Friday, November 07, 2008

Dreamliner Delayed Again: McNerney's Continued Troubles At Boeing

Wednesday's Wall Street Journal described the new delays in its 787 Dreamliner. I last wrote about this continuing problem here, last April.

Interestingly, nowhere in Wednesday's article was any mention of Boeing's CEO, Jim McNerney. Yet, this latest setback seems to continue the company's woeful failures of management in its most visible, bet-the-company project.

You'd think McNerney would be at least addressing it personally, if not in public. As I noted in the earlier post, McNerney hasn't exactly left a trail of successes in his prior positions. And Alan Mulally, although having his hands full at Ford, is probably feeling that his erstwhile senior management is getting its just desserts for passing him over for a guy who never ran something so complex as an airplane maker.

This latest snafu on the Dreamliner involves the improbable widespread use of the wrong special fasteners on dozens of parts fabricated by the many subcontractors for the plane spread around the globe. According to the Journal's article,

"Boeing's Ms. Leach said engineers traced the latest problem to "specifications that weren't specific enough.""

You cannot make this stuff up, can you?

Wouldn't you have guessed that Boeing would have its own quality control employees in a few pilot subcontractor plants to supervise the entire process? This sounds like an overall failure of program management at Boeing. If this process was allowed to continue in this manner for so long, what does that say about the capabilities and effectiveness of Boeing's middle- and senior-management?

Thanks to this latest delay, and the little matter of Boeing's recent strike, the first Dreamliners aren't expected to be ready for delivery until 2010.

Any guesses as to how many more of these delays Boeing can take before McNerney is asked to take the fall for them?

Thursday, November 06, 2008

Michael Dell Seals His Company's Fate

Yesterday's Wall Street Journal contained an article discussing Michael Dell's efforts to cut $3B from his company's expenses.

From my proprietary research on company performance, Dell has now entered a pattern that will leave it very little chance of outperforming the S&P in the foreseeable future.
The nearby, Yahoo-sourced chart displays Dell's last five years' performance, along with that of the S&P500 Index. The company hasn't outperformed the index for several years, and has underperformed significantly over the period.
My research indicates that companies which attempt to turn around from a formerly-successful, high-growth strategy have little chance of success.
Furthermore, the total return performance premium over the index shrinks dramatically from what it was in the company's better days. The result is a very minimal expected return premium from a shrinkage of the firm, followed by an attempt at a return to growth from its 'right-sized' base.
The second chart illustrates Dell's price performance since the late 1980s. It obviously roared past the S&P in its prime, but has flattened since the dot com crash of 2000. In effect, this decade has been a 'lost' one for the company.
At this late date, Michael Dell's attempts to cut his way back to superior performance is basically wrong-headed.
Sometimes, companies are just outdated, with business models which no longer merit investment.
Michael Dell would do himself and his shareholders a favor by declaring the end of the era in which his model excelled. Next, he should merge Dell with another retail tech product provider, or close it, and spare his shareholders further needless loss of their remaining capital.

Wednesday, November 05, 2008

My First Trip To Whole Foods

I recently had the occasion to visit a Whole Foods store for the very first time. Separately, Monday's Wall Street Journal contained an article discussing the company's recent troubles extending its growth in the current economic environment.

My first impression of the store was how different is its layout is from most other chains. It reminded me of Trader Joe's, whose aisles are also laid out in odd patterns, and similarly narrow.

These aisle patterns and widths seem to discourage fast, volume-oriented shopping. Supporting this, shopping carts are smaller, too.

In line with the Journal's piece, I noticed some fairly high prices on many items. Not uniformly so, but sufficient to make it clear that spending most of one's grocery dollar at Whole Foods would quickly make a major dent in your budget. Following up on my daughter's questions about some cuts of beef, I noticed that Whole Foods' offerings were literally triple the price of the same items at Costco, from which we had just come.

The mix of customers were more like those I saw in Trader Joe's, too, and less like other, larger local grocery chain stores. For example, there seemed to be fewer parents with young children. Perhaps the largest difference I noted was that lack of pace of other shoppers. Some were obviously married, empty-nesters, taking a lot of time strolling through the store.

On a Sunday afternoon, the store did not seem especially crowded. Then again, maybe it never is. As I noted, this was my first visit.

Turning to the article about Whole Foods in Monday's Wall Street Journal, it seems that perhaps what I observed on Sunday echoes what the chain is experiencing nationwide.

Nearby are the 2- and 5-year price charts for the company's stock and the S&P500 Index.

For the past 24 months, Whole Foods' equity price has fallen by some 80%. It's decline really accelerated in the past 12 months.

