Friday, May 04, 2007

Microsoft & Yahoo Merge? You've Got To Be Kidding

It's all over the business news today. Microsoft and Yahoo are in formal talks, allegedly via Goldman Sachs, to merge.

The pundits are on the air, waxing eloquently about this putative deal. Per my earlier post, here, nobody whom I've heard has the courage or temerity to bluntly assess just how awful this combination would be.

To clarify, let's state what is supposed to be the obvious: Microsoft and Yahoo have both failed miserably, over the past few years, at competing with Google. The first Yahoo-sourced chart (please click on the chart to view a larger version) demonstrates this. It's a two year view of Google, Apple, Yahoo, Microsoft and the S&P500 Index. Since these are all technology stocks, it's reasonable to view the price chart as a very good approximation of a picture of total returns.

The picture is clear- Microsoft and Yahoo haven't even been able to beat the index over two years, even with the former's pop from releasing the new Office and Vista software systems. Yahoo has actually declined in value. In contrast, Google has been doing much better, with a slight flattening since early 2006. I have included Apple as an example of a transformational technology company's potential performance. This is what one would presume MSFT/YAHOO aims to mimic.

Looking a little further into the past, here's a five year Yahoo-sourced price chart of the same entities. This time, Yahoo looks better, but both it's and MSFT's performances have clearly flattened in the past several years. Neither looks to be an engine of value-creation that is primed to rival Google.

However, to do so, on Google's playing field of online value-added services, several questions need to be considered.

First, doesn't one of the partners usually have to be successful already for this sort of combination to work? Remember the Time Warner/AOL merger? AOL turned out to be more fragile than expected, while TW was stuck in neutral.

In the case at hand, Microsoft still dominates a rather unexciting sector- PC software. Online-based software is the hot item. Oh, right. Google does that already. Meanwhile, as I've written so many times (search my blog for, or click on the label for "Yahoo."), Yahoo is the 'used car' of the internet. It's not a standout for anything. This recent post, just over two months ago, details my views on some of Yahoo's strategic mistakes. With neither MSFT, nor Yahoo in a position of superiority in a relevant product/market which competes with Google, I think this combination fails the test of having at least one partner actually being successful.

Second, why would a merger of these two huge, lumbering companies create more than a more focused, nimbler marketing alliance agreement between the two? The latter would be far more likely to succeed, in my opinion. These two technology giants are already past their prime and too sluggish to have a high probability of combining in a manner that can yield a consistently superior total return performer. The companies are not similar in their product/markets, so there won't be much in the way of cost savings, yet they will spend considerable time and money attempting to mesh and reorganize post-merger. I suspect it is a recipe for disaster.

Third, Yahoo is, in my parlance, the 'used car of the internet.' This is going to be Bill's/Steve's new ride? Hardly an inspiring last act for the software titan. Can't they do better than a bumbling online-oriented hodgepodge of businesses mismanaged by a former entertainment executive?

Fourth, together, these two still probably won't catch Google. It's not about the's about the ideas. Neither has shown themselves capable of generating successful new ideas which have driven consistently superior total returns in the past five years. How will just mashing the two mediocre firms together change that?

Lastly, as one pundit reminded me, there is US anti-trust regulation and the EEC's animosity for all things MSFT. Thus, he felt that perhaps all that will result is some sort of marketing venture.

Actually, that might be a blessing. But I still feel that there's precious little the two can conceive and execute in time to affect Google's hegemony in areas that matter in the next two years.

As a parting view, here's a Yahoo-sourced chart of the five data series over roughly the past decade. While Yahoo is the second-best value creator, it's been sliding for several years, with an overall erratic pattern. Apple, for example, reflects what a radical product/market transformation would resemble, and neither Yahoo nor MSFT remotely looks like this. Instead, MSFT has been flatlining for over six years. Just looking at the chart suggests a dynamism in Google and Apple that Yahoo and MSFT now lack.

If this combination materializes, I will go on record predicting that it will not result in a firm that can regain a pattern of consistently superior total return performance. It will, over time, fail shareholders, relative to their option of simply buying the S&P index.

Thursday, May 03, 2007

Sarbanes Oxley- Good or Bad? It Depends On Your Metric

Now we have a case of dueling studies regarding the effects of the notorious Sarbanes-Oxley Act of 2002.

