Friday, May 18, 2007

Investor Action At Citi

This weeks' announcement that hedge fund investor Eddie Lampert has bought more than 15 million shares of Citi seem to have finally triggered an explicit sense that the end is near for CEO Chuck Prince.

While the company has been languishing under Prince for years, as my various posts (search on the label "Citigroup" for my prior posts) have noted, Lampert's arrival is thought by many to signal that there will soon be action, one way or another.

True, Lampert isn't the largest stockholder in Citi, by far. However, after his radical moves resulting in the takeover of KMart and Sears, nobody seems to think he'll sit still while the stock continues to tread water.

Interestingly, some wags are just now suggesting that the real culprit in all of this is Chairman Bob Rubin. He is alleged by some to have been fiddling around, globally glad-handing while Prince has mismanaged the firm. Thus, a corporate governance issue has been raised, asking why Rubin, as the board's senior guy on station, hasn't done more to move Prince to action, or just remove him.

Either way, the 4% rise in Citi shares on Wednesday, following word of Lampert's investment, would seem to indicate that others are now piling on, in hopes of some value-releasing activity in the near future.

I say it's more than about time. Ideally, Citi needs to be split up into more easily led and managed, standalone units which may more nimbly respond to market and competitive forces in their particular financial service sectors. As a financial supertanker, Citi has proven unmanageable in a manner that performs consistently better than the markt for its owners. Can it really do worse as a number of smaller, more responsive entities?

Thursday, May 17, 2007

More on Cerberus Offer to Buy Chrysler

As the week has progressed, more ink has been spilled over the Cerberus-DaimlerChrysler deal.

As one reads the numbers, it's just appalling to see how Daimler paid around $36B for Chrysler, and is now letting 80% of it go for $7.4B, and paying another $400-700MM in pension topups. Whatever the exact numbers, it marks a stunning end to Daimler's attempt to enlarge its automotive empire.

The Wall Street Journal's Tuesday edition had the requisite article discussing various aspects of the deal, along with a very interesting table. Entitled "Soured Deals," the exhibit reminds us of these gems from the past:

-PennCentral Railroad (1968) ended in bankruptcy 1970
-Revco's LBO (1986) ended in bankruptcy 1988
-ATT buys NCR (1991) spun off five years later for a $4.1B capital loss
-Quaker Oats buys Snapple (1994) sold off with a $1.4B capital loss nearly three years later
-Time Warner & AOL (2001)

I don't have the auto industry acumen that the staff of Cerberus evidently has. Perhaps they see a way to recover value from the weakest Detroit auto manufacturer, despite sector economics that would seem to be beyond the scope of Cerberus' internal management team to address and solve.

Never the less, I can't help but think that this deal forestalls the natural course of Schumpeterian dynamics. It's well understood that this sector has global excess capacity. The obvious high-cost, most excessive capacity is in American auto plants. That would seem to suggest that Cerberus is buying into a losing proposition.

Most pundits immediately rush to discuss the union/labor pension and healthcare cost issues. How Chrysler is saddled with uncompetitive, excessive costs per car that must be trimmed. Nevermind that prior Chrysler management freely negotiated to give these benefits to labor. And union labor leaders freely accepted the IOUs in exchange. In fact, this ill-considered bargain was the subject of one of my
very first posts on this blog.

Perhaps Cerberus is after the combined auto loan portfolios of GMAC, which it already owns, and Chrysler. Then, some pundits argue, there is the tie between Cerberus' auto supply company holdings and Chrysler. But this would seem to actually be a burden, because what Cerberus cuts from Chrysler's buying may hurt its own other units. Of course, once the private equity firm takes its new acquisition behind the curtain of secrecy, there's no telling how the subsequent accounting and cash flows will make the deal ultimately pay off.

Swirling throughout all of this, and, one would think, very sensitive to that last point, is the UAW. How will it know that its members are getting the deal that the UAW believes them to be getting? Will UAW leaders get to pore over Cerberus' books, and comment on its executives' compensations? I just have a very hard time believing that Ron Gettelfinger, head of the union, is going to roll over and give some highly-paid private equity executives benefit and/or wage give-backs that he withheld from Daimler. If he is doing so, does this mark a conversion on the road to Damascus, so to speak, for the UAW? Will it now become sensible and cut its own members' compensation and deferred and accrued benefits, to save jobs?

Again, if so, this is big news indeed!

