Friday, June 13, 2008

What Shareholder Democracy Does NOT Mean

This week's news is replete with opportunities to discuss 'shareholder democracy.'

Dick Fuld's Lehman Brothers has mismanaged itself so badly for the past year that there are serious questions about its long-term viability. Fuld sacrificed his CFO and COO yesterday.

Where's the shame, Dick? How about your scalp, too?

Then we have Carl Icahn fighting for the average shareholder at Yahoo, seeking to replace its board with his own slate. Mr. Icahn, known as a corporate raider several decades ago, does pretty much the same thing now, but with a much better image.

Whereas he and his ilk were thought to be simply greedy in the 1980s, now they are more correctly viewed as threatening inept boards and corporate management teams.

Over at Citigroup, the current CEO's hedge fund, Old Lane, has finally been closed by the bank. Remember that it was Bob Rubin, Citi's Chairman, who pushed the bank to buy the untested, new fund in order to get Pandit. Now, the fund's mismanagement has caused outside investors to flee and the whole mess to be simply closed. At tremendous cost to Citigroup's shareholders.

Where's your shame, Bob?

Finally, we see InBev formally go after Annheuser-Busch, the American brewing giant headed, but not controlled by, a member of the company's founding family.

To a greater, or lesser extent, these corporate situations all involve an aspect of that now politically-correct, perennially-hot topic, shareholder democracy and its cousin, corporate governance.

As I understand the manner in which Congress, and many institutional investors, define shareholder democracy, they believe company owners, using their votes for slates of directors and various issues on proxy statements, should exert their will on a company's board of directors and management team.

Forgive me for being out of step, but I don't buy that. To me, that is not what shareholder democracy means.

In my view, shareholder democracy means one thing, and one thing only.

I can buy or sell any US equity for an inconsequential brokerage fee into a liquid market in which a price exists by reason of the competing forces of buyers and sellers for that, and other equities.

Look at the nearby Yahoo-sourced five-year price chart of the companies I mentioned above, and the S&P500 Index.

What do these companies have in common?

First, none have had a five-year run about which their CEOs should, or can be proud. Yahoo barely beat out the passive S&P Index.
As the next chart shows, also for the last five years, next to Google, Jerry Yang and Terry Semel did nothing for their shareholders.
So, what's my point?
This. Why would anyone own these turkeys, when there are many more, better-performing equities in the US markets?
A second thing all of those equities share is that we- my investment partner and I- don't own any of them, or options thereon, in our portfolios.
Sure, Carl Icahn, with billions to invest, representing his fund holders, has the experience, cachet and financial heft to take large positions and then create upward pressure on a stock because of what the market believes will probably occur once he gains influence over his target's board.
But the average investor- even an institutional one- is not Carl Icahn.
For the vast majority of them, the myth of voting their shares to change corporate behavior is just that- a myth.
The real genius of the US equity markets is the average, or even rather large investor's ability to simply sell what s/he no longer thinks is a good investment, and buy something else, at a very low transaction cost, and virtually no impact on market price.
Next to this simple, easy-to-understand capability and expectation, the long, expensive and typically futile process of buying sufficient shares to vote a board out or otherwise influence a company's management seems agonizingly difficult.
Finally, let's take a moment to consider the genesis of our modern publicly-held common stock corporations. I don't believe they exist because hundreds of colonial Americans came together down near Wall Street back in the early days of the country, near a buttonwood tree, to demand access to then-private investment vehicles.
No, I'm guessing our modern corporate form owes more to the Dutch and British trading companies which had common shareowners. These firms needed to raise capital, and issuing shares to investors was a good way to do that without the cumbersome need to have hundreds of equal 'partners.' Instead, a board was 'elected' by the shareowners, but the operating officers of the firm really ran the companies.
Even today, how many shareholders actually nominate directors who win board seats? Very few. Mostly, it takes a Carl Icahn to do that.
So the intent of the publicly-held corporation was never to let shareholders actually influence how the company was run. It was to give them the feeling that they voted for a group of respected people who oversaw the company's management.
Truth is, the people who founded and ran publicly-held companies, or do so today, don't want shareholder interference- just their money.
People, wake up! Shareholder democracy means you can enter and exit a publicly-held company's shareholder group easily and with minimal price impact.
It doesn't, never did, and is not supposed to mean you actually get to influence the management team, nor how much they are paid.
If you like the total returns you (could) enjoy from a company's management, then buy the firm's stock. If you don't, then don't buy, or sell it.
Believing that you, as an investor, can do anything more, with any real effect, is simply to delude yourself.

