years of relatively high total returns is no solid predictor of consistent outperformance of the S&P.
So, I think it remains to be seen whether H-P can even be a high-growth, long-term consistently superior total return company again, going forward. As I have written in prior posts, creating a successful second act for a technology company is a nearly-impossible task to achieve.

Thursday, February 22, 2007

Google & The Networks: Is Content King?

Yesterday's Wall Street Journal featured an article discussing the push back of NBC, CBS and Viacom to YouTube's approach to airing their video libraries. Additionally, Paul Vigna, a writer for Dow Jones, wrote an editorial declaring the networks safe, for now, because content will always be king.

This week's alliance between online video site Joost, and Viacom, is clearly aimed at setting up and reinforcing a competitive threat to Google's YouTube.

Did Google make a mistake buying the best-known piece of online video distribution real estate? Probably not.

Does Google, via YouTube, expect to air all the video content of the networks for free, or just shares of advertising revenues? Again, probably not.

Is Viacom going to get as much viewership for its content at Joost as it has, or would, at YouTube? Once again, probably not.

I don't think the issue here is whether YouTube will successfully deprive owners of existing video content of value for distributing that content directly online at a very popular site. I also think many pundits mistake YouTube as a joke, just full of some home movie producers.

The issue is whether YouTube successfully exemplifies the ability of one or two sites to become so valuable that they will rival the owners of content in importance.

In this regard, I disagree with Mr. Vigna. I don't believe the networks have much time to build any proprietary online distributions sites. YouTube is already pervasive. Why won't some creative production team approach YouTube directly for a distribution deal, and never even stop at the networks? Just release content on their own URL, and via YouTube. Or Joost. Perhaps one or two other sites.

What Mr. Vigna overlooks, a la AOL-TimeWarner, is that nobody has successfully owned distribution pipes and content. Either one may be managed successfully, for a time, to provide consistently superior total returns. But it's doubtful any company can provide both and have that performance.

Other content originators suspect a distributor who also produces content. Other distributors suspect a content provider who also owns distribution.

But, alone, the best-run, most creative distributor or content producer can easily dominate their business, and even fight its functional counterpart to an even revenue-sharing arrangement.

YouTube isn't an empty threat just yet. I think it will simply take a little time for the reality of the new, disintermediating online opportunities to fuel the move of content producers directly online. If so, then Google's bet on YouTube will look smart after all.

Wednesday, February 21, 2007

The CIO as Strategy Officer- Again

Yesterday's Wall Street Journal contained an article discussing a new trend toward involving CIOs in company strategy deliberations and formulations. Included in this is an old holy grail of technology/operations management- the commercialization of internal IT operations as a business development function to produce revenue.

"Companies are requiring CIOs to be more thoughtful about strategy," Reynold Lewke, a recruiting partner at Egon Zehnder, is quoted in the article.

You have to read to the end of the piece to get the real message, however. Louie Erlich, formerly just CIO of Chevron, now also VP for Strategy and Services, is quoted as saying,

"The CIO title is misused, frankly. If all a CIO does is oversee tech systems, they should be named a tech manager. A CIO should be enabling a business to grow."

Mr. Erlich's statements seems eminently sensible. It also points up the likelihood that, for several decades now, "CIOs" have, in fact, been over-elevated, misnamed technology and operations managers who have not had a clue as to how to integrate their functions into the support of corporate growth and development strategies.

I saw the first run of that movie at Chase Manhattan Bank some years ago, and it wasn't pretty then. The hoped-for commercializations of internal operations never materialized. Managers were more comfortable with technology, and building walls around their fief, than they were venturing out to support and facilitate business development. That's why so much financial services innovation tends to occur in monoline startups, be they credit card, mortgage banking, hedge funds, or private equity firms.

I suspect that the moral of this story is to watch for some quasi-spectacular failures as corporations try to market their own IT groups' interpretations of how to assemble systems which their vendors are already marketing, right beside them, to other customers.

Erlich's focus on truly broadening the scope of "information" used to facilitate Chevron's strategy sounds reasonable and may potentially lead to more profitable growth and consistently superior total return performance. Trying to commercialize internal IT doesn't.

The New Kraft Foods

Yesterday's Wall Street Journal's Marketplace section featured an interview with the CEO (as of last June) of Kraft Foods, Irene Rosenfeld.

The genesis of the piece is Kraft's imminent spinoff from Altria, and an analysts' conference for Rosenfeld, on that occasion.

By all indications, Ms. Rosenfeld is a capable and sensible businesswoman. What is troubling is the simplicity and classic nature of her prescription for fixing Kraft.

