Friday, March 21, 2008

Starbucks' New Strategy

Thursday's Wall Street Journal featured an article about Michelle Gass, the putative head of strategy for Starbucks' new attempts to recapture its former growth.

Ms. Gass states, per the article,

"I'm not a traditionally trained strategist....I've never worked at McKinsey or Bain."

Well, neither am I, by that measure, but I've been a strategist since my early days at AT&T. For some, strategy is an orientation and way of thinking, not a result of a specific training ground.

Ms. Gass' training and experience involves heavy interest and involvement in consumer research while at P&G, which is quite admirable. And she successfully introduced the Frappuccino at Starbucks.

So far, so good. She is now Schultz' right hand woman on the big makeover at the coffee giant.

However, one line in the Journal story left me with doubts about Gass' and Starbucks' long term success. The story reads,

"She says she hasn't been focused on competitors in developing the new plans. "I think we'd all readily admit that a lot of the situation we're in is self-induced." "

Perhaps Ms. Gass needs one or two courses in strategy, after all.

As I wrote in this post a few months ago, Starbucks is very much locked in a competitive battle with at least McDonalds, as well as Dunkin' Donuts,

"The outcome of this battle royale between two retail food giants, Starbucks and McDonalds, with Dunkin' Donuts also roaming the same terrain, will be fun to watch. If you ever wanted to view a classic marketing struggle between two fairly well-matched firms in a clearly-defined market, this is your chance."

Thus, I find Ms. Gass' comment to be dangerously short-sighted and internally-focused.

Instead, she might wake up to the reality of Schumpeterian dynamics. Between Starbucks' own prior expansion into lower-income segments, and McDonalds' search for growth in kindred products, the former's market dominance was almost certainly going to come to an end, one way or another.

As it is, Starbucks is being bracketed by another coffee retailer on one side, and a fast-food giant on the other. This has less to do with Starbucks' 'self-induced' troubles than it does with recent targeting of the coffee giant's business by two very large, savvy food retailers.

I hope, for Howard Schultz' and Starbucks' sake, that Ms. Gass begins to become aware of this reality.

Thursday, March 20, 2008

Congressional Witch Hunt On Financial Services CEO Pay

The March 11 edition of the Wall Street Journal carried an article by the Journal's minority-owned unit,, regarding the recent Congressional hearings on financial service company CEOs' compensation. I also happened to have caught some of the witch hunt live.

One satisfying aspect of the breakingviews column is that they recommend a set of fixes, all of which echo my own ideas from prior posts. They include: paying large incentive compensation in company equity; lagging incentive compensation to match long term corporate performance, and; provision for effectively escrowing such compensation, in order to recapture it, should performance reverse.

That said, however, I don't believe any of this should be regulated. It ought to be the responsibility of boards of directors to do this, or face shareholder lawsuits. In this day and age, it is a simple task for a board to hire a reputable external compensation consultant to design a 'best practices' suite of senior executive compensation guidelines.

Why the US Congress should meddle in how publicly-held, private enterprises choose to compensate their executives is unclear to me.

Wednesday, March 19, 2008

Rick Wagoner's 33% Raise in 2008

Just over a week ago, I wrote this post noting GM's Rick Wagoner's new, reduced role at the perennially-struggling auto maker. After reading the Wall Street Journal's piece extolling the new COO, Henderson's skills, I wrote,

"Call me sceptical- hey, it's the name of the blog- but I don't see how the same guy who, as CEO, lost 1/3 of GM's value, is going to magically become an asset to the firm once he has a COO. If this were so important, why didn't he do it several years ago?

Perhaps GM shareholders, of which I am not one, have the pleasure of seeing Wagoner at last stop wrecking the company by his operational role as CEO. The piece concluded with Wagoner opining on performing less operational duties...."

Now, upon returning from vacation and catching up on past issues of the Journal, I see an article from the Friday, March 7th issue of the paper, announcing Wagoner's compensation increase for 2008!

That's right!

The GM board has decided to pay Wagoner 33% more in cash and stock for the coming year, as compared with the at least $1.68MM he was paid last year.