Assuming the deal closes, what about the product and marketing management issues still dogging Chrysler? It's vehicle lineup was not chosen by the guys and gals on the factory floor. Cerberus apparently cannot simply close dealerships without running afoul of some pretty stringent and expensive franchise law. To me, the union benefits and wage argument for why Detroit can't compete globally has always seemed a convenient smokescreen for the underlying current problem. That is, GM, Ford and Chrysler have consistently made poor product design and marketing decisions for decades. Combined with the legacy of poor labor relations and cost management left by earlier senior managers in the auto sector, the resulting burden seems, to me, just too much to expect the weakest of the three American auto producers to be salvageable.

Then there was the editorial in the Journal extolling private equity for taking a risk on Chrysler, so taxpayers would not, once again, be forced to do so. I guess there is some sort of benefit to this, in an indirect way. But I still have the sinking feeling that Schumpeter would have preferred to see the number three Detroit auto company just close up shop with its current losses, rather than prolong the pain and bleeding.

The fact that the various deals mentioned in the Journal's article, mentioned above, reminds us that, in prior years, other very intelligent and experienced people entered into some ill-advised transactions. Not every sector-restructuring deal ends happily and profitably

If I had to bet, I would bet that the Chrysler-Cerberus deal will not meet the latter's expectations for ultimate profit and disposition of the assets it is buying.

Wednesday, May 16, 2007

Stephen Ross on Behavioral Finance: From the Ridiculous to the Sublime

Last night, my business partner and I attended a wonderful event hosted by the local alumni group of one of his alma maters, MIT. The occasion was a talk given by Stephen Ross, now the Franco Modigliani Professor of Finance and Economics at that august bastion of quantitative learning on the Charles River.

By the way, for what it's worth, the far better University in Boston than its better-known, non-empirical neighbor in Cambridge, which shall go unnamed. The only clue being, the seasons changed, and Summers' gone now.....

Anyway, back to last night's dinner and talk.

For the ridiculous, the evening began with polite talk over drinks on the breezy, brick patio of a pleasant catering facility. We engaged in conversation with another couple, the woman of which was the MIT graduate. Her partner is a recently-retired businessman who has just sold his enterprise. Upon learning of my equity portfolio work, he eagerly began to describe his latest interest- a web-based trading site/system known as WiseTrade. Suffice to say, WiseTrade is to equity investing what 'no money down' home buying is to real estate finance.

What was humorous about the episode is that, while the man excitedly discussed how easy it was to buy or sell green- or red- shaded stock tickers, based upon their appropriately colored-lines on a chart, his MIT-educated partner pointedly asked whether the use of such a program by perhaps thousands of people at the same time might not affect the ability of "the program" to mint money at unheard-of rates?

Now, to the sublime. My partner and I were fortunate in being seated at "the finance" table, with about eight other alumni, and Prof. Ross. We caught occasional wisps of his conversation, seated, as we were, across a rather large table.

If I had been a little more aware, I'd be posting a (admittedly posed) digital picture of Prof. Ross and myself, with me, no doubt, looking pensive as he appeared to be making a sage remark.

As we worked through a very serviceable catered-style dinner, Prof. Ross gave a talk of incredible lucidity, insight, sensibility, and humor. MIT is very fortunate indeed to have lured him to its classrooms and research facility.

As concerns my interests, and this blog, Ross' remarks provided the following insights and reinforcements.

First, he clearly stated his belief that there are many unresearched anomalies in finance. Thus, he noted, simply because we do not know why an anomaly exists, or how it works, does not mean that neo-classical finance does not, or, in time, will not explain why.

To simply throw up our hands and resort to behavioral finance explanations in the absence of any other research is mistaken.

Second, Ross chose the anomaly of closed-end funds well-known pricing at a discount to their net asset value, to illustrate this point. He provided an excellent survey of the phenomenon, prior research, and conclusions by other finance academics. He then described his own simple, sensible hypothesis, and subsequent research which confirmed his hypothesis.

It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.

Third, and perhaps most important, Ross remarked that, in his opinion, the best research into various anomalies typically is not overly-complicated, nor dependent upon 'fancy statistics,' but, rather, usually involves sensible ideas and relatively straightforward quantification of the phenomenon to resolve the apparent anomaly. Higher-level math or complicated statistical models are not necessarily indicative of reliable research, in his opinion.

Fourth, he consistently focused on the fundamental neo-classical contention that returns and risk are linked. Excess, or unexpectedly high returns, are invariably linked to added risk, whether that risk is explicitly known, measured, or described.