Essentially, she arrived, toured the company's facilities, talked to employees, and conducted ground-level, personal visits to customers and their kitchens throughout the world.

Here's what the Journal had to report,

"Ms. Rosenfeld concluded the nation's largest food maker- whose household-name products range from Jell-O to Maxwell House coffee to Velveeta cheese- had lost sight of how its offerings fit into consumers' lives. Deep cost cutting had eaten into Kraft's product quality, eroding the strength of some brands and causing the company to lose market share. Workers were afraid to speak up when they saw problems.

Today, at an analysts' conference....Ms. Rosenfeld plans to unveil a new strategy to reignite Kraft's growth as it gets ready to spin off from Altria Group Inc. Instead of just selling meal components, Kraft will make more complete meals like prepackaged salads and ready-made sandwiches with its Oscar Mayer meats and Planters nuts."

This all sounds great. Except for one thing. Where was this strategy for the past several years? What was the board at Altria doing for the past five years or so, while Kraft slipped into the coma from which Ms. Rosenfeld intends to wake it?

How sad that a leading brand name in American consumer packaged foods simply lost the salient skill of such vendors- staying close to the consumer and her/his habits and needs. Nearly thirty years ago, when I was a graduate student at Penn, we were constantly regaled with tales from our consulting marketing professors of the various new products and consumer research being conducted at their clients, who were typically large US packaged goods purveyors.

As a little consumer behavior aside, Ms. Rosenfeld refers to something that has remained true for over thirty years. Back in the day, one of my marketing professors, Jerry Wind, related how research revealed that completely prepared foods didn't score as well with consumers as 'mostly' prepared foods did. For instance, instant cake mixes didn't use powdered eggs, so consumers could add fresh eggs and feel that they prepared the cake.

Today, Ms. Rosenfeld relates how they leave the consumer to zap a product in the microwave, to give the illusion of a freshly-cooked meal that, in reality, was essentially already prepared in the box.

Still, while Ms. Rosenfeld seems like the real McCoy when it comes to marketing and new product/growth development, isn't it sad that this conventional wisdom of more than three decades is now required as major surgery on a fallen consumer brand portfolio? This is the true failure of corporate governance.

Why didn't Altria's board ask questions about growth and new product introductions? Why didn't they ask what the impact of the ready-to-eat food assortment at 7-11 had to do with Kraft's demise?

How many tens of millions of dollars do you think were paid to inept, under-performing heads of the Kraft unit under Altria?

Well, the silver lining for me is that, perhaps in four more years, I'll be able to invest in Kraft, when Ms. Rosenfeld leads it to performance that qualifies it for my equity portfolio selection criteria.

Monday, February 19, 2007

Investors, Hedge Funds, and Market Timing

My partner and I were discussing private equity takeovers last week over lunch. It was a continuation of an earlier discussion involving timeframes of various investors.

I was relating some business reporting on these private equity groups looking to clean up and "unlock value," as the pundits were saying of Goldman Sachs last week, in regard to the rumored AMR-BA merger.

It occurs to me that there are basically two kinds of investing: betting on continued excellence, or betting on someone bailing out and fixing a loser.

The latter approach requires at least three assumptions:

1. Someone else will view the poorly-performing asset of which you own a share as fixable
2. The right person/group will come along to fix that asset
3. You will be allowed to realize increased value from the fixing of the asset, or the act of buying it from you (and other shareholders) in order to privately fix it

To me, these seem very problematic and risky assumptions to make, and they must all come true if the investment is to be worthwhile.

It's at least a timing issue, and more. That is, this type of investment is a variation of market timing. The white knight which comes along to 'save' or fix the asset in which you have invested is looking to 'unlock' value and sell, not necessarily reorganize the company for long-term, consistently superior total return performance.

Along these lines, my partner sent me a New York Times article from this past Sunday by Mark Hulbert entitled "A Good Word for Hedge Fund Activism."

Herewith is some of the text of his article,

"WHEN hedge funds buy shares of a company and start agitating for changes in the way it is being managed, they may seem to be gunning for a quick killing at the expense of longer-term shareholders.

But, in fact, the evidence shows that for the most part, buy-and-hold investors ought to cheer when hedge funds jump aggressively into a stock, according to a new study. Titled “Hedge Fund Activism, Corporate Governance and Firm Performance,” it was written by Alon Brav, a finance professor at Duke; Wei Jiang, an associate professor of finance and economics at Columbia; Frank Partnoy, a law professor at the University of San Diego; and Randall S. Thomas, a professor of law and business at Vanderbilt. The study has been circulating in academic circles since the fall.