As the Journal notes,

"a 33% raise for 2008 and equity compensation of at least $1.68 million for his performance in 2007, a year for which the auto maker reported a loss of $38.7 billion."

According to the Journal article, Wagoner's compensation increase is part of a general management package including awards of $1MM or more for the new COO, Henderson, Vice Chairman Bob Lutz, and others.

If I were a GM shareholder, I think I'd be selling. This is the type of unlinked premium pay for non-performance that has Congress, unions and average Americans shaking their collective heads in dismay.

After frustrating Kirk Kerkorian's attempts to add value to the company, and seeing off attempts by Carlos Ghosn to seek a partnership with his firm, Wagoner has presided over shareholder losses as depicted in the nearby five-year price chart. The Yahoo-sourced chart shows GM's stock price plunging some 25% during a period in which investors in the S&P500 Index enjoyed more than a 50% increase value.

How in the world can GM's board defend this latest action? Are they afraid Wagoner will leave GM if he isn't paid more, and possibly clear the way for the company to actually make money?

Or that some other large US company is clamoring for Wagoner's value-destroying skills?

Honestly, sometimes corporate America is its own worst enemy. This is clearly one of those times.

Tuesday, March 18, 2008

The "Taking" of Bear Stearns

Was Bear Stearns improperly shut down and sold to Chase this past weekend?

Was there a more equitable process by which markets and counterparties could have been assured of the performance of Bear's book of positions, while providing for a competitive bidding environment on Bear's businesses and assets?

My partner is of the opinion that whatever Paulson, Bernanke & Co. decided to do by the opening of European markets on Monday morning, the explanation of it had to

"fit on a bumper sticker."

With which I agree.

Still, was if fair to indemnify Chase to the tune of $30B for agreeing to buy Bear Stearns? Why weren't Wells Fargo or Wachovia invited to bid on the same terms, with the same $30B guarantee?

Or, for that matter, a consortium of private equity firms?

Could not the Fed and Treasury have acceded to Schwartz's call to declare Chapter 11 bankruptcy, immediately move to name an official in charge of the process, and hire Chase or some other firm with trading facilities to operate Bear's book with loans backed by Fed guarantees? Then take a month to auction the pieces of Bear Stearns?

It seems to me to be a somewhat unlawful taking for the Fed and Treasury to have forced Bear to sell itself in an uncompetitive bidding situation.

Rather than bundle the financing of the firm with its purchase, it seems to me that Fed and Treasury officials could more easily have foreseen this type of meltdown. It's hardly unique, in that LTCM suffered the same type of margin calls and liquidity crisis when it failed ten years ago.

Somehow, giving Chase and Jamie Dimon a sweetheart deal for far less than they were reported to have bid, with a $30B loan guarantee gift is out of character in a 'private sector' solution.

No doubt there will be litigation about this in ensuing months. I'm not arguing for the shareholders getting more for the wreck of their firm. As equity owners, they are last in line, and, sadly, especially the one-third of owners who were also employees deserve what they get for not diversifying their investments from the source of their livelihood.

Rather, I am concerned, as a taxpayer, that the Fed has used my money to guarantee the value of assets involved in the takeover, but only by offering the sweetener to just one firm. Why not to any potential bidder?

Glass-Steagall, The Fed & Investment Bank Access

In light of Bear Stearns' demise, and the hand-wringing over Lehman being next, do we need a new equivalent of Glass-Steagall? I wrote about the unintended consequences of its removal here and here recently.

Or do we, as Treasury Secretary Hank Paulson is promising, need a regulatory overhaul to unify regulation of investment and commercial banks, now that Glass-Steagall's absence has finally led to the Fed lending to non-commercial banks? In that regard, the second of the above-linked posts discussed Henry Kaufman's idea for a 'super-regulator.' I still don't see the need for another regulatory body, but this past weekend's historic and unprecedented granting access by non-commercial banks to the discount window suggest regulatory structure has to finally catch up with Glass Steagall's removal.

But what about moral hazard? Are we just seeing the final consolidation of financial services that is long overdue?

For example, mortgage origination and trading capacity could be trimmed. What about trading and asset management in hedge funds and private equity firms? Don't they constitute significant capacities of these product/market segments that don't typically need much capital?