Looking back further, the 5-year chart shows the company's rising fortunes in 2004 and 2005. Beginning in 2006, however, the peak of the company's equity price had been realized.

Thus, there may be a lot of truth in a quote appearing in the Journal piece by Bob Summers of Pali Research,

"It's kind of the wrong time, wrong concept."

For what it's worth, the local, lower-priced Stop & Shop chain has organized its own product portfolio into a private-label organic brand. Further, it has grouped those items into one section of the store. So the organic-based differentiation of Whole Foods has already been competitively addressed by other chain stores in the area, including BJ's and Costco.

That makes the overall tone of the Journal's article quite believable. It notes the lack of cash on Whole Food's balance sheet, and its Starbucks-like wrangling with landlords in various shopping centers as it attempts to back out of prior lease commitments.

It's not hard to see the company continuing to appeal to a segment of high-income, small-family or empty-nest couples and singles who wish to consume only organic food and can pay the higher prices for it. That's a reasonable strategy, but for a niche player, not a nationwide chain of large grocery stores.

The next 12-18 months should be interesting ones in which to observe Whole Foods adapt to economic changes in the US.

Tuesday, November 04, 2008

Bernanke's Next Step To US Bank Nationalization: MBS Insurance

This weekend's Wall Street Journal reported on Fed chairman Ben Bernanke's comments, delivered to a mortgage finance conference via video link, on a continuing Federal role in housing finance.

My business partner and I have reasoned, since the Fannie and Freddie takeovers, that the government is unlikely to allow the past levels of profitability in mortgage finance to continue in the future. It's the simplest way to avoid a repeat of the excesses of the past few years and recent real estate lending cycle.

I've written a few posts on the nationalization of US banks, both recent, and, ideally, in the future.

Part of those futuristic musings of mine came a step closer to reality with Bernanke's comments. I actually saw part of his address live on Friday, but didn't know the context of what I was viewing.

In his remarks, Bernanke sketched out a continued role for the Federal government in housing finance in at least one of three ways: heavily regulated covered bonds to back mortgages; a 'public utility' model which featured a cooperative between private mortgage originators and GSEs, or; Federal mortgage bond insurance.

Taken in conjunction with Bernanke's comments concerning the difficulty in making the current GSE model function, it's not clear how the 'public utility' model is really any different than the current one.

But his description of government-issued mortgage bond insurance sounds like the sort of step that will further cement a nationalized banking system into place.

Can you imagine trying to sell mortgage-backed bonds in a market without such Federal insurance, when all the competing, similar bonds carry the Federal insurance? It would seem foolish.

About the only way you could do so would be to market the mortgage equivalent of high yield, or junk bonds. And we just saw what has happened to those in the past year. Much like the original junk bonds, such a mortgage-backed variant, even without the CDO overlay, would only be attractive during periods of risking markets.

But, back to Bernanke's comments. Introducing government-sourced mortgage bond insurance would encroach upon the conventional, private-sector bond insurers, such as MBIA and AMBAC. However, observing their disastrous plunge into insuring CDOs, it's unclear whether they could credibly re-enter the non-municipal bond insurance market again and offer simple mortgage-bond insurance.

With government provision of mortgage bond insurance, there would likely be a permanent foreclosure of the market to private enterprise, much like the effective elimination of private mortgage conduits when Fannie and Freddie were allowed to dominate that market.

We are probably seeing, therefore, the next concrete step along the road to heavy governmental regulation and de facto nationalization of core banking and lending functions in the US.

Nassim Taleb's Black Swan Appeared

Nassim Taleb, author of the recent hedge-fund-related book, "The Black Swan," directly influenced the optionization of the equity strategy which my business partner and I have been operating for over a year. In this second Taleb-related post, based upon a Wall Street Journal piece, I noted the likely inconsistency of returns to Taleb's strategy,

"In it, Taleb's approach is described in more detail than prior articles I have read. It reinforced my feeling that his is a very inconsistent strategy. That is, he is constantly buying puts, losing a little money routinely, in hopes of profiting from the really big market meltdowns. This is what I more or less sensed from my prior reading about Taleb's hedge funds.

In the Journal piece on Friday, however, Taleb's performance is discussed. His last fund earned a 60% return in 2000, then lost money in 2001 and 2002, with only low single-digit gains for the next two years. He closed the fund on the heels of such mediocre performance, during years when conventional hedge funds rack up much higher gains.

Thus, Taleb's approach, and, probably, that of the new fund using his ideas, tends to be erratic, and depend upon high volatility to earn large returns."

Of course, the events of September and October, with their double-digit negative monthly returns, provided the once-in-several-decades windfall that is the payoff of Taleb's deep out-of-the-money put strategy.

The question now, of