Friday, June 22, 2007

Blackstone, Schwarzman, & The Tax Code

The current flap over: Blackstone's IPO; Steve Schwarzman's ostentatious lifestyle, and; Congress' intent to modify the tax code to "get" Schwarzman and his ilk, has many interesting aspects on which to comment.

Regarding the Blackstone IPO, my thoughts have not changed since I wrote a multi-part series, part three of which is found here, and this later piece. You can also simply click on the "Blackstone" topic under the Labels list, and read all of my pieces about this firm and its recent activities.

Basically, I suspect Schwarzman is selling at the top. More on this when I discuss Schwarzman's personal issues in the media of late.

Next, as I have frequently said to my partner recently, regarding the Blackstone IPO,

"Why in the world would you be buying, when one of the smartest private equity shops on Wall Street is selling?"

I also said this at the time of Goldman's IPO.

Then there is the little issue of 'fair value' for many of Blackstone's components, as discussed in one of my earlier, linked posts, above.

In summary, the Blackstone IPO essentially amounts to selling investors a limited interest in a blind investment pool. Once I put it that way, most intelligent investors realize that the Blackstone brand name is the only thing that gives this IPO any value whatsoever.

With that observation, let's turn to Steve Schwarzman's lifestyle. The Wall Street Journal and CNBC have run countless articles recently discussing Schwarzman's wealth, income from the IPO, his dietary habits (the expensive stone crabs), his birthday party, that he has a chauffeur and butler, and what tax rates those employees pay, relative to Schwarzman (allegedly higher than their boss).

Rather than comment on Schwarzman's lifestyle, let me try another tack.

Since an investor is buying a non-voting interest in a blind pool, s/he has to trust the judgment of the CEO and senior management of Blackstone. Does Schwarzman's recent behavior cause you to trust his judgment?

Here's a guy who is rapidly becoming the John D. Rockefeller of his era- obscenely wealthy, seemingly arrogant, aloof, and insensitive to the opulent and decadent life he is perceived to lead.

Hardly the poster-boy you want for your brand new equity asset.

Years ago, former Treasury Secretary, former Salomon partner, former WesRay partner Bill Simon was similarly featured in the media as being distant and obscenely wealthy for, come to think of it, being an early leveraged buyout king. Fairly rapidly, (I assume) his publicist set to work showcasing Bill and family's Christmas Day stint serving food at a local Morristown, New Jersey soup kitchen, as well as his many philanthropic activities. Rather than remaining demonized, Simon became more human and caring.

Not so, Steve Schwarzman. He seems to have this 'thumb in your eye' attitude. The comments about not having the slightest idea how expensive his and his wife's lunch of fresh stone crabs was. His frequently-quoted comments about wanting to 'win' at private equity, be the best, beat everyone else.

I think it's relevant that Schwarzman seems to have lost, assuming he had some to start with, any common sense regarding appearing as 'obscenely rich public enemy number one.' Personally, I would not want to own interest in a company led by someone whose judgment is now seeming so clouded.

Think Dennis Koslowski, Michael Millken, Ivan Boesky, et al. Things just seem to go badly when corporate titans wander into the public eye too prominently. None of those companies fared well as their leaders came under scrutiny.

Pete Peterson plans to retire as Chairman of Blackstone. Nobody really knows Larry Fink. Maybe they should gently nudge Schwarzman aside and let Fink become the lower-key, more kindly persona of the firm?

Finally, we come to the tax code aspect. This article describes the current tax situation for private equity partnerships, and proposed tax code changes.

My business partner and I discussed this yesterday over lunch. The reality of the tax code is that it is a collection of special-interest loopholes. Various industries get pilloried, or coddled, depending upon the year, the party in power in Congress, and economic conditions. Think about pharma, oil, 'high tech,' now private equity.

It's understandable that private equity partnerships should enjoy a capital gains treatment of their carried interest in risky buyout-and-turnarounds. However, if that includes paying lower rates on fairly quick payouts of 'special dividends' and operating profits of their owned operating units, then it's less clear that this is 'fair' to begin with.

It's unclear to me, as I write this post this morning, whether or not such special cashflows are shared by limited private equity 'partners,' i.e., investors, or only by the master partners. If it's the latter, then I would have less of a problem with the particular taxation of such income at shorter-term rates.

