Friday, September 14, 2007

The Future of Streaming Video

The Wall Street Journal's guest column, '', had an interesting, if misguided piece on the future, or lack thereof, of streaming video.

Robert Cyran, evidently someone connected with the firm/website, writes in today's column that Netflix, among others, is pursuing the wrong technology/strategy, by concentrating on delivering video content via streaming.

Cyran argues that with download speeds allowing storage of a movie in only 20 minutes, more people will buy movies, rather than just view them via streaming. He cites the migration of audio from streaming to the iTunes model as further evidence that streaming can't compete with storage/ownership, once bit transfer rates are sufficiently high.

I think Cyran is dead wrong. Here's why.

First, most people whom I know, other than children, which is to say, adults, don't watch a movie very frequently in a short space of time. The desire to own a movie for frequent viewing is, I contend, not all that common.

However, music is different. We take our favorite music with us everywhere on iPods and MP3 players. I have listened to some songs, I'm sure, many hundreds of times. And will hundreds more. So I own that music.

At the iTunes store, I buy tracks, rather than use alternative systems which make me pay monthly to store rented audio content.

Thus, I contend, the audio example is not relevant to video content. Too, audio tracks are priced less than a buck a piece. It's almost a mindless purchase.

But what about all those sales of movies on DVD? Well, that's different.

When VHS came out, and movies were duplicated mechanically on VCR tapes, buying a copy of a movie was expensive. Some people did that, but it was pricey.

DVDs, in contrast, requiring a much cheaper duplicating process and materials, were, thus, less expensive to buy. The difference between buying and renting would be so small that, at volume retailers such as Wal-Mart, people just bought a copy of a movie, rather than pay little less, and only rent it at Blockbuster.

Now, however, the content is available digitally. On demand.

And that, I contend is the difference.

Now, I know that, in time, any movie or TV program episode I want to view will almost certainly be available somewhere, for 'on demand viewing.' Netflix prices by time, not title, so there's no reason to buy any single title. I can watch the same movie constantly, for no additional charge, other than the time I spend viewing it. Which works out to something like $1.50/movie.

So with all this content coming available as on demand streaming, why would I pay money to own video content I don't view too often, when the same dollars provide me with constant access to any video content?

Personally, I think Cyran has it backward. Even with computer storage devices becoming larger and less expensive, more applications are moving to the 'net. Look at Google's office productivity suite. Even Microsoft has quietly begun moving that way.

Cyran closes his piece with this statement,

"From a technological perspective, a song is similar to a small movie. It is likely that video will follow in music's footsteps."

Cyran may be correct, technologically, but he's totally overlooked the different behaviors people have toward music and video. You may listen to music as passive background filler, but video tends to command your total sensory attention. They're not at all the same, and I don't believe the future of their digital delivery will be, either.

Thursday, September 13, 2007

Apple In The News Again

I noticed Apple corporation has been in the news again recently. In fact, I wrote a post about Apple's latest product introductions here, within the past week.

On that point, Herb Greenberg, a periodic contributor to the Wall Street Journal's Weekend edition, and columnist/analyst for MarketWatch, penned a piece calling Apple's recent price cuts into question. Essentially, Herb noted the recently-emerging disparity between volume growth of iPods, and the revenue growth rates corresponding to those unit growths. The price cuts, say Greenberg, should cause shareholders to worry that product maturity has finally caught up with Apple and its signature product line.

I like Greenberg. He's one of my favorite guests on CNBC, even if I don't always agree with him. His irreverent, often-minority viewpoint attracts my attention.

Even in his Journal column, Herb quotes another analyst, one Charles Wolf, as noting that the real growth in revenues for Apple's iPod line come from the halo effect it has on other Apple products and services- the Mac computres and the iTunes online store.

In this, I think Wolf is correct. Apple has more than a single hot product line. It has an entertainment system. As I've noted before, you can quibble all you want about its compatibility with MP3 players, and the copyright protection. But nobody forced anyone to buy iPods. They simply are compelling price/performance offerings.

All those iPod owners have helped fuel the iTunes store revenues, no matter what Jobs wrote earlier about how much stored iPod music is ripped off of CDs already in the owners' possession.

Granted, Greenberg charts Apple's declining rates of unit and revenue growth of iPods over the last two years. I don't think this is news to either Jobs, or the firm's management team. In fact, I'd say the recent spate of new products and lower prices is calculated to ignite both growth rates, due to totally new price/performance points. Certainly Apple has done for the iPods, by adding video screens and capacity, something Forman's grills, with which Greenberg compared them, never could.

One Forman grill is pretty much like another. Yes, the larger sizes and removal grill plates are nice product line extensions. But not so vital that most people would replace their existing grill. I haven't. Part of their original allure was the incredible ease with which they can be cleaned. Who really had to have them removable?

The new iPods are very different. Whole new, valued functionalities are included, at dramatically lower prices.

Speaking, or writing, of Apple's entertainment system, another Journal article mentioned that NBC is removing its video content from iTunes after their contract expires in December. Apparently, Fox and NBC hope to collaborate on their own, new online video site.

While I still believe there won't be just one site which all video viewers learn to visit, as Comcast's CEO contended some months ago, I believe a few, such as YouTube and iTunes, tend to predominate their respective product/service spaces.

Will people re-learn to visit iTunes for music and some videos, then skip over to (the new NBC-Fox site), remembering their TV program shopping list while they buy more content there? Perhaps so, perhaps not. I suppose die-hard program fans will do that, if they haven't already visited the free replay sites right after the episodes aired. Or wait to rent them on Netflix.

Personally, I think Apple is still in the driver's seat on this one, because of formats. Will the downloads on Hulu support iPods? If not, will iPod users bother?

GE/NBC is too diversified and sprawling to have anywhere near the intellectual horsepower and financial incentives to attract sufficiently talented people to out-manage Apple on this. Fox is similar. Apple, by contrast, tends toward laser-like focus on their few product lines- music players, downloading services, computers, and now, phones.

Besides, Apple has Jobs. Neither Fox nor GE appear to have a similarly motivated, talented key executive facing off against Jobs in this matter.

In accordance with my recent piece on financial institutions, competitiveness, and diversification, it should be no surprise that my money is on Apple in this fight.

Wednesday, September 12, 2007

Equivocation from the Pages of The Wall Street Journal

Last week, the Wall Street Journal published a rather equivocating piece by one of it's columnists, Justin Lahart. I found the piece to be, at best, a waste of time and, at worst, supporting and advocating specious analysis regarding Fed rate cuts and subsequent investment performance.

Consider these quotes from the Lahart's piece,

"Perhaps some of the rules are changing. Investors tend to believe that interest-rate cuts are good for stocks. Research seems to bear that out....

But interest rate cycles don't always appear to be a great guide to stock performance. In the 1960's, for example, stocks did well even as interest rates were rising. It would be unwise to ignore the past 33 years of history, but it might also be unwise to put too much weight on them."

Gee, thanks Justin. Glad you could add value on this issue.

Does Lahart fill us in on inflation rates during the periods involved? That might help us understand the effect of Fed rate cuts, in that the overall market and economic contexts clearly matter. How about GNP growth during the periods, too?

Oh, and what about the market impact of technology in at least three ways: the advent of derivatives trading; computerized trading technology, and; availability of information via computerized technology, to more rapidly and thoroughly react to fundamental and technical information?

Does anyone really believe that you can just compare one activity or measure, such as Fed rate cuts, over time, and assume it will soak up/account for total variance of something like overall stock prices?

Not only is Lahart's piece of no actionable use, it questions credulity as to its reasonability.

I wonder if this thesis would even rate a grade of "D" in any graduate economics course. I expect better from the Money Section of the Wall Street Journal.

Don't you?

Tuesday, September 11, 2007

Money Center Banks as Investments

Last Thursday, the Wall Street Journal ran an article entitled, "Do-It-All Banks' Big Test."

In it, Robin Sidel focused on how the nation's largest three commercial banks- Citi, Chase, and BofA- will be able to whether the current turmoil in the credit markets.

Her emphasis was on profitability, losses from exotics and mortgage lending.

She quoted one Robert Maneri, a portfolio manager at an also-ran bank, KeyCorp, of Cleveland, as saying,

"These banks rarely hit on all eight cylinders at the same time, but they can make a pretty good profit hitting on six out of the eight."

True. My old boss, Gerry Weiss, one-time SVP of Corporate Planning and Development at Chase Manhattan Bank, used to note,

'Despite our ineptitude, we still make a lot of money. Can you imagine how well we'd do if we really tried?'

Sadly, they never actually try. I conducted extensive research into the performance of a wide variety of financial service firms, while Director of Research at Oliver, Wyman & Co., now the financial services unit of Mercer Consulting.

What I discovered is that universal banks and diversified brokers/investment banks almost never attain consistently superior total return performance, relative to their industry index. Later, I found the same to be true for them regarding the S&P500, as well.

The Yahoo-sourced price charts for Citi, Chase, BofA, and the S&P500, for periods of 1, 5, and longer numbers of years, appear in this post.

All three banks have drastically underperformed the index over the last year, as shown in the one-year chart.

The five-year chart, which appears nearby, finds only Chase outperforming the index over the past five years. But most of the outperformance can be traced back to early 2003- well before the current conglomeration. Otherwise, Chase has more or less mirrored the index, and the other banks.

Only looking back much further, to the mid-1970s, do we see Citi significantly outperforming the S&P. In this case, we see BofA and Citi even with the index in 1996.

It is essentially the next five years that account for Citi's current return lead over the index during this 30-year timeframe. Even then, it experienced a severe dip during those five years, in 1998- the Asian crisis and LTCM debacle.

Hardly 'consistently superior total return' performance, is it? More like a lucky five years over a period of 30+ years. The other two banks, ending up below the S&P over the same period, couldn't even manage that and hang on.

Avoiding risk and loss is not the point of super-money center banks. Consistently superior total returns is. And none of them have demonstrated the ability to do it. Ever.

It's extremely unlikely that these companies will ever achieve such performance going forward, either.


Basically, because they are too diversified. Last December, I wrote this post, in which I quoted Kirk Kerkorian said,

"Diversification is for people who aren't sure about what they are doing."

Just so. Money center banks are in so many businesses that one is always blowing up. Same thing with large investment banks. This is what I learned in my research at Oliver, Wyman.

The only types of financial service firms which showed themselves capable of consistently outperforming their sector index were mono-line firms: credit card companies, asset managers, and mortgage bankers. They would have streaks of several years of outperformance, then fall back to earth. It's just the way Schumpterian dynamics works.

However, by being focused on one or just a few businesses, these companies were able to actually grow fast and profitably. Money center banks just can't do this. They're too big, complicated, and costly to run.

Even back over a decade ago, when I was a senior strategist at Chase, my SVP, Gerry Weiss, noted how complicated a money center bank was to manage. That it was probably beyond most of the best CEOs in the country- and we didn't get them. We got loan officers who had been promoted too far.

So I think Ms. Sidel is focused on the wrong measure of success. Money center banks may well avoid disaster in the near future. But they won't be worthy of investing, beyond some lucky timing plays.

Monday, September 10, 2007

Countrywide's Mozillo's Irresponsible Letter

The weekend edition of the Wall Street Journal carried an article focusing on Countrywide Financial's 20% cut of its work force, and selected quotes from the related letter by CEO Angelo Mozillo to employees of the firm.

In my opinion, at least one part of the letter was totally irresponsible, as well as misleading.

For instance, the Journal article cites Mozillo as writing that current downturn is the

"most severe in the contemporary history of our industry."

Let's consider that statement from a few angles.

First, it appears to let Mozillo off the hook as CEO of Countrywide, as he is about to fire 20% of his employees. It's as if he's saying,

'Hey, people.... It's not my fault...look at this terrible market...yep, most severe ever.....'

Nice try, Angelo. But didn't you lead the charge with alt-a and sub-prime loans? Aren't you CEO? Shouldn't you have been appropriately hedged, and have obtained longer-term, secured lines of funding, to avoid cashiering a fifth of your workforce? Just weeks after declaring that this shakeout was great, as your firm would take increased market share in the mortgage sector?

Then there's the lack of context of Mozillo's comment. Does it not arguably follow that the 'most excessive upturn' in the industry's contemporary history was followed by its 'most severe' downturn? Seems reasonable to me.

Was that excessive upturn not led, in part, by Angelo's company's "innovations?"

It's not only the mortgage banking industry that has had trouble with explosive growth. Look at, in their time, Boeing, the railroads, Advanta, and Atari, to name just a few.

This is pretty much your average story of a firm letting details go, loosening operating standards and, as befits a financial firm, scraping ever-lower down the creditworthiness scale to find customers. All of this finally came home to roost, and Mozillo would have you believe it's someone else's fault.

Maybe he's watched Bear Stearn's Jim Cayne's attempt to blame 'the market' for Bear's fund management woes, which I described here, and figured he'd give it a try, as well.

Apparently one of the behaviors we must now live with in this age of instant electronic communications is that of CEOs getting out in front of an issue and pointing their fingers at anyone and everyone else in blame, rather than take responsibility for their own actions, or inactions, as the case may be.

(Southern) California Dreamin' : Real Estate Woes

A friend of mine who works in the Southern California real estate industry spoke with me at length about a week ago regarding the status of the sector, buyers, and her own firm's experience.

In order to disguise her firm and the major project on which she works, I'll leave details vague.

However, what she explained both reinforced my sense of the nature and extent of the country's mortgage problems, as well as highlighted how detached from reality a particular locale can become.

One clear signal that the credit woes of the housing market are having real effects is that instead of her project's escrow closing late this fall, she now casually remarked that it won't close until, I believe, sometime late next year. In fact, there was evidently some question as to whether the entire venture was still viable. Which is why I'm being careful to completely avoid any reference to the project, beyond noting that it is residential in nature, and in southern California.

When I related MarketWatch's Herb Greenberg's observations that southern California real estate "values," meaning notional asking prices, in places like Riverside, had risen far above the national average home price, my friend agreed that the regional real estate market had become unsustainably over-valued.

Thus, her firm's project was already selling into an over-priced market, on a national basis.

Yes, I know, you're saying,

"But don't you realize, real estate is local?"

Well, yes, and no. Yes, if it's priced within reasonable, national parameters. No, if it's not, because of the securitized nature of the broad market, and the specialized nature of jumbo mortgage financing.

Put the two together, and you have expensive real estate projects which rely on short-term construction financing, and consumers taking jumbo mortgage loans to buy them, depending upon a very precarious long term credit market.

As I spoke of this situation with my business partner, we agreed that the only way my friend's project could have become insulated to credit forces was to have secured long term lines of construction financing, and, then, secured forward commitments to lend to its buyers who met certain criteria, from jumbo mortgage lenders. Absent such arrangements, a project such as my friend's, located in an area of stratospheric housing prices, was bound to be among the first to experience difficulties, once the credit market tightened.

Did I mention, by the way, that my friend told me she does not know of one person, directly, who has not bought a home in southern California without using two mortgages? The main mortgage for 80% of the purchase price, and the piggybacked alt-A or sub-prime for the remaining 20%.

That second part? That's what we in the Midwest, where I grew up, and even out here, in the East, call the "down payment." That's the part that assures all other parties that you have sufficient personal equity invested in your commitment to buy and pay for your home.

My friend is well aware that the California market, like Las Vegas, Florida, and a few other well-contained markets, simply became over-priced, with respect to what the now-national, if not global, ultimate holders of mortgage paper, would consider affordable by the borrowers.

Thus, new residential purchases on the same old terms is finished. And my friend's project is in somewhat dire straits. Essentially, they can only complete their sales by attracting buyers who can afford the full 20% down payment, in order to take a conventional jumbo mortgage for the balance.

It's ironic. My friend is educated, intelligent, and very competent. She chose to work in an area that, until recently, added considerable value to the local economy, and promised her substantial rewards for successful job performance.

No more. As she told me recently,

"I might well be able to visit you next week, or the week after. Because I may not have a job tying me down."

Such is the manner in which a thousand or more similar stories, combined, make for a national economic event. Everyone in California, in the housing-related sectors, knew that some of their real estate values were indefensible to the larger financial markets, should credit conditions change in a tighter direction. But they still behaved as if it would not, did not, matter.

Perhaps this fact, more than any other, demonstrates why financial-related businesses need to remain vigilant about creditworthiness. Financial lending bubbles and high-growth businesses always implode when lowered lending standards at least meet initial defaults and delinquencies. It has ever been thus, and, probably, ever shall be.