If they are over-leveraged and make unwise investments, they go under. Must we be afraid of these legitimate consequences of our capitalistic system?

Isn't that what Bear Stearns did, except they were publicly owned?

Don't we want to squeeze out excess capacity, a la Schumpeterian dynamics?

Is the underwriting business really so rare and profitable that we need all the capacity the Street had? Even prime brokerage is probably looking a bit over-served right now.

Maybe what we should acknowledge, with Glass Steagall's demise, is that most investment banks and brokerages like Bear Stearns should really be part of commercial banks. They currently exist, for the most part, due to the desire of commercial banks to offer 'broker loans.' Their funding is due to repo's to commercial banks, the latter having always had access to the Fed window.

Maybe now, we should not only allow investment banks access to the Fed, but simply realize that all brokers are implicit extensions of commercial banks, because the latter can do all that the former can, and have permanent, rather than temporary, Fed and banking system access.

This fundamental new reality has become apparent due to mortgage-related CDOs.

As the values of, and markets for these opaque securities have evaporated, the liabilities with which they are funded are being called- by commercial banks.

If only investment banks and brokerages had stuck to existing, fairly understandable assets like bonds and equities. Of course, profits on those are thinner, thanks to competition.

That's why the Street invents vehicles like CDOs. They are less-easily understood, and, thus, more profitable.

Could it be that this latter truth is really an indication of the over-served nature of financial services?

This morning, on CNBC, former Vanguard chairman John Bogle opined that, instead of adding value to our economy, the financial services sector now sucks value out, as witnessed by the sector's recent annual profit which exceeded that of the semiconductor sector.

I believe he has a valid point. By its creation of purely speculative, no-money-down mortgages and the packaging of these mortgages in CDOs, financial services firms have polluted the markets with opaque, now-unmarketable securities, after first taking profits for the creation of both instruments.

The result, as I observed in a recent phone call with my business partner, is what Alan Greenspan sees, correctly, as a financial debacle of historic proportions.

Ordinary, plain-vanilla fixed-income products such as bonds, and equities, tend to have nearly-constantly available markets which provide price discovery. You just don't see those markets ceasing to function unless an issuer goes bankrupt.

Now, however, we have performing structured finance instruments which have no markets because of their questionable asset value, not their income streams. And commercial banks are as culpable as any other financial institution in this mess.

BofA, Chase and Citigroup aren't your father's bank anymore. It's debatable, in the wake of Glass Steagall's demise, that any publicly-held brokers or investment banks should or can really exist independently of a commercial bank. In the new environment of securitized toxic structured finance instruments, a large commercial bank is uniquely able to survive, by dint of its Fed access and judicious use of its 'investment account' provisions.

There's much more to these topics. But for now, those are my initial thoughts.

Fed Rate Action

In this post a little over a week ago, I cited the errors which I think Bernanke's Fed has recently made, including,

"To date, it's unclear that any of the extra Fed-supplied liquidity has affected the credit markets in a substantial, lasting manner. Instead, equity markets have reacted to the various rate cuts like heroin addict to his latest fix. After the effect wears off, he looks for the next dose, hoping it will be even larger.

The editorial points out that the Fed is notoriously bad at what used to be called "fine tuning." In this case, knowing when to suddenly switch from recession-fighting rate cuts to inflation-fighting rate hikes seems likely to be problematic."

Now we learn that the Fed will certainly cut interest rates at least 50bp tomorrow, with market expectations having reached a full percentage point, or 100bp.

What the heck is going on here?

The Fed's rate cuts going back to this summer haven't exactly lifted either the economy or financial markets out of whatever difficulties they are experiencing. So what will an additional one percentage point cut accomplish?

Brian Wesbury opined, in a discussion on CNBC this afternoon about Bear Stearns, that, ironically, the Fed's rate cuts had helped to drive the firm out of business. Wesbury noted that rates were falling on various risky assets, as the Fed lowered rates, while risks remained high. As returns no longer matched or compensated for risks, instrument prices tanked.

The result, for 'mark to market' securities, which composed much of Bear's book, was a rapid contraction of value.