The authors examined nearly 900 instances from 2001 through 2005 of what they call hedge fund activism. The professors compiled their database in large part from the reports that hedge funds must file with the Securities and Exchange Commission whenever they acquire at least 5 percent of a company’s outstanding shares and intend to get involved in running the company.

Though the professors concede that they have no way to know whether their sample included every instance over this five-year period of hedge funds trying to change a company’s behavior, they write that they believe the sample “includes all the important events.” Included in the professors’ database are not only aggressively hostile actions like threats of lawsuits, proxy fights and takeovers, but also offers to help management enact policies intended to bolster the company’s stock price. Inherent in such cases, Professor Brav said, is an implied threat of hostile actions if management rebuffs those offers.

The professors found that the stock of the average company singled out by a hedge fund outperformed the overall market by 7 percentage points over a four-week period: the two weeks before and the two weeks after the hedge fund’s public acknowledgment that it was aiming at the company. ........If hedge funds did nothing to improve the target company’s profitability, this short-term boost to its stock price would be temporary, and the stock would fall back. But that is not what the professors found. In the year after that initial month of market-beating performance, the average target company’s stock kept pace with the overall market. And over the subsequent two years, the professors also found, the operating performance of the target companies improved markedly.

In finding that the market’s reaction to this type of activism was the rule, not the exception, the professors concluded that the average long-term investor in companies singled out by hedge funds has benefited significantly."

I found this article to be very interesting for two reasons.

First, that the best that could be found for hedge-fund activism, which, for an existing shareholder, is probably better than private equity activism, in which the shareholder loses his shares and all future gains in the company, is a month's worth of outperformance. That's it. One month.

Clearly, these hedge funds are out to "unlock value," meaning, get a quick pop and unload most of the position, a la the Goldman Sachs activity in the airline sector.

Apparently, in the best case, as in the bolded passage, there's a one month outperformance, followed by a year of average performance. The comment about "operating performance of the target companies improved markedly," is code for, 'darn, no more total return effects after that month, but, hey, at least the fundamentals seem to have improved, although without any corresponding stock price gain.'

Second, the authors of the paper, and the NYTimes piece, Hulbert, all consider timeframes longer than a month to be "long term." Even as little as that extra year of average returns is ostensibly good for "long term" shareholders.

Yet, my own research has demonstrated that even for periods as long as three years, there are incredibly large volatilities associated with total returns, such that they are neither predictable, nor reliable.

Further, even I am not a "long term" shareholder. I look for long term patterns of consistency, but I only hold for a period sufficient to suggest I will reliably earn another increment of superior total returns. Holding an equity for years, on the hopes of some sort of magical uplifting of the stock price above the market, is a mug's game.

The paper to which Hulbert refers reinforces my point. One has to be extremely fortunate to already be in an equity which is sufficiently depressed to attract the right sort of attention. Timing has to be down to the month, to really optimize one's gains. Who among us, not managing a hedge fund, is that good at market timing?

I'd much rather identify patterns of consistently excellent fundamental and technical performance, and buy, in the expectation that such above-average performance is causally based, and likely to last just a little longer. That way, I don't need to rely on a somewhat complicated, loose transmission system of poorly-performing equities, white knights, and timing.

It takes discipline to use my approach, rather than simply hoping for good luck and a white knight.

Home Depot & Relational Investors

There were amazing developments at Home Depot last week. According to Alan Murray's comments on CNBC on Monday afternoon, here's what happened.

First, Relational apparently got the Home Depot board to agree to revisit the 'supplier' business which Nardelli and his lieutenant, now CEO, Frank Blake, built and acquired.

Second, in presenting their analysis, Relational allegedly corrected a prior mistake in calculating this unit's ROI. This part is just amazing. So Blake and Nardelli, two exorbitantly-compensated senior executives, couldn't even do the basic math to correctly determine the return to HD of a new business? Can we say "mediocrity?"

Consequently, third, the board is now agreeing to consider getting rid of the unit. Maybe a good idea, maybe not, as some note, because they would be selling 'at the bottom,' the housing sector being as weak as it is just now.

How can the board actually retain a CEO, even a new one, who was responsible for incorrectly providing the basic arithmetic of calculating operating performance for the new business unit, and presenting it to the board? For more thoughts on this, see my
post on MBAs this week, as well as this one on a recent application of a very old marketing management method at GE/NBC. It's easy to see why I am so sceptical of the value of an MBA, isn't it? Somehow, common sense was simply lacking, even among GE-trained senior operating executives. Neutron Jack would be so proud.

Does the Relational Investors saga make you wonder what else is going on at Home Depot that smacks of grade school ineptitude? Not to mention how little spine the Home Depot board seems to have, bending to whomever has pushed on it with the most force most recently?