I don't condone Congress using Schwarzman's personal lifestyle and financial situation as a reason to "get" all private equity firm partners and their wealth. That's capricious, confiscatory, and symptomatic of class warfare. We don't need that. It is, in fact, antithetical to the whole basis of the American Dream- work hard, get rich.

For Congress to decide this month that some people who have succeeded must now be penalized, is extremely discomforting.

By the way, while I'm on the topic, does anyone else recall the last time Congress legislated its righteous indignation at another corporate excess? CEO compensation?

Remember when Congress became so critical of CEOs who earned large cash compensation that they imposed a special tax rate for salaries above $1MM?

The result was to pay CEOs with ....... stock options! Yes, the now-discredited compensation scheme that was spawned by Congressional ineptitude and jealousy.

Fact is, as Lloyd Blankfein, Goldman Sachs CEO, opined on CNBC this morning, tax code changes should be carefully considered by Congress before being enacted. Knee-jerk, envy-based changes will have serious consequences.

What Blankfein didn't explicitly say, but implied, was this. Who do you think is, on average, smarter- the average Wall Street/private equity partnership CEO, or a US Congressman or Senator?

Right. Nobody really smart stays in politics for long. So you have a bunch of basically mediocre, average-intelligence, at best, Congressmen and Senators enacting legislation, to be subsequently outwitted by some of America's most intelligent, best-educated and experienced minds.

The same thing happens every election cycle with campaign finance so-called "reform."

The ill-considered changes in the tax code for private (equity) partnerships will be no different.

Will such changes in the tax code trigger a private equity pullback, and, correspondingly, a public equity market value meltdown? The next market collapse, with attendant domino effect on asset values, buying behavior among average Americans, and, finally, economic recession?

Possibly. If it does, figure on a radical change in the political landscape in the runup to the 2008 Presidential and Congressional elections.

However, my guess is that it won't trigger such apocalyptic consequences. More likely, it will result in a higher hurdle rate for deals, a slowdown in their pace, and a gradual cooling off of the private equity deal frenzy.

However, nobody really knows. This particular focusing event, the Blackstone IPO, is fast becoming the transformational event in the longish journey of private equity firms as they emerge from their shadowy world of truly private activity, into the glaring light of publicly-traded interests.

One final observation. It's noteworthy that, despite the enormous financial and political stakes involved, pretty much everyone is fated to behave in their 'real' fashion, despite how it plays out in public.

Schwarzman is seen as a callous, ruthless financial titan, insensitive to how his actions affect public and political reactions to them. He is fast-becoming the lightning rod for legislative action to punish wealthy capitalists like him.

Henry Waxman appears as the power-hungry socialist he is, attempting to interject himself into the Blackstone IPO process, via an appeal to the SEC, with no basis for it. With any luck, his antics will attract sufficient attention to shift control of either or both Houses of Congress in two more years.

Investors are, even now, at 9:36am, feverishly bidding to own an uncontrollable, non-voting share of a pig in a poke. Sometime further down the road, when the nth private equity partnership sells public interest shares, there will be a fiasco of some sort, and perpetrators will be accused and convicted in the press and Congress long before anyone is indicted and brought to trial.

Some things never change, do they?

Thursday, June 21, 2007

Web Radio Tries To Go Mobile

Monday's Wall Street Journal carried a piece describing how web-based radio is now aiming to go mobile, rivaling XM and Sirius.

According to the article,

"Unlike satellite radio, Internet radio offers the potential for greater personalization without the cost of monthly subscriptions or satellite receivers."

Additionally, it notes that Internet radio uses stored program material which is 'pushed' down to the receivers. That makes it essentially a playlist of songs.

So, unlike XM and Sirius, or most 'radio,' Internet radio doesn't have a "live" component. It's just a unique mix of music, or other program material. Call me old-fashioned, but when I think of "radio," I think of news, live voices/commentary, and maybe some weather and traffic.

Internet "radio" is really just another digital music download method which can play through your radio.

How does this differ from my nearly-limitless capacity iPod?

From my limited experience with Internet radio through my PC, I know it can be soothing and enjoyable to listen to a stream of pre-programmed tunes while working. But I would not envision paying for that type of pablum on a hand-held receiver, or in my car.

