Friday, June 06, 2008

On Microsoft's Mismanagement of Its Operating System Dominance

I've contended for at least two years, as noted in this May, 2006 post, that Microsoft would do its shareholders a service by breaking itself up into at least 3-4 pieces: operating systems, desktop applications, gaming, and online/advertising.

Now, in Wednesday's Wall Street Journal, technology columnist Lee Gomes provides more examples of how Microsoft's integrated businesses model has badly served customers in ways that almost certainly means it has also hurt shareholders.

Gomes' clever article was entitled "Dear Windows 7 Programmers, I Have a Few Ideas..." In it, he sends up some of XP's and Vista's worst faults.

Among his priceless quotes are,

"SKU stands for "stock keeping unit," and one of Microsoft's most baleful decisions for Vista was to wring from it as many SKUs as possible. Thus was born Vista Home, Vista Professional, Vegetarian Vista, etc. Each successive version had more features and, naturally, a bigger price tag.

Whatever incremental revenue Microsoft raised with this ploy couldn't possibly have been worth the confusion and ill-will it engendered. A certain technology columnist who will here go unnamed because I don't want to embarrass myself, once spent a lengthy session with Microsoft tech support trying to get my Vista to see a disk drive. Only well into the process was it discovered that the requisite "dynamic disk" feature wasn't in that particular SKU.

If society is going to be inflicted with an operating-system monopoly, society might at least get the benefits -- especially the one where everyone shares a common base of the same software. The Vista SKU epidemic gives us the worst of both worlds: software silos combined with a single big supplier.

Open-source software such as Linux is traditionally seen as the opposite of proprietary software from the likes of Microsoft and Apple. But that's a false dichotomy. Why can't Windows be proprietary, for-profit and copy-protected -- while at the same time be open for user control and inspection? If Windows were a car, you'd never be able to open the hood and see what was underneath.

OK, a cheap shot, I know, but just last week, I installed the new Service Pack 3 for XP, only to see my brand new Internet Explorer 7 crash in the first two minutes of use. Granted, I was doing something especially demanding -- surfing from one Web site to another one -- but still, I expected better.

It's well-known that massive teams of programmers are the worst thing possible for good software because they make the process so bureaucratic. But if a small team is what's needed to make Windows 7 great, then Microsoft is big enough to spend whatever it takes to build a team smaller than everyone else's."

I've felt for years that, no matter what else their market share dominance in desktop operating systems, Microsoft's arrogant attitude to issues such as Gomes mentions has caused them to have a customer base that actually loathes the company and its products.

That just can't be good. Dealing with your computer's Microsoft operating system is almost as bad as dealing with your- or my- bank. And if you've read my recent columns about that, you know it's not a good thing.

Would an independent operating systems group treat customers as badly as the current Microsoft unit does? As I saw at the old, integrated ATT of nearly three decades ago, I believe Microsoft's operating system group management is sub-optimized in favor of helping its fellow divisions- applications, gaming and online. Thus, rather than do what is the best thing for paying customers of operating systems, the group probably does what is best for maximizing overall Microsoft profits.

How differently would you or I expect a separate, standalone MSFT operating systems company to behave?

As Gomes notes, it might not lock the hood on your operating system, preventing you or anyone else from easily diagnosing problems in the software you now own.

Or maybe they'd go directly to the subscription model, similar to anti-virus vendors. That way, you'd enjoy more smooth, continuous updates and fixes to the software. And perhaps even some better online or on-system diagnostic tools.

For nearly every computer user to loathe buying a new machine, as I do, because of the trouble we know we're in for when we 'upgrade' to a new operating system must mean that we'd pay more for a better situation. Or the same to at least have something less awful.

If Microsoft's CEO's inability to manage the firm to consistently outperform the S&P500 over the past few years doesn't clue you in to the firm's problems, maybe knowing how much customers hate the firm for the necessity of buying its operating systems on their new PCs will.