In that vein, during the post-talk Q&A period, he fielded my question regarding the newly-developed dividend "index" funds by Jeremy Siegel, now allied with Wisdom Tree funds. His thoughts are that one can construct many different weightings for funds, which he pointedly did not call "index" funds, which outperform classical indices such as the S&P500. However, when such constructed weightings lead to higher returns than those of indices, he attributes the excess to unrealized risks inherent in the constructed portfolios. As such, he effectively said, without engaging in any personal comment on Siegel, that the dividend-weighted index funds owe any above-average returns to risks which they seem not to have yet identified.

Finally, in a review of various other 'schools' of finance theory- behavioral, physics, and biological, he stressed two of the hallmarks of neo-classical finance that remain important. One is the field's clear-cut theory of efficient pricing of risk and information in markets. The other is its ability to quanitfy effects, which, specifically, he believes behavioral finance cannot. He likened behavioral finance, with its focus on overall behaviors of investors, to economics, rather than finance. That is, as a professor of both, he noted that economics is concerned with average behaviors of many market participants who effect prices, whereas finance is concerned with behaviors of a few 'sharks' who ferret out and capture price and risk inconsistencies, at the expense of the many who are not similarly motivated or informed.

I came away from Prof. Ross' talk feeling that my own proprietary equity research, and the conclusions resulting from it, on which my equity portfolio strategy is based, are on very solid ground. According to Ross' views, I have identified a heretofore unrealized anomaly which may well continue to exist for decades. Due to some of the specific ways in which I classify and measure various attributes of stock performance, there may never be many, if any, other finance researches who identify precisely the type of return opportunities which I have found. Further, the research I designed and performed is remarkably simple. I used some fairly straightforward concepts from my quantitative market research background, off-the-shelf point-and-click statistical software, and basic analytical tools to discover the phenomena which I use in my portfolio strategy.

When a finance academic of Stephen Ross' caliber provides me with information and insights which dovetail with my own work and methods, I feel reassured and confident in the strength and longevity of the underpinnings of my equity portfolio management approach. While it is theoretically possible for all anomalies to eventually be reduced to understanding and, perhaps, eliminated, in practice, it's not possible. Further, as Prof. Ross pointed out with several examples, often times, explaining the anomaly does not eliminate it. It simply provides the reason why the particular investment approach works as it does.

As I told my business partner, it was a dinner well worth whatever he paid for it.

Tuesday, May 15, 2007

CBS Tries Another Online Strategy

Monday's Wall Street Journal carried an article discussing CBS's abandonment of its proprietary website for video content. I last wrote about this topic here, in February. That post referenced my earlier piece, here, in October of last year, wherein I discussed Comcast's attempt to become the megaportal of the web for video.

While a worthwhile article to read in its entirety, here are some salient passages from the Journal piece,

A year ago,
CBS Corp. announced the creation of Innertube, an entertainment channel on designed to make the company a player in online video. It streams video of sporting events, news reports and reruns of shows such as the hit comedy "How I Met Your Mother."
CBS's new chief Internet strategist now jokes that the Web address for Innertube should be ""

CBS, after a year of experimenting with various Web initiatives, says that forcing consumers to come to one site -- its own -- to view video hasn't worked. Instead, the company plans to pursue a drastically revised strategy that involves syndicating its entertainment, news and sports video to as much of the Web as possible. It represents a stark departure for the TV industry. Most of CBS's major competitors, including
Walt Disney Co.'s ABC, General Electric Co.'s NBC Universal and News Corp.'s Fox, are to some degree all betting that they can build their own Internet video portals.

"We can't expect consumers to come to us," says Quincy Smith, the president of CBS Interactive. "It's arrogant for any media company to assume that."

Joanne Bradford, chief media officer of MSN, says advertisers would be served better by buying online ads directly from Web sites rather than buying Internet packages offered alongside their upfront TV deals with the networks. "I'm a little irritated that the networks have put together a digital package that lets a marketer check a box and isn't as robust or deep," she said at a conference last week for advertisers in Seattle.

Advertisers will ultimately decide if CBS's new strategy is the right one. So far, media buyers are positive about the move, although they note that CBS has had troubles implementing some heavily promoted digital efforts in the past. CBS has already signed up major advertisers for its digital network such as
Procter & Gamble Co., General Motors Co. and AT&T Corp.'s Cingular Wireless.