Further, using those Internet radio stations prevents me from hearing other audio on my PC.

Unless I'm mistaken, XM and Sirius are, or were, trying to merge, because the market for their services hasn't been growing sufficiently quickly to give their business model a reasonable chance for profitability anytime soon.

Now we have an ostensibly cheaper, less value-added version, Internet radio, which is simply a glorified playlist.

I know there is at least one MP3 player, Sansa Connect, about which I wrote here, that allows 'rental' of music, pushed via WiFi. And I can always buy music for 99 cents per track from iTunes, and use my iPod. With the addition of a relatively inexpensive wireless accessory, or an older-technology cassette-based adapter, I can listen to my iPod in my car.

So, remind me why I want to buy another expensive electronic device, and probably pay a monthly fee, in order to have yet another collection of music, and process to learn. But I don't actually own the music.

As I opined in my Sansa Connect post, perhaps it's just that I'm not the target market for Internet radio. However, it really doesn't seem to add much more to my life than another method of downloading music to a portable digital player. Doesn't almost everyone now have access to a PC, high-speed access, and iTunes?

Who needs Internet "radio," when it's really just another means of playing digital music.

Wednesday, June 20, 2007

GE's & Pearson's Reported Bid for the Wall Street Journal

It's hard to know just where to begin this post. It has so many interesting angles.

To begin with, let's take a look at this Yahoo-sourced price chart (click on the chart to view a larger version) for Pearson, LLC, GE, Dow Jones, and the S&P500 for the past five years. Ironically, of the three companies, Pearson has had the best five-year record of stock price performance (which I'm using here as a quick proxy for total returns), followed by GE and Dow Jones.

Even with Dow Jones' recent uptick in price, due exclusively to the acquisition offer by Rupert Murdoch (discussed here), it still badly trails the S&P. As does GE, despite its recent runup. The latter's price gains, by the way, are confined to about three weeks in the past five years, all of those weeks being in the past three months. If anything, it could well be some institutional investors pre-positioning for an eventual GE breakup.
However, back to the subject of the Dow Jones offer. Last month, I wrote, in part, in that linked post,
"The Dow Jones board's recent Chair has been trying to goose the company's performance, to little avail. My guess is that most investors understand that the old media pond within which Dow Jones lives is going to overwhelm the effects of any one firm's individual efforts. It's time for a more modern media vehicle to properly invest in and use the Journal's brand franchise.

No, the narrow version of the journalistic independence argument won't work for a publicly held company. Maybe if Ottoway and the Bancrofts wanted to take the firm private. But that's not what they want. They want top dollar and journalistic immunity from any economic realities.The likely best outcome for the Journal and the rest of Dow Jones' media assets is to join a modern, global multimedia entity which can leverage their values further than is possible currently, while affording investment in them to retain their current competitive attributes. More than anyone else in media, Murdoch fits this description.