Thursday, June 05, 2008

GM's Further Woes

This week's GM shareholders' meeting was cause for more gloom and doubt about the continuing viability of America's largest- by market share- auto maker.

Yesterday's Wall Street Journal had one article noting that the price for credit-default swaps on GM instruments has been soaring, indicating a higher perceived risk of bankruptcy. It's cash position, relative to, say, Ford, is very weak. In light of GM's need for some serious product policy turnarounds, it's looking increasingly as if the company might finally bottom out financially before it can ever re-ignite sales and profit growth, let alone achieve some semblance of consistently superior total returns for shareholders.

No surprise there.

But this morning's edition of the business newspaper went much further in documenting the incredible, continuing ineptitude of the nation's battered vehicle-producing giant.

As the Journal article reports in a piece ominously titled "GM Shifts Its Strategy Into Reverse,"

"After three years of restructuring and tens of billions of dollars in losses, General Motors Corp. shifted direction once again Tuesday, unveiling plans to close four truck plants and possibly sell its Hummer brand.

The moves were forced on GM by soaring gasoline prices, which are prompting more consumers to opt for more fuel-efficient vehicles. The struggling auto maker must now try to rapidly reduce its dependence in North American truck sales, once seen as the key to its turnaround.

The abrupt shift, outlined at GM's annual meeting, is an acknowledgement that Chairman and Chief Executive Rick Wagoner miscalculated in 2005 when he bet big on trucks. That plan, based on expectations of steady vehicle sales and gas prices in the U.S. through 2008, won the backing of GM's board and helped Mr. Wagoner prevail in a 2006 board-room battle with then-shareholder Kirk Kerkorian."

If you are, sadly, unfortunately, still a GM shareholder, those paragraphs ought to be sufficient to end that. Plus the knowledge that Kerkorian sold his GM position and now owns shares of Ford.

Need I even state what I think the board should do to/with the hapless, inept Wagoner?

How can GM's board possibly defend continuing to let Wagoner hold any job at the company after an error of such tremendous magnitude that the vaunted turnaround of two years ago now must be reversed? SUVs were the wrong bet, and now Hummer has to be sold. How much do you think anyone else will pay for the latter, with US gasoline prices near and above $4/gallon?

Can you say, "shareholder value destruction," Rick?

As CNBC covered Wagoner's opening remarks at the GM meeting the other morning, I heard Wagoner try to smear lipstick all over the pig, including hopefully mentioning the company's new Volt electric car.

Too bad it's due out in....... 2010. Will an independent, non-bankrupt GM even still be around to produce and market the car by then?

Take a look at the nearby 45+ year stock price chart for GM, Ford and the S&P500 Index. Makes you sick, doesn't it?

At least Ford has had positive price action over nearly half a century.

Yet, in the same timeframe when the S&P rose nearly 2000%, GM has actually lost ground, and is now worth less, on a price basis, then it was when Kennedy was President! Sure, throw in some dividends and it's probably positive by a bit.

The bad news about Wagoner is how little he seems to understand what it takes to get GM to the point of delivering consistently superior shareholder returns. The only good news is that he's really not that much worse than every other GM CEO for the past half-century.

They have all been pretty mediocre CEOs, with boards to match, judging by the complacency with which the latter have allowed the former to preside over the slow death of this American automotive giant.

You know it's really bad when the Journal writes,

"Some shareholders are frustrated.

"You don't get a sense that the General Motors crowd really gets it," said Sister Patricia Daly, who represents the Sisters of Saint Dominic of Caldwell, N.J., a religious order that owns GM shares, in an interview on Friday.

"Even in the 1990s, it was clear they weren't going to be able to sell the big SUVs for 15 years without any impact." "

Now that's really scary, isn't it? A Catholic nun has better instincts about the US car market than the CEO of GM?

Here's hoping, for their Order's sake, that those sisters are out of GM by the end of tomorrow.

Wednesday, June 04, 2008

After Bear Stearns, Is Lehman Next To Collapse?