The Fed's recent actions regarding accepting various types of paper at its windows for discounting, including now allowing non-commercial banks access to these facilities, seems appropriate to me in this market.

But further stoking of inflation through needless rate cuts seems to me to be a major mistake.

Monday, March 17, 2008

On Bear Stearns' Demise & Its Purchase By Chase- Part One

Just two weeks ago today, I wrote this post on commercial banking concentration. Little did I know that I would be so close to the truth, and by such a short amount of time.

Rather than the collapse of a commercial bank, it is an investment bank/brokerage- Bear Stearns- that has failed. But the thrust is the same, as has become clear from comments of many pundits in the last 24 hours. And from an analysis of the current condition of financial markets.

As I most recently wrote on the 'mark to market' issue here, a few days after the other linked post,

"As I began to suggest in my earlier post, businesses and companies in the business of trading and investing with the constant expectation of selling and buying securities should probably mark their assets to market daily. If that causes them to use less leverage or avoid exotic structured finance instruments, so be it.

Financial service businesses intending to hold assets, whether they be whole loans, exotics, or what have you, beyond a pre-determined duration, should probably be able to value those assets on the basis of performance, rather than immediate market value."

In essence, Bear Stearns got caught in the former situation, holding large amounts of exotic securities, for which there is no current 'market,' with borrowed money. Between increased demands for collateral and worries over its liquidity, its counterparty risk made it an unsustainable trading entity.

Goodbye Bear Stearns.

Because of the genesis of this current financial turmoil, exotic, somewhat opaque structured finance instruments, I wrote this post last September. In it, I opined,

"Now, with this latest credit market debacle, the first since really heavily asset securitization of mortgages and corporate loans have kicked in, we are learning that there are market conditions under which non-banks may not be viable for very long, if they originate and/or hold volatile fixed income assets.

It's an interesting phenomenon. Who would have guessed that there was life in the old commercial bank model, yet?

Back in my days at Chase Manhattan, our group's boss, Corporate Planning & Development SVP Gerry Weiss, attempted a number of efforts calculated to move Chase into some sort of arrangement with a US investment bank, in order to, as he put it, so to speak,

'get their management in charge of our assets, with the advantages of our regulatory structure.'

Therefore, it's ironic to me that something like this might happen. Sure, Sandy Weill agglomerated a bunch of different piece parts to form the now-unwieldy Citi bank. But Salomon and Smith Barney are now almost lost inside of it. And the bankers remained in power, as the investment banks they took over had been weakened by various events.

Now, it would be possible to see a Chase or BofA take Bear Stearns, for example.
An interesting development in the quest for a viable, efficient, profitable organizational structure with which to transact fixed income businesses."

So I guess I did sort of foresee this development. But, being no particular fan of Jamie Dimon, I wouldn't give him too much credit just yet.

For one, Chase is the only true money center bank left standing which can absorb Bear Stearns right now. Citigroup and BofA both damaged themselves with unwise capital markets activities last year.

Second, it's not clear that Chase has really bought much of value. At $2/share, it would seem that the bank doesn't put more than notional value on the 'assets' it has purchased. Mostly, it seems this is a favor to the Fed and the US banking system, as a sort of quid pro quo for the status Chase enjoys as one of the largest US commercial and money center banks.

Now there are some who allege that Bear's CDO book will eventually become quite valuable, yielding a profit windfall to Chase, and, thus, making Dimon look like a prescient hero in a few years.

If that's true, though, again, it's not through any particular wisdom of Dimon's that this has occurred. If Citigroup had been healthier, there would have been a bidding war. And what is the fairness of making Bear Stearns mark such a book to a non-existent, zero-value market, force it to sell itself to Chase for a song, only to allow Chase to hold zero-value instruments in case they do, and, probably will rebound in value over time?

According to CNBC this morning, the Fed preferred Chase to J.C. Flowers as the rescuer of Bear Stearns.

Why? Perhaps Flowers correctly understood the longer-term value of Bear's exotics, and was willing to pay a bit more than $2/share to own them. In fact, it was reported that Chase had bid up to $15/share when competing with Flowers to buy Bear.

I'll add some more thoughts shortly in part two of this post topic.