I take two messages away from the CBS experience. The first is a reinforcement of my original prediction that it will be unwise for anyone to plan to create and run the single, most-important media site on the web. YouTube happened more or less by accident. It is similar to EBay in that it hosts the work of others, but does not, per se, create content.

This is why I think Comcast is going to fail in its expensive quest to create a web media hub that is the ne plus ultra of the 'net.

The second message I note is how much what is old is new again. New technology, new empowerment of consumers with respect to what to watch, when, and how. Yet, advertising is still going to pay for all of that convenience.

Funny how that ad model keeps recurring for 80 years now, isn't it? It's followed media advancement from radio in the 1920s all the way to multi-media web video in a new century.

Monday, May 14, 2007

Cheating At Colleges and Grad Schools

This Friday's Wall Street Journal featured an article discussing cheating at Duke University's Fuqua School of Business. It went on to mention the percentage of cheating reported in some other graduate disciplines, and undergraduate programs.

According to the Journal article, undergraduate cheating hovers around 50%. Using a slightly looser definition, Donald McCabe, of Rutgers, found, in research for the Center for Academic Integrity, that undergraduate cheating approached 67%. The B-school average for students who cheat is reported to be 56%. That of other graduate programs is said to be around 50%.

Rather than tackle the moral dimension of this sad situation, a simpler notion comes to my mind.

Does this prominent example of B-school cheating have anything to do with the increasing mediocrity we seem to see emanating from US businesses? Could we simply be seeing businesses increasingly hire graduates who have cheated so often that they simply don't have the skills which are expected to accompany the degrees they have allegedly earned?

Perhaps it's not so much the day-to-day, low-level skills and knowledge, but higher-level applications of that knowledge.

There will always be a few brilliant, driven young men and women who become tomorrow's innovators. Engineering, physics or chemistry students at universities like MIT, CalTech, Carnegie, Stanford, etc.

But what of the mass of middling graduates from so many other four-year programs? And graduate degree programs? I'm beginning to think that many students are so fixated on receiving (already inflated) grades, that they are simply skipping true learning, in order to secure an initial billet upon finishing their degree programs.

Of course, once you're in the work force, as a very wise grad school professor and mentor told me, it's rare people recall the school from which you graduated six months later. If they do, he intoned, you have a problem. Performance is what predominates in the workforce, although, of course, not in every case. Connections, relatives, alumni, can sometimes grease the skids for the somewhat-above, or just truly, mediocre. However, if so many students simply cheat to finish college, is it any wonder that they might not really have the knowledge that forms a foundation on which they, and their employers, can progress and improve?

Chrysler's Latest Rescue

As I wrote in this post in the fall of 2005, I expected at least one of America's Big Three auto makers to have some sort of change of control by 2010. My exact wording was,

"Judging from where GM and Ford appear to be putting much of their energies these days, I’d say we’re going to be shy at least one major US-based car manufacturer before the decade is out. It may involve a merger among onshore rivals, if Congress is afraid to let so many UAW workers lose their jobs at once through a total financial failure of GM or Ford. But I'm willing to bet there will be one less automotive CEO in Detroit when 2010 dawns."

My verbiage was, I suppose, focused on the still-independent companies. My intent was to predict a change of ownership in one of the three, if not bankruptcy.

Today's sale by Daimler, to Cerberus, the private equity group, of its Chrysler unit, in my opinion, qualifies as meeting my prediction.

What puzzles me, though, is how Cerebrus plans to actually operate the weak man of Detroit at a continuing profit, amidst the general consensus about excess capacity in the sector. Sure, they own some suppliers, and maybe even have a few old auto company hands. Does that mean John Snow & Company can turn back the tide of industrial economics in the sector, and restructure and rehabilitate Chrysler's product line, financial situation, and marketing so thoroughly, successfully and quickly as to create value where nobody else could?

We all know that the UAW can break any deal for Chrysler. Or the other two- GM and Ford- for that matter. Whether they can actually make the deal....that's another question.

I have my doubts. So many analysts, including many of today's commentators on CNBC, focus on the labor costs when they discuss these auto makers. But it was the white-collar managers who led GM, Ford and Chrysler to where they are now. I don't think the machinists and assemblers down on the factory floors can remedy those ills.

Of course, once Cerberus gets its hands on Chrysler and drags it behind the impenetrable curtain of its private balance sheet, there's no telling what will come back out, and with what profitability dynamics. I'm eager to see this one come out the other end.