Friday, April 20, 2007

Blackstone's "Fair Value" Valuation

Wednesday's Wall Street Journal's Money & Investing section featured an article discussing the method by which Blackstone is valuing itself. The firm, on account of holding non-market priced assets, will use "fair value" to estimate the worth of its various parts.

To quote Charles Niemeier, a member of PCAOB, the accounting oversight board,

"The biggest problem with fair-value accounting is management bias."

Blunt and pregnant with implications, if ever a brief statement was.

The article quotes Mr. Niemeier again as stating that the rule is "bad business" and will "come back to haunt" the accounting rule makers.

Needless to say, Blackstone is keeping mum on the issue. No surprise there. As I wrote recently, here and here, I'd be very careful of being on the other side of Blackstone on any equity deal. This fair value issue explains much of why I feel that way.

Not only is Blackstone allowed wide latitude to account for revenues as it chooses, mixing fees it pays to itself from acquisitions, in effect, transferring funds from one pocket to another, but, now, it also is given wide latitude to determine the underlying value of those assets, too.

When I was at Chase Manhattan Bank years ago, I spent a lot of time troubleshooting our financial information services unit, IDC, in Boston. One of their businesses was providing bond matrix data- in effect, estimating value for infrequently-traded debt by using values from various issues with similar attributes. As the CFO for the business told me,

"Merrill's biased and we're wrong,"

meaning that Merrill, having the debt in its inventory, had an interest in specific valuation biases, while IDC, although objective, was less likely to get the valuation right.

Blackstone is now in the position of Merrill. Its investors are in IDC's position- on the outside, hoping to guess reasonably correctly about the actual value the assets in Blackstone's "poke."

A further complication is touched upon later in the Journal article. It notes that there is a risk of favoring current investors in Blackstone's deals, over new investors, due to the differing information flows to each.

This is a dilemma about which I have written before, and is the crux of why I favor using a 'consistently superior return' over time, rather than instantaneous measures of performance. It's too easy for management to 'maximize present value' when their interest is involved, essentially leaving no additional value to be created from the existing situation for future investors.

This is yet another reason I would be cautious about being on the buying side of a deal, when the seller is Blackstone, and the assets are its partners' interests.

Thursday, April 19, 2007

Yahoo's Disappointing Results

Yesterday's Wall Street Journal carried the following piece:

Yahoo Slumps on Earnings Drop

Shares of Yahoo sank $3.78, or 12%, to $28.31 on the Nasdaq Stock Market. Investors have pushed up the company's stock price in anticipation of Panama, its overhauled online-advertising platform, but Yahoo said the financial benefits of the system won't materialize until the next quarter.

I cannot say I am surprised in the least. Susan Decker, the new CFO, notwithstanding, this seems reinforce Yahoo's inability to pull a consistently superior-performing business out of a collection of various online initiatives.

In this case, the blame is placed on their new ad system. Even if Panama had delivered, does anyone expect Yahoo to overtake Google in this product/market? I don't think so.
As the Yahoo-sourced chart above, comparing Yahoo, Google and the S&P500 demonstrates, the Yahoo has plateaued for the last two years, while Google has outperformed the index from its IPO date.
In this post from March, I discussed how Yahoo had squandered its rich deal with AT&T in 2001, only to have it about to be renegotiated upon its expiration next year. Yahoo failed to use the funds to develop either leadership in the areas in question, or new services which would continue to differentiate it in the online marketplace.
Now, one of the few paying services it has, online ad sales, is faltering as it tries to compete with Google and Microsoft. Perhaps it's time for the Yahoo board to consider replacing Terry Semel, before the only major decision they have left is to whom to sell, or with whom to merge, to salvage some value from the Yahoo brand franchise.

Wednesday, April 18, 2007

Time Warner's Big Cable Decision

Yesterday's Wall Street Journal featured an article in its Marketplace section which reported that Time Warner is seriously considering unloading its cable holdings. CNBC, as it often does, due to its alliance with the newspaper, featured a discussion of the article. At least one fairly on-air-headed anchorperson wagged her tongue about the 'fat cash flows' from Time Warner's cable businesses.

That, of course, misses the point. Public companies are not run for cash flows, because, in a capital market which is liquid, cash can be borrowed. Shareholders rarely seem to buy stocks for dividends, as they did thirty years ago, when transaction costs were exhorbitant. Instead, stocks are viewed with an eye to total returns.

There was one key passage in the Journal article that says it all about Time Warner's situation,

"For years, Time Warner has believed in wedding its movies and television programs to powerful distribution networks- primarily its cable operation- as a way to ensure that their content wouldn't be blocked by rivals. But with the Internet increasingly serving as a home for TV and film offerings, content companies may feel they no longer need to control old-style distribution networks such as cable or satellite TV."

In prior posts, here, and here, plus a handful of others you can find by searching my blog for the term 'Time Warner,' I have argued that old media, as represented by Time Warner and the networks, have ignored the coming, now at hand, disintermediation of broadcast and cable channels by direct URL access.

My post yesterday concerning H-P's entry into the hardware product/market space for this missing link portends just how broad this disintermediation is likely to become- quickly.