Robert Grady, a partner who runs the venture capital arm at the Carlyle Group, wrote a long op-ed piece in last Thursday's Wall Street Journal on the evils of Sarbox. In his opinion, it has depressed the creation of small, high-potential, economically desirable smaller tech IPOs. Grady believes that, in a Sarbox world, companies like Intel, Cisco and E*Trade would not have been able to go public. The cost and effort required by Sarbox would have discouraged their IPOs, relegating them instead to being purchased by some larger companies, thus dampening their eventual entrepreneurial success.

On Friday, the Journal published an article about two university finance professors who insist that Sarbox hasn't hurt the US in terms of its pre-eminence as a financial hub. They cite price premiums of companies listed here and overseas, versus those dual-listed in london.

The two authors come to different conclusions because they are measuring different phenomena. However, I think Grady is right. The damage to the US economy results from the manner in which Sarbox strangles innovation and new-company formation. This has been the engine of innovation, growth and American economic leadership since the early days of the space race in the 1960s. Sarbanes-Oxley is threatening to destroy that leadership by hampering the creation of new, young, innovative companies due to its burdensome requirements.

The effect of Sarbox on existing, large-company listings is rather less important. They are not the main engines of continuing US global economic leadership.

Innovation is.

Wednesday, May 02, 2007

Observations on Actively-Managed vs. Passive Mutual Funds

Last Wednesday, Eleanor Laise of the Wall Street Journal wrote an interesting piece in the Money & Investing section concerning actively managed funds.

Typically, actively-managed funds are downplayed by many commentators, because the likelihood of any one fund manager consistently outperforming the market for many years is small. Investors frequently end up chasing last year's hot fund, and good returns, only to, in effect, 'buy high' and 'sell low,' only with funds, rather than individual equities.

Still, as Ms. Laise writes, while the average of actively managed funds may underperform the market, there are a few stellar managed funds in virtually any category.

The article provides some research data, mostly on small-cap funds, suggesting that, at best, perhaps a little more than one in three managers will beat style-specific indices.

However, at the end of her column, Ms. Laise suggests the following,

"Instead of picking active managers based on sector, you should look for low costs and a long-term consistent track record. Since fund expenses reduce returns, lower fees mean managers must clear a smaller hurdle to beat the index."

In effect, she is saying that, while most fund managers cannot beat the market average over time, it's worth finding the few that can, and investing in them. The key is to look for consistency, rather than specific style or sector descriptors.

From a theoretical viewpoint, what Ms. Laise appears to be contending is that, although the probabilities of the average active fund manager beating the index over time is small, there do exist managers who have done this, and their existence means it can be worthwhile to identify and use such managers. So, rather than throw all active managers out and, instead, resign yourself to choosing passive index and sector funds, you can and should find managers who have consistently outperformed the market over many years, and invest with them, not letting the averages blind you to the existence of a few significantly better-performing managers.

Ironically, I would normally agree with the passive fund allocation advice, too. My own equity strategy consistently outperforms the S&P, but I wouldn't invest in most other actively-managed funds, were I not already actively managing equities. Since I already have access to my own strategy, which fits Ms. Laise's description, I'm content to invest in my own, and don't have to go looking for the other few managers who can consistently outperform the S&P500 over time.

Tuesday, May 01, 2007

GE Breakup Discussion Today on CNBC

In fairness to my post yesterday, there was an accidental, spirited discussion this morning on CNBC regarding its parent, GE, being split up within two years.

Guests on the program, fund manager Mike Holland and Andrew Ross Sorkin, of the New York Times, along with CNBC reporter David Faber, began by discussing whether private equity firms are the new conglomerates. All missed the fundamental difference between the operating models.

Faber waxed nostalgically as to how GE has 'operating acumen,' while private equity funds just 'buy companies cheaply and sell them more dearly.' Not quite, David.

In fact, GE has shown an inability to operate its business units in a manner that has drawn investor reactions which result in consistently superior total returns. In contrast, private equity firms buy ailing or undervalued businesses, make necessary changes to increase their value, then, typically, resell them and reap a return for the value they have added.

Joe Kernen then asked why NBC/Universal should not be sold, and nobody disagreed. Fabe's first comment was 'why are you doing this to me,' followed by some mumbling about losing his job. The video of this whole exchange is available today, for free, on CNBC's site, but I won't paste the link, as it will become inoperable by tomorrow.