This week's hot investment banking story is the vulnerability of one of the remaining weak sisters among publicly-owned investment bank/brokerages, Lehman Brothers. I last wrote about this issue here in April.
Nearby is a price chart of Lehman, Goldman Sachs, Morgan Stanley, Merrill Lynch and the S&P500 Index for the past five years.
Goldman is clearly the class of the class, especially distinguishing itself since late 2006- months before last summer's mortgage finance-fueled fixed income markets crisis.
Of the other three investment banks, Lehman has the relatively 'best' performance. Of course, that's not saying very much, since none of the three could give an investor a better return than the S&P500 did over the period.
As I read yesterday's Wall Street Journal piece about Lehman's new difficulties, I noticed the article making a really big deal about how Lehman's leverage has recently been lowered from 31.7 to 27.3. Today's Journal has a lead piece in the Money & Investing section about Lehman looking abroad for capital.
In my opinion, this completely misses the point. As I wrote here in late March,
"Looking beyond simply Bear Stearns, can anyone truly justify the existence of all four of Goldman Sachs, Merrill, Lehman and Morgan Stanley? Especially in the modern world of large private equity firms and hedge funds? The former provide additional underwriting, M&A advisory and asset management, while the latter focus on providing trading capacity and investment management.
Other than emotional reaction of former employees seeing their old firm's name vanish, what would be different if one or more of those names were bought by or merged with a commercial bank?
Contrary to Andy Kessler's view, in the Wall Street Journal this past January, about which I wrote here, it's unlikely now that an investment bank will do the buying. With their high leverage and dependence upon commercial banks for funding, I suspect the investment banks are the more vulnerable. Now having access to the Fed discount window, it's only a matter of time before the regulators get around to levying a new regulatory framework on the investment banks."
It's not whether Lehman reduces their leverage right now by a pithy 4 or 5 percentage points. That's going to be irrelevant if/when their big meltdown comes. Bear Stearns saw billions of dollars of client assets, and customer business, vanish in days.
Quite simply, as I wrote in that prior post, Lehman exists at the pleasure of its commercial bank Broker Loan divisions to fund them beyond the current maturity of outstanding liabilities. Whether the leverage is 30, or 25, 20, 15, won't matter when customers leave within two days.
At that point, anything above 1:1 spells dissolution. The mechanics of profitability, risk management and leverage have simply changed for long term survival of most publicly-held investment banks.
A plethora of hedge funds and private equity shops have trimmed profit margins in virtually every investment banking business except asset management. There, the best managers head for private firms ASAP anyway. Meaning the publicly-held investment banks, with the exception, still, for now, of Goldman, are largely the province of the lesser-skilled bankers at the mercy of commercial bank funding and the need to take ever-larger risks to offset declining profit margins.
A recipe for long term death of these firms? You bet.
As I wrote later in that March post,
"A natural consequence to this will probably be even more smart financial services people migrating back to the privately-financed arena. Just like consumer goods merchandising has the 'wheel of retailing,' whereby new entrants compete at the low-cost end of the market, as existing players migrate upwards in terms of quality, service, selection and price, so, too, it seems, will financial services now have its own version of this 'wheel.'
Only in financial services, the 'wheel' is between publicly- and privately-held concentrations of capital and risk management. Again, viewed from afar over decades, the story of commercial and investment banking for the past forty years has been a gradual selling of transactions, asset and risk management businesses at their 'tops,' as formerly-private banks of both stripes went public, followed by managerial ineptitude, decline in risk management, and excesses in pursuit of growth via more risk."
And, as I wrote in my recent post on Wachovia CEO Ken Thompson's demise,
"To me, the pecking order of smart management in financial services begins with the best private equity and hedge funds. After them would come Goldman Sachs. Then.....well..I don't know if there is anyone else thereafter."
So to me, this breathless watch over Lehman's viability is sort of misplaced. As soon as confidence begins to erode, it's 'game over.' Bear's situation proves this. As I wrote in the earlier linked post, why doesn't Fuld just take the opportunity to sell to a commercial bank and retire gracefully, while his image is still in good shape?