Taking all of this into account, I can only marvel that Time Warner has dawdled as long as it has to come to the realization that its cable assets are about to become as 'valuable' as the old Bell System's local copper loops and land lines. Being a common carrier is simply not likely to earn consistently superior returns in the future of direct video content access from URLs on the internet to a TV.
Beyond that, Time Warner's strategy of attempting to own both the distribution and the content was never fated to work well. It never has, and never will. I've written about this as recently as February of this year, here. Essentially, superior content will always find a market. Superior carriage will always command a premium and have supply. Owning a mediocre combination of both assures that, in time, both will fail to provide consistently superior returns.
I've included a Yahoo-sourced chart of Time Warner's past five-year stock price performance, compared with the S&P500. It's pathetic. The firm's stock price has ended up essentially flat, having plunged early on, plateaued, then rose, and now sunk again. It has woefully underperformed the index over the period. It's hard to believe the firm's senior management and/or board has been attentive to its long term prospects.
The Journal article alleges that the two-pronged strategy involving holding cable assets is CEO Parson's preference. That figures, since Parson's has pretty much bumbled the management of the combined Time Warner-AOL since he took over from Gerald Levin. Parsons is a lawyer with no evident grasp of business strategy.
Thus, it's no surprise that Time Warner might be as much as five years too late in exiting cable systems and using the resulting funds to buy into online properties at lower prices than today's.

Tuesday, April 17, 2007

HP's Entry Into Web-TV Integration

This past weekend's Wall Street Journal featured Mark Hurd, H-P CEO, as its customary interview.

It's a nice piece, and Hurd seems like a fine CEO. But what really drew my attention was this little passage,

...Hurd points to H-P's new MediaSmart HDTV, which can receive entertainment directly from a PC, as a glimpse of where the company is headed: "to integrate content across the home, whether it's emanating from the Web, from satellites, from cable, or the PC, and bring that to the consumer's touch."

Then Hurd reportedly said that he'd 'probably just told you more than I should have...'

This pretty clearly positions H-P to be in the running, with Apple and TiVo, to market the missing link in video content for the home. That is, the server with wireless access to high-speed cable,, and wired delivery of downloaded and stored content onto home video devices, such as television screens.

In this respect, H-P is certainly morphing itself from a collection of old, force-fit computing platforms (DEC, Compaq), into a competitively-positioned, modern technology-producing device manufacturer. H-P will probably never be the Windows-based equivalent of Apple when it comes to novel and beautifully-designed digital devices, but it seems to be heading toward that ideal under Hurd.

This is great news for consumers, and uncertain news for investors. Were Apple to have had the AppleTV space all to itself for an extended period of time, its investors would probably be ecstatic. The way things are shaping up, though, it looks as though at least TiVo and H-P are going to be joining in, with who knows how many other solution providers on their collective heels.

Does this not bode well for: rapid technological advancement in the product space, falling prices, and ever-wider distribution points for the devices? Perhaps they will be the coming years' equivalent of large, flat-screen TVs for the big box electronics retailers?

Time will, of course, tell all. But personally, I'm excited to see so many technological resources being poured into this rather obvious 'missing link' device space. It should speed the demise of cable companies, push the creaky old media video content owners into a final solution, and provide, at last, a nearly seamless way of acquiring, storing and viewing/consuming digital video content.

Seeing as how I mentioned the cable companies' upcoming dilemma, and noting today's Wall Street Journal piece concerning Time Warner's deliberations on that business, I will write about that tomorrow.

Monday, April 16, 2007

From The Files: Edward Prescott on 'Competitive Cooperation'

When it's been a slow couple of days for business strategy or equity markets news, I often turn to a pile of choice articles I have saved from earlier editions of various business publications.

Today, I want to touch on an excellent piece by Nobel Laureate, and periodic Wall Street Journal contributor, Edward Prescott. Back on February 15 of this year, Prescott wrote about 'competitive cooperation,' with the just-turned-50 European Economic Union, the product of the 1957 Treaty of Rome.

Among the many pieces of economic data Prescott cites, these are some of the most compelling. The original six Common Market countries progressed from having a productivity level that was 55% of that of the US, to having achieved rough parity twenty-five years later. However, three countries which did not enter the pact- Denmark, Ireland and the UK- but were near parity on productivity with the six in 1957, fell behind. The same trends held true for subsequent signatories to the Treaty in in the 1980s, '90s and this decade.

Prescott continues the analogy by noting the progress made in Australia and its trading partners in Southeast Asia. The glaring laggard geographic area is Latin America. There, Prescott cites the region's preference for protectionism as having predictably 'poor' results and consequences. Specifically, referring to research by some of his Minneapolis Fed colleagues, he writes,

".....from 1950 to 2001, per capita GDP for Europe increased 68% relative to the US; Asia increased by 244%, while Latin America decreased by 21%. This is all the more striking when we realize that Latin America's per capita GDP actually exceeded Asia's by 75% in 1950."

Prescott sums up his article by noting that protectionism's short term seductiveness inevitably has disastrous long term consequences for relative and absolute wealth creation. Getting the flywheel of economic development and growth going is key, and protectionism tends to slow that flywheel down and cement existing economic conditions in place, while the rest of the competitive global economies move forward.

With this point in mind, I will close this piece with a quote from the beginning of Prescott's editorial,

"If the government has any economic role at all, surely, this.......(to protect US industry, employment and wealth against the forces of foreign competition).....must be it. Actually, no. Government has a higher calling in this country...which is to provide the opportunity for people to seek their livelihood on their own terms, in open international markets, with as little interference from government as possible."

While Prescott is understandably vague on the particulars, I'll be more blunt. At a time when the US Congress has been taken over by liberal Democrats, and their economic protectionist and income redistribution agenda, this sage advice is more crucial than ever. It's a big mistake for government to attempt to manage the how of economic activity, in hopes of attaining a collective economic welfare. The names we have historically used for that vary, but include socialism and fascism.

Rather, the US has historically allowed its citizens to determine the organization of economic resources, as well as own them, while simply setting some minimum, and minimally changing, guidelines within which to pursue their individual economic welfares. If we depart from that history to any great degree, thanks to the current Democratic Congressional agenda, I fear that Prescott's warnings will ring true in America quite soon.