Sorkin predicted that GE will sell its entertainment unit after the Chinese Olympics, when its value may be at a maximum. Mike Holland seconded Sorkin, and predicted that it was likely to be sold or spun-off at the end of two years. However, nobody went further, castigating Immelt for failing to create value from the various parts of GE. The focus remained simply on CNBC/Universal, stay or go?

So, my hats off to CNBC's Squawkbox for having the guts to discuss splitting up its parent, beginning with the unit of which the network is a part. However, lets be clear- the conversation topic was one comparing private equity to large corporations, and Kernen simply made a sharp left turn in the discussion to toss out the GE situation. But to their credit, the producers didn't cut suddenly to a commercial and end the segment.

Not surprisingly, since last week, CNBC has covered the alleged call to break up CitiGroup more than the CitiGroup analyst's call to break up GE.

Michael Dell's New Thoughts On Direct Sales

The New York Times' writer Damon Darlin wrote a piece on Saturday discussing a recent memo from Michael Dell to his employees. It appears that I called it right last September, in this post, when I bought a laptop from a competitor, HP, at a Staples store, and wrote about why I had checked Dell first, and declined to buy one of their machines. My sense then was that Dell had missed a sea change in computer purchasing among many consumers. Dell's memo, as related in Darlin's piece, supports this.

Mr. Darlin wrote, in part,

Michael S. Dell, the chairman and chief executive of Dell, who built his business by selling direct to his customers, is now thinking about changing the way the company markets its computers.
“The direct model has been a revolution, but it is not a religion,” Mr. Dell wrote in a memorandum sent on Wednesday to 80,000 Dell employees.

It is the first time that Mr. Dell or any other senior executive has publicly conceded that the business model that was crucial to the company’s success could — and should — be altered. Until now, the company responded with an adamant no when Wall Street analysts or customers asked whether the company would consider other ways of selling.

While Mr. Dell’s memo was short on specifics, he also told employees, “We will continue to improve our business model, and go beyond it, to give our customers what they need.”

“We know our competitors drive complexity and needless cost into customers’ environments,” he wrote. He said their “so-called service divisions” create a never-ending buying cycle with no clear return on investment.

“We intend to break this cycle,” he wrote.

I'm not so sure about Dell's last comment. I have yet to call H-P regarding the laptop we bought. It's performed flawlessly. Frankly, I've had far more trouble from my Dell desktop over the years I've owned it.

However, the important point is that, as is typical, it takes the original leader of a cult to allow for directional change. The acolytes, like the Dell employee who commented on that September post of mine, tend to simply, mindlessly, follow and believe the original, received wisdom of the founder.

Whether any of this will return Dell to its years of consistently superior total return performance is open to question. Based upon my analysis of technology-based companies, it's unlikely Dell will repeat its prior return performance, unless it somehow morphs, like Apple, into a much different product purveyor.

If all Dell does is ally itself with one or more retailers, or opens its own outlets, I doubt that will affect its ability to achieve consistently superior total returns. It might raise revenues, but it's still in a commodity products game. And that doesn't look to change any time soon, with or without Michael Dell.

Monday, April 30, 2007

More on Speaking Truth To Power

Back in the first month or so of this blog, in the fall of 2005, I wrote this post predicting severe, near-bankruptcy conditions for at least one of the Big Three Detroit auto manufacturers.

Shortly thereafter, I wrote this
post, wherein I asked,

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.

Last fall, when I bought a new laptop for my daughters, I wrote this
post discussing why I didn't buy one from Dell, and why I thought the company had seriously erred in keeping its business model current. That post garnered a reply from a Dell staffer admonishing me for my comments, and assuring me that the direct sales model was alive, well, and prospering!

It's taken until this past week for Michael Dell himself to announce that maybe the direct sales model needs to be revisited at Dell. In the interim, there wasn't a whole lot of criticism of the firm, other than it changed CEOs. Perhaps the word "gingerly" describes the business media's attitude toward the struggling computer maker during this time of poor performance.

I've written about GE's need to be split apart, back in August of 2006, but it took until last week for an analyst to have the courage to suggest the same remedy. Even then, he's been doubted by most other pundits, or just ignored.

As I discussed this with my partner yesterday, we came to the conclusion that this is simply the result of the structure of business media.