Thursday, June 12, 2008

More On Lehman's Slide To Oblivion

Today's breaking financial service sector news is all about Lehman- again.

This time, the firm announced the departure of its CFO, Erin Callan, and its COO, Joseph Gregory.

Somehow, amidst the firm's turmoil and management mediocrity, CEO Dick Fuld remains untarnished and firmly in place.

As the nearby Yahoo-sourced three-month chart for the embattled investment bank and the S&P500 Index clearly shows, it's been a stunningly-fast decline for the firm's luckless shareholders.

Or, maybe witless shareholders?

In just three months, Fuld and his team have managed to destroy roughly 50% of their shareholder's value, while recapitalizing the firm just three days ago by about 50%, after first saying it was unnecessary.

While Lehman is the smallest and weakest of the four remaining investment banks- Goldman, Merrill and Morgan Stanley being the other three- one wonders why anyone would have bought equity in these firms after January. Especially in Lehman.

Trying to time 'turnarounds' is dicey in the best of circumstances. In financial services, trouble tends to come from excessive, poorly-managed risk. In Lehman's case, this is true in spades.

Being number four doesn't just mean being smaller. When it comes to risk management, judging by the results of the past twelve months, it seems to also mean just being worse at this key financial service firm function.

That said, I would simply re-emphasize the conclusions of my prior posts about Lehman, found here and here.

To repeat David Einhorn's observation, Lehman has added capital it said it didn't need, to offset losses it had earlier denied experiencing, from instruments about which it was less than forthcoming.

Now, the firm has jettisoned its two key members of its own mis-management team.

What trust can possibly be remaining by anyone regarding Lehman? Investors? Debt holders? Eventually, even counterparties and customers will worry about the safety of their assets or trades, and the slide into oblivion will accelerate for Lehman.

This time, though, Hank Paulson & the Fed have recent experience with Bear Stearns on which to draw to manage a less market-affecting end to the smallest public investment bank.

Wednesday, June 11, 2008

Dennis Kneale's Succinct Analysis: We Are NOT In Bad Shape

Yesterday on CNBC, co-anchor Dennis Kneale, late of Forbes, presented the very defensible and, in my opinion, correct view that the seemingly-widespread handwringing about the current US economic situation is overdone.

As Kneale noted, 1980 was far, far worse than 2008.

Back then, the price of a barrel of oil was roughly $107, versus $130 now, a rise of slightly less than 30%. But consider the following other measures.

The average fuel efficiency of a car was 25mpg in 1980, versus 32mpg now. Even with so many SUVs on the road. That's a rise of roughly 23%.

What about non-transportation usage of oil for power generation? Six years after the initial 1974 oil embargo, the US generated only 10% of electricity generated from oil. Now, it's down to only 1.6%! More than an 80% decline.

The inflation outlook is similarly different now from then. Back in 1980, a typical monthly CPI change was 1%, in contrast to today's modest .2%. Again, an 80% decline!

Lastly, interest rates are at totally different levels. In the Carter era, rates were north of 10%, whereas now they are far lower, with Treasuries at 4% this morning.

Yes, the Carter era was incomparably worse than today's Bush economy.

The US is nowhere near the levels of misery index and widespread despair that led to Carter's mistaken steps such as: windfall oil profit tax, gasoline rationing, and lectures to Americans on reducing credit usage and wearing more sweaters.

Certainly, with a Presidential election season gearing up, we'll be hearing a lot from at least one candidate about how the US is on the brink of depression, failure, catastrophe, etc.

Don't you believe it.

Tuesday, June 10, 2008

The Beauty of Markets: Energy and Julian Simon

Wednesday's editorial in the Wall Street Journal by Holman Jenkins, Jr., entitled "The Coming Oil Investment Boom," largely sums up my own thoughts on the current situation involving oil supply, demand and price.