Tuesday, June 03, 2008

The Folly of Corporate Diversification

I've written a handful of posts about diversification. Perhaps the two that I find most important in conveying my core philosophy about diversified companies are found here and here.

Not surprisingly, because it is probably the best known American diversified conglomerate, GE has been the primary subject of those two posts.

However, GE isn't the only American company that is probably overly-diversified. Consider yesterday's sacking of Wachovia's CEO, Ken Thompson. One of Thompson's mistakes, in his rush to make Wachovia larger and faster-growing, was the unwise purchase of Golden West Financial at the top of the real estate boom in 2006.

Now, it appears that Wachovia, like its Charlotte rival, BofA, would have done better simply remaining a large commercial bank without trying to become a major presence in the now-national business of mortgage lending.

Over the past decades, auto makers have bought, then sold: EDS, Hughes, and several financial service companies.

Who knows how much better-managed and -positioned for today's changing, challenging environment GM, Ford and Chrysler would have been, had they not frittered away precious capital and management attention on these diversifications?

Or consider TimeWarner's disastrous merger with AOL. Eventually it destroyed huge amounts of shareholder value. A needless diversification that never truly worked.

Microsoft has grown cumbersome and complicated to understand and manage, judging by their total return performance over the past decade.

When I consider both Microsoft and GE, it seems pretty obvious to me that too broad an assortment of businesses, especially when their commonality is eclipsed by their differences, leads to mediocre total return performances for shareholders.

Who really believes that Microsoft's applications businesses need to share a corporate structure with the games division?

Or that GE's aircraft engine business has a lot of interdependence with its Universal/NBC unit?

What are the odds that executives overseeing these unlikely combinations actually add value that exceeds the costs of their administration?
Look at the nearby price charts for five companies and the S&P500 Index for the past five years.
The monoline companies- Google and Apple- far outperform the diversified ones- GE and Microsoft.
I know there are many reasons to assail this comparison. What I want to show is the huge performance gap between operating models. The focused, largely single-business firms have created far more value for their shareholders in the last half decade than have the two diversified ones.
How can Gates, Ballmer and Immelt possibly excuse such lackluster performance for so long?
I contend that CEOs who collect and 'manage' businesses too many in number, with little inter dependencies, are ineffectively constructing mini-indices of their own. As Microsoft's and GE's performances so clearly demonstrate, at best, they might perform like an index..but with much higher risk.
That's why I have written for years that both GE and Microsoft would benefit their shareholders by splitting their companies into their logical constituent parts. In both cases, their business units are sufficiently large to operate as independent corporations, and would have much more transparency and focus if they did so.
With total return performances like GE's and Microsoft's, it's hard for anyone to argue I'm wrong.
Does any reader know of a legitimate exception to my position? That diversification of corporations is, in today's environment, with deep, broad equity pools, needless and counterproductive for shareholders and managements?

Monday, June 02, 2008

Synfuel & Energy Security

Back on May 21st, the Wall Street Journal ran an interesting article describing efforts by the US Air Force to test the use of synfuels in its bombers and fighters.

As the Journal article explained,

"Despite its high-tech connotations, synthetic fuel -- often dubbed "synfuel" for short within the industry -- has been around for decades. The basic technology for transforming coal or natural gas into synthetic fuel was invented by a pair of German researchers, Franz Fischer and Hans Tropsch, in the 1920s. The Nazis later used the Fischer-Tropsch process to mass-produce synthetic diesel fuel. During the apartheid-era embargo against South Africa, scientists there tweaked the technology so it could also produce synthetic jet fuel.

The Fischer-Tropsch process transforms a synthetic gas derived from coal or other material into liquid gas. The resulting synthetic fuel is different from biofuel, commonly produced from corn, sugar or other plants. Continental Airlines Inc. has announced plans for an experimental flight using biofuel this spring, which would be the first by a U.S. carrier; Virgin Atlantic also has done some testing."

I have had a vague awareness of this process for some time. Originally, I thought it converted coal into liquid hydrocarbons, then I later thought that was mistaken, and it only 'gassified' coal to burn like natural gas. In fact, it does produce liquid fuel. Sounds too good to be true, right?

Well, in a sense, it might be, as the Journal piece noted,

"The pure synthetic fuel Syntroleum sold the Air Force for the B-52 test flight in 2006 cost almost $20 a gallon. Its price since has come down sharply, but the synthetic product used in the B-1 supersonic test in March still cost $4.62 a gallon. It was mixed with petroleum fuel costing $3.04 a gallon, according to government officials."

You can guess, and the article confirms, that if large refiners knew that the US government stood ready to buy their output at some reasonable minimum price, the cost and, subsequently, price of synfuel would fall dramatically.

But then there's this aspect to the synfuel solution,

"Military use of synthetic fuel faces significant obstacles. The energy bill signed into law by President Bush last year included a clause preventing the government from buying the fuel if it emits more pollution than petroleum. Manufacturers have promised to meet that target by recapturing carbon dioxide and other greenhouse gasses produced in refining. Without those efforts, synthetic fuel can emit up to twice as much pollution in refining as conventional petroleum."

Here is where common sense would hopefully prevail. Seeing the US, as Boone Pickens believes, spend $500B per year buying oil from external suppliers, isn't it worth something to avoid that import bill?

Screw the greenhouse gases for now, we're talking energy security. Military energy security. As the Journal article states,

"The problems are particularly acute for the Air Force, which uses about 2.6 billion gallons of jet fuel a year, or 10% of the entire domestic market in aviation fuel. The Air Force's fuel costs neared $6 billion last year, up from $2 billion in 2003, even as its consumption fell by more than 10% over the same period because of energy-savings measures, including a campaign to shut off lights and lower thermostats at bases.

The Air Force wants to be able to purchase 400 million gallons of synthetic jet fuel a year by 2016, an amount equal to 25% of its total fuel needs for missions in the continental U.S. This year, it expects to buy slightly more than 300,000 gallons."

With all the handwringing about US energy security, surely it's worth first reducing our dependence on overseas petroleum, then working on the emissions issues.

Here we have a clear, proven, even old technology which will make good use of coal, the fuel which America has in such abundance that we are sometimes called the 'Saudi Arabia of coal.' And yet in the midst of tight petroleum supplies and dwindling non-sovereign control of the energy source, we needlessly hamper our own ability to convert coal into synthetic oil and gasoline.

And the Air Force tests? The Journal had this to report,

"On a clear day in March, the three men took off for New Mexico with a reporter aboard. When the B-1 crossed into the closed airspace above the White Sands Missile Range, Capt. Fournier yanked back his throttle and sent the plane climbing almost straight up, throwing the bomber's occupants back into their seats. He then pitched into a steep dive. Pens and other small objects hovered around the cabin, weightless, until the plane leveled off again.

Capt. Fournier fired the plane's afterburners and sent the bomber roaring over the range. A small dial in the cockpit showed that the bomber was flying faster than Mach 1.

Back at Dyess, the crew packed into a small conference room to analyze the flight with a crew of military and civilian officials, including a pair of engineers from GE, which makes the bomber's engines. Capt. Fournier said the plane handled normally at high speeds and on sharp turns. The only difference he noticed was that the synthetic fuel had a different smell than conventional jet fuel. "So it didn't give you the normal buzz?" one of the engineers joked.

With the B-1 certified to fly on the synthetic mix, Maj. Donald Rhymer, the deputy director of the Air Force's alternative-fuels certification office, said the Air Force would soon test fighters such as its workhorse F-16.

"Our biggest litmus test was Capt. Fournier coming out of the B-1 and saying that it was an unremarkable flight," Maj. Rhymer said as the meeting ended. "That's the subjective endorsement we're looking for with all of the planes.""

Ken Thompson Fired At Wachovia

Well, it's official. At least one commercial banker has gotten the axe for his boneheaded 'leadership.'

CEO of Wachovia Kennedy "Ken" Thompson's forcible resignation was announced this morning.

As the nearby Yahoo price chart illustrates, Thompson's Wachovia (WB) hasn't really delivered for shareholders for the past five years.

Wachovia barely tracked the S&P until early last year, when the bank's stock price went flat, while the index rose, and then plunged precipitously while the index flattened.
Guess buying Golden West, the California mortgage bank, in 2006, at the top of its value, wasn't so smart after all, eh, Ken?
Of course, the other Charlotte-based "Ken," Lewis, about whose bank I wrote here recently, has had his share of problems, as well, as depicted in the chart.
While Thompson's Wachovia actually lost about 25% of its value in five years, Lewis' BofA barely managed to stay above the flat line. Neither, at their best in the past half-decade, ever showed signs of out-performing the S&P.
In Lewis' case, the purchase of Countrywide, another California-based mortgage lender, hasn't helped BofA. The early purchase of an interest in the real estate financial firm, to help shore it up, looked expensive by the time Countrywide collapsed and offered the rest of itself to BofA at a much lower price.
Isn't it ironic that the two one-time North Carolina regional powerhouses, NCNB and First Union, by virtue of astute risk management in the 1990s, managed to scoop up the west coast money center titan, BankAmerica, and assorted other US bank chains. Then, in the latter half of this decade, squandered their shareholders' value by returning to..where else?....California to buy mortgage lenders which subsequently caused large loan losses.
Almost seems like some sort of revenge of California finance on the North Carolina banks worthy of a Greek tragedy, doesn't it?
Now Thompson's out, and Lewis is looking less and less effective.
This morning, on CNBC, Dick Bove, a long-time commercial bank analyst, opined that both franchises lost their focus and moved out of basic deposit-taking and lending, thus damaging themselves with mortgage banking.
As I wrote here last October,
"Quite simply, as a group, US commercial bank CEOs are typically less-broadly experienced and, frankly, less 'smart,' in a business sense, than their investment banking CEO counterparts.
Stretching back to the 1970s, I think only David Rockefeller and Walter Wriston were, among commercial bank CEOs, possibly on a par with their investment bank peers in terms of vision and business acumen. Even then, these two were encumbered by the inherent obligation, as leaders of large US banks, to act to protect the banking system, rather than focus primarily on their shareholders' interests."
Further on in that post, I noted,
"As I consider the M-LEC and its supporters, I can't help but see it as essentially an attempt by the less-savvy commercial bank CEOs to stave off a fire sale of fixed income assets which they abetted by their operation of various SIVs. Meanwhile, the savvier investment bank, hedge fund and private equity CEOs circle, like sharks in the water, waiting for the inevitable disgorgement of SIV assets to begin. They will wait for near-bottom prices, buy and hold and, eventually, realize tremendous profits for their risk taking."
Among the investment banks operating when I wrote that post, Bear Stearns is gone. Lehman is teetering, as it attempts to outlast liquidity concerns amidst weak performance. Merrill has been run for decades more akin to a money center bank than an investment bank.
To me, the pecking order of smart management in financial services begins with the best private equity and hedge funds. After them would come Goldman Sachs. Then.....well..I don't know if there is anyone else thereafter.
What Thompson, Lewis, and perhaps even Dimon, seem to forget is that commercial banking really only grows without excessive risk in two ways: with market demand, or by expanding geographically without overpaying for acquisitions. Typically, moving into new businesses, such as mortgage banking and capital markets, brings disaster.
It has for Wachovia and Thomson via Golden West. Lewis has capital markets losses and the specter of Countrywide's losses with which to contend.
It's too early yet to discern whether Chase has really bought anything worthwhile by scooping up the remains of Bear Stearns.
Commercial bank CEO's rarely learn the lesson of long term risk management vis a vis growth. Each large bank CEO wants their bank to be the largest, their asset and income growth to be the fastest.
To their shareholders continuing regret.