The crocodile tears over a potential loss of editorial independence and a standalone media presence are misplaced. This is about a too-small, old media company which has failed to properly take advantage of its best brands to create shareholder value. It's time for the Bancrofts to put up or sell. Either commit to investing in Dow Jones to enable it to consistently earn superior returns and realize its brand values, or sell it to someone who can."
Seen from this perspective, my own analysis of the recently-revealed GE-Pearson plans for a joint takeover of Dow Jones is as follows.
First, as the Wall Street Journal article published yesterday noted, most M&A deals are done from weakness, not strength. This one is no exception. Dow Jones isn't courting any suitors.
Rather, Murdoch wants the world's premier business print news brand to fuel his multimedia plans for the business news sector.
As such, it's difficult to see what Pearson adds, because it is a print publisher. In fact, according to various sources, its shareholders have rewarded it for reducing emphasis on its Financial Times unit. In fact, it's no accident that Pearson and Dow Jones both lag the S&P. Expensive, print-based business news organizations in the multimedia, YouTube and cable world, are just waiting to be cannibalized via Schumpeterian dynamics.
Now we turn to GE. Where to start? Here's a company that can't get out of its own way to reward investors with consistently superior returns for nearly six years under CEO Jeff Immelt. Now, it wants to form a closely-held joint venture with a European-based company, to merge print businesses.
What flavor of Kool-Aid are they drinking over at GE and NBC/Universal these days? You've got different social cultures, plus business cultures to merge, and a third-party entity to form, answering, one presumes to both parents.
Yeah. That's a surefire recipe for success. What Immelt's merry band can't manage with their own, wholly-owned assets, they will now fix by sharing a completely new business with a third party partner. Oh, and did I mention that the nascent bid is reported to allow for the Bancrofts to continue as minority shareowners?
Yes, that's going to make running or eventually disposing of the unit a lot simpler! Right!
Here's where the part about merging/acquiring from weakness comes in. The only reason GE is doing this is to try to keep The Wall Street Journal out of Murdoch's hands. Everyone knows that Murdoch wants that brand to fuel his imminent cable business news channel. What better brand name to use than "The Wall Street Journal News Channel," or somesuch moniker?
Ironically, whereas Murdoch pledges to invest in The Wall Street Journal, should he buy the parent company, most observers are fairly sanguine about the need for Pearson and GE to cut costs at Dow Jones in order to justify their bid. So not only are the two companies conglomerating an expensive new asset, but they plan to gut it while they attempt to manage it with some sort of trans-Atlantic management structure.
Will GE/Pearson get a credible bid together, and/or win Dow Jones? I have no idea. I will offer this insight, though. If they are successful in acquiring Dow Jones and, thus, The Wall Street Journal, look for it to be a financial non-event, at best, and failure, at worst, over the next decade.
Here's a funny little aspect of media businesses that seems to have escaped everyone. Everyone except, I am guessing, Rupert Murdoch. The key assets walk out of the door each night. Or email their work in from assignments each day.
If GE/Pearson buys Dow Jones, look for Murdoch to spend richly to buy a list of key Wall Street Journal talent, and distribute their well-regarded efforts via his multimedia empire.
Ironically, if GE were to spin NBC/Universal to shareholders, then it could cleanly pursue the Dow Jones acquisition as a media pure play, dispensing with the complexity of the Pearson angle. Perhaps even sell CNBC to Murdoch, and let him have Dow Jones, too, while reaping an enormous profit on the sale.
As with so much Jeff Immelt has touched since he became CEO of GE in late 2001, I think this business move will fail to lift the company's total returns to a consistently superior performance, relative to the S&P500. At best, it will prop up NBC/Universal, which may, when the unit is spun off under Immelt, or as part of a private equity de-conglomeration of GE, fetch a better price. But it's unlikely to be worth the price paid, especially if it leaves the Bancroft's with a say in management or editorial affairs.

Tuesday, June 19, 2007

Yahoo Finally Admits Failures

Yesterday's shuffling of senior officers at Yahoo, beginning with Terry Semel's departure, is long overdue. As long ago as last summer, in this post, I wrote of the company's lack of strategic direction, including Semel's ability to even correctly describe his firm's need for 'strategic planning.'

Since that time, I've written several other pieces about the firm's travails. You can locate the most recent ones by clicking on the label "Yahoo," among the listed topics on the side of the main page of this blog.
As this, ironically, Yahoo-sourced chart displays, the past two years have been abysmal ones for that firm. Especially compared to Google. What clearly meets the eye is how the S&P500 easily outperforms Yahoo, with Google far above it. With its long experience in online businesses, you have to wonder how Yahoo squandered its early brand awareness.
I continue to contend, as I did in this post, from March of this year, that Yahoo has never successfully identified just what it offers that can command a sustainable price in the online marketplace.
Now, Semel has stepped down, and co-founder Jerry Yang has assumed the CEO title. As my partner said, when I mentioned it,

"yeah, that's going to work."

Doesn't it always? Chuck Schwab at his firm, or Ted Waite at Gateway Computer. Oh, right, and another computer maker, Dell, with Michael Dell returning to its helm.

Whether recent-hire, and newly-appointed President of Yahoo, CFO Susan Decker, will actually make a difference, is questionable. Some analysts believe she is only going to need to be open to a sale or merger, in order to effectively discharge her new responsibilities. Perhaps so.
I'm sure there will be lots of press about Microsoft/Yahoo or AOL/Yahoo mergers. And maybe one of them will even occur.
To me, however, the most likely epitaph for Yahoo is that it remained the used car of the online world for too long, wasting its early, premier position in so many nascent areas. Now, I believe Schumpeterian dynamics have overtaken it, rendering it a largely has-been collection of concepts, technologies and online information offerings. If they haven't managed to collect revenues for most of this by now, thus setting expectations of free services, what makes you think someone else can do better without losing visitors, resulting in continued problems achieving profitable growth and, with it, consistently superior total returns?

Hello Atlanta

The Sitemeter counter on the bottom of my main blog page provides me with some rather detailed information. While I never record them, individual IP numbers for each visitor are shown, along with the IP provider, web browser, computer operating system, time, date of visit, length, number of pages read, entry page, and a few other items.

That's how I know that someone from Home Depot's Atlanta HQ visits my blog every morning between 7 and 8AM.

I'm guessing that, due to the stream of posts I wrote about the ailing firm while it suffered under mediocre management by Bob Nardelli, someone in the public relations function is tasked with monitoring my blog, among others which have featured the firm.

It may even be an automated blog crawler, as my partner suggests, rather than a live human.

Either way, this post is for you, Home Depot.

As Nardelli's exit has partially removed the spotlight from your firm, it's quite possible that it may be months before I write about your firm again. Most of the interest was in comparing the egregious behavior of Nardelli with his inability to operate Home Depot in a manner which earned consistently superior total returns for shareholders. Something it actually had done for years prior to his arrival. In fact, in those days, I owned and profited from owning the company's stock. I wrote a post about it, here, last July.

However, if Frank Blake would like to know what I know about what level and patterns of operating performances will increase the probabilities that Home Depot's stock will consistently outperform the S&P500, I'd be happy to share my proprietary knowledge with him.

Although I now use my proprietary research for equity portfolio management, it was, in fact, originally developed as a knowledge transfer product. It has been applied to one large financial institution whose then-CEO is, even now, a well-known figure in US business circles. As I did with that firm's senior executives, I am quite sure I can help Blake and his colleagues understand what sort of fundamental operating performances are likely to lead to Home Depot's return to consistently superior total return performances.

Just post a comment here with contact directions, and we can discuss the matter privately.

Monday, June 18, 2007

GM's Union Negotiations

According to Thursday's Wall Street Journal, GM is once again in negotiations with the UAW to try to solve its profitability problems on the backs of its blue-collar labor force.

I know, it sounds like I'm some sort of Debsian liberal. But I'm not. I actually happen to believe that the responsibility for Detroit's auto makers' mess is management's, not union's.

As I wrote in one of my first posts on this blog, here,

"Why did unions ever begin taking future pension contributions from the companies for which their members worked, instead of cash compensation?

When you think about it, some of those company CEOs of yesteryear were deceptively brilliant. They managed to get unsecured loans, in the form of future pension “obligations,” from the unions representing their workers. No bank would have lent the same sums on the same terms for the same prices. That’s because, ultimately, companies have much more latitude with which to discharge or change their pension obligations in bankruptcy than they have to escape a group of angry, unified, legally-empowered financial creditors in the same situation

In hindsight, “defined benefit” plans of any type or name, public or private, are a clever way for a public corporation or a government to fund operations with implicit loans. For big steel, autos and airlines, as well as other labor-intensive sectors in the ‘50s, ‘60s and later, this amounted to labor union members lending, via unsecured future compensation and fringe benefit promises from their employers, sums of money for which they had no collateral. Financial engineering which puts modern investment bankers to shame.

Where is the expose on the union leaders who foolishly negotiated, on behalf of their members, to accept unsecured IOUs from companies on terms that the companies’ banks would never have lent them the money?"

As I read the Journal article, what I see is further futility in the actions of all parties. Management attempting to close its cost gap with competitors mainly through cutting its employees' compensations. Union leaders breaking their organization into tiers, so that older members get higher compensation, while sacrificing newer workers, to preserve union membership and jobs. A very French-style, Faustian bargain.

Don't get me wrong. I think the union wage scale has remained stuck at an unsustainably high lever, with respect to the value now added in the manufacture of Detroit products. It's just a little sad to watch even the union leaders sacrifice their own members for the leaders' political aspirations of remaining head of a large union, when the number of members should be declining, with the value of output, and the number of employees necessary to create that output.

Looks like business as usual in Detroit this summer, all the way 'round.