Congress is engaged in folly, as it both tried, and failed to pass a massive piece of pork masquerading as an energy bill, decries the result of functioning world oil markets, demands more supply from others, yet won't fully exploit America's own energy supplies.

But, as Jenkins writes, the real world is reacting correctly to the oil situation,

"With a couple billion Chinese, Indians and others joining the global marketplace, they will need energy, and lots of it. The price mechanism is our only hope.

Sure enough, it's working. Money is pouring into Canada's massive tar sands. A thousand substitutions are taking place on the demand side. Sales of SUVs are falling; sales of four-cylinder sedans are up. The number of miles driven by American motorists shrank in February for the first time in 26 years.

At $70 a barrel, we worried only that the folly of India and China in artificially holding down prices to consumers would spread. The news is happy here too. Taiwan, Indonesia and Malaysia are cutting back subsidies or thinking about it. India and China may not let prices float anytime soon, but they're letting gas lines and spot shortages ration supply anyway."

Yes, already consumers and markets are adjusting supply and demand via price, while onlooking producers and investors are also behaving rationally. New substitutes for conventional, oil-based hydrocarbon energy are being developed without any government mandating them.

Jenkins continues by opining on whether the current price of oil is largely a function of speculation,

"If today's towering price of oil reflects some speculator's bet on a long-term scarcity of liquid motor fuels, this will prove the misguided bet of a lifetime. Hydrocarbons are abundant and can be extracted from living plant matter as well as from their fossil remains. Many oil fields under current technology are considered depleted when they're still 50% full. But technology advances, doesn't it?

Yet there's one miracle of adaptation that even $135 oil apparently can't vouchsafe. It can't bring intellectual coherence to American rhetoric or policy on energy.

By one count, America sits on enough oil and gas to meet its own needs for half a century. We won't help ourselves although our environmental delicacy somehow doesn't stop us from screaming at other countries to tear up their own pristine wildernesses to supply us with cheap energy. President Bush rushes to the Saudis, supplicating for more oil. Congress threatens OPEC with antitrust action. Go figure. That U.S. politicians can afford to indulge a persistent unreality about a basic input of industrial civilization only testifies to how responsive and resilient the global energy market has been despite the political silliness it meets at every turn."

This passage really hits home. Just this morning, on CNBC, the Democratic governor of Kansas spent several minutes speaking carefully out of both sides of her mouth. When asked directly by the program's guest host, a Bush administration economic official, whether she supported exploiting US energy resources currently off-limits due to Congressional legislation, the governor managed to say everything and nothing. She's for conservation and lower energy prices, preservation of American wilderness for future generations and energy production.

Nowhere did she acknowledge how silly American politicians look as they behave as described by Jenkins- demanding the despoiling, if that's what it is, of other countries' environments to supply the world with more, less expensive oil.

As I wrote here in November, Julian Simon would be nonplussed about the situation. Without the signals of higher oil prices, how will markets and consumers ever know to behave in ways which allow market forces to bring about solutions?

As Jenkins writes,

"But the biggest fools today may be those greenies who are clapping their hands over $135 oil as if this somehow represents the beginning of the end of fossil fuels. High prices are not the equivalent of carbon taxes – they will have the opposite effect in the long run, spurring investment and technological progress to bring vast new resources of fossil energy into production. For instance, turning coal, oil sands and oil shale into motor fuels, which is cost-effective at half of today's oil price, means massive additional releases of CO2. It's the worst nightmare of the climate worrywarts."

Yes, indeed. Because if you think that the US Congress or any other governmental body on the planet knows more about which energy sources, at what prices, should be developed to replace oil, you deserve the ham-handed governmental solution you're going to get from that.

In summary, Jenkins contends that the global warming crowd needs to 'grow up',

"Growing up would begin with recognizing that science doesn't prove the case against CO2. Our political system has been looking at the problem of climate change for a generation, and lack of action is not due to the machinations of big oil – but to the inability of policy to bridge a giant chasm between proposed costs and benefits. Even if carbon's guilt is assumed, the economics are far from certain that it wouldn't be cheaper just to endure a changing climate.

Growing up would also mean realizing that climate activists are in danger of losing all political credibility as they become handmaidens to corrupt pork bonanzas for the corn ethanol lobby and Silicon Valley alternative energy impresarios. Look no further than the climate bill being debated on Capitol Hill this week. The only real question it poses is how much Congress will spend on climate pork while having no discernible impact on climate.

Finally, growing up means recognizing that their one politically and morally saleable proposition is to offer carbon taxes as a de facto consumption tax, with the proceeds used to offset labor and capital taxes that discourage work and investment. This would be a case of taxing "bads" not "goods," with benefits for growth and the average voter's bottom line independent of any problematic evidence about CO2 and climate.

Voters and their representatives then could at least contemplate supporting a climate policy on cost-benefit grounds, rather than on the religious posturing that Al Gore and others adopt to push what they can't sell rationally. Will the greens learn these lessons? Not likely – which is why $135 oil may prove the beginning of the end of any political movement to do anything about climate change."

That last sentiment is really insightful. How many times do politicians mandate what won't sell on the free market? When you hear "mandate" from a legislator, look out. Someone's lobbyist hit pay dirt and you're going to pay.

In this case, as Jenkins notes, what Al Gore and company can't present as a salable proposition in the free markets, they hope to connive and manipulate the US Congress to mandate instead.

That energy/climate change bill mercifully failed already. In the meantime, people we don't even know, and some who we do, are busily engaged in innovation to supplant $135/barrel oil with new energy solutions for America and the world.

If we're lucky, oil prices will remain relatively high long enough to see these new technologies come to market and result in the world moving again to a lower long-run energy cost curve.

Monday, June 09, 2008

Lehman Again- Today!

Back in April, here, shortly after Bear Stearns' demise, and, again, more recently, here, I have written about the remaining weakest investment bank, Lehman Brothers.

Currently, the smallest public major investment bank is having difficulties due to largish losses and a very public fight with short-seller David Einhorn.

Einhorn was on CNBC one morning last week, launching salvos against Richard Fuld's Lehman. Lehman has been studiously silent and declined to also appear on CNBC to answer Einhorn's allegations regarding the investment bank's asset quality and probable writedowns, plus their need for capital.

This morning, as I write this, the news is that Lehman is, in fact, seeking some $6B in commmon and preferred equity to remain in decent shape in terms of its balance sheet.

On CNBC discussing all of this is, shock of shocks, my old boss of bosses, George Ball, once CEO of Hutton, now a part of Lehman, and, later, PruBache Securities. I find it curious why the former CEO of what were essentially retail wire houses would be the appropriate guest host to discuss a primarily institutional investment bank's potential demise.

And, to make my point, Ball was mouthing silliness such as, maybe when Fuld is under fire for leverage, is the time he should shrink, stay independent, and lever up even more, to stay independent!

You can't make this stuff up!

Who exactly does Ball think will lend a levered up Lehman more money? And with less total asset cushion, as they sell off assets to manage risk?

More to the point, the talk on CNBC was about just who would want to buy Lehman at this point. Like me in the second linked post, they felt that Lehman's business model is now hopelessly and fatally flawed.

And, like me, they considered the really strong players- private equity and hedge funds. I didn't bother to write about this element of the Lehman endgame, but it's sensible to me.

Commercial banks don't really need a Lehman, since they all compete with it anyway, lend it money for liquidity, and, to a bank, are in fairly serious straits themselves just now.

The more likely result is for the Blackstones and their ilk to cherry pick the choice employees and, finally, bid for parts of Lehman's balance sheet, after forcing writedowns of the toxic stuff.

The real issue here is, again, public versus private ownership of these types of financial institutions. As I've written for nearly a year now, the really good financial services talent, except for Goldman, has left for the private world years ago.

If you think I'm wrong, consider Dillon Read. How many times has that boutique investment bank sold itself to a slow, fat public financial services company- Equitable comes to mind in one round- at a market top, only to buy itself back at the bottom? I have literally lost count.

But it begs the question of why anyone thinks there are really good opportunities for long-running, consistently superior total returns at any publicly-held financial service firms anymore, when their competition is off the radar screen, in the privately-held world.

I suspect that if today, this week, this month, aren't the end of Lehman as an independent publicly-held company, they probably mark the beginning or middle of the end of that era.