For instance, my partner noted that, because politicians crave coverage and publicity, commentators, analysts,, think nothing of savagely attacking them. In fact, they are paid to do that. The more detailed their criticisms of politicians and elected officials, the better. Their targets don't have enough money to really affect the media covering them, and, besides, the politicians have to have that coverage.

Not so in the business world. Because most business media depend upon advertising revenues, large corporations wield an important, potent weapon. By withholding advertising, as well as refusing to grant interviews or access to events for members of an offending publication, broadcast or cable network, large corporations seem to be relatively immune to honest, factual, blunt criticism.

As my recently-added link to my prior predictions illustrates, there are several instances in which the signs of trouble were obvious for some time (GM, GE, Dell), yet the business media refused to report on the issues.

In GE's case, it's actually laughable, because the company owns CNBC. So when David Faber tried to soft pedal the Citi analyst's report on the air last week, he looked ridiculous. While noting GE's flat performance under Immelt, he never the less alleged that 'some people would say he (Immelt) has actually performed better than his predecessor.' Ha! Who, besides Immelt and his board, believes that?

It seems to me that, anymore, the only really trustworthy business coverage is that which does not require corporate target spending (on, e.g., advertising, consulting, brokerage, underwriting, etc.) to exist. Like....well....blogs!

However, if you are waiting for Wall Street analysts, media columnists, or business television network reporters to break major stories, before the fact, about serious problems at many large companies, don't hold your breath.

A New Link to Old Posts

In light of my correct prediction on the structure of Harman International's buyout, noted in this post, today, my partner suggested that I begin to catalogue the cases in which I have been prescient on some issue or company event.

Thus, I've added a link entitled Early Trend & Issue Identifications In This Blog to my link list on the right of the main page. In this post, which, for my own convenience in locating it, I have dated as the first post of the blog, from September, 2005, I will list the issues or topics on which I wrote a clear prediction or conclusion, and the corresponding date and nature of the same realization in the market at large, or among other published pundits/analysts/CEOs, etc.

Harman's Buyout Structure Follows My Proposal

Friday's Wall Street Journal piece on Harman International's (the old Harman Kardon) proposed private equity buyout echos my own concept of offering current shareholders a chance to remain as passive owners on the same terms as the buyout group. I wrote about it here, last August, in the wake of the Kinder-Morgan buyout. At the time, my theme was corporate governance.

My partner and I discussed this, and he wondered aloud why this structure has appeared now? Surely, he said, outfits alike KKR and Goldman must have kicked this around for years.

My sense is that, with the recent publicity accorded buyout firm CEOs like Steve Schwarzman (of Blackstone), there is a growing fear of some sort of regulatory backlash. The last thing Blackstone, TPG, Silverlake Partners, Bain, KKR,, need now, is for a Democratically-controlled Senate Finance Committee to legislate curbs to their buyouts, or attach deal-killing 'protections' for current shareholders.

Thus, the harmless, and even secretly helpful, tactic of allowing current shareholders to remain, at a discounted percent ownership, and with complete passivity (i.e., no voting power), to share in the flow of post-buyout gains, while contributing their capital in the bargain.

In truth, this allows the shareholders who remain to experience the best of what I informally call 'corsair capitalism.' I wrote about it here, in February. My closing thought in that post was,

"Now, for a prediction as to a form of solution which may develop. What is to stop private equity firms from issuing securities of participation in their ventures, in small denominations, as limited equity partners? Would not brands such as Texas Pacific, KKR, and Silverlake command a premium in the market? By attracting investor capital to their privately-held efforts, these partnerships could effectively begin to drain capital from poorly-run public firms, and then slowly, inexorably, pull them into the private equity world, where the value they add would accrue to the small, limited partner.

Truth is, the worst part of the structure of today's publicly-traded firms is that the board-CEO governance mechanism mitigates against the effective management of the firm for consistently superior total returns. Read Murray's passage quoting Mr. Conde of Sungard. Conde essentially says that he could not run the company 'right' in the public markets. So the small investor has no chance, currently, to enjoy the fruits of really top-notch corporate management or governance.

Maybe they'll get a break, when some of the better private equity firms begin to add investment vehicles for the smaller investor."

Perhaps, going forward, the price for some of these buyouts will come down, when existing shareholders realize they can effectively sell the firm's governance to a top-notch private equity group, and reap a decent share of the resultant gains.

My guess is that the Harman buyout structure marks the first instance of what may become a saving grace for the private equity sector, and the beginning of a significant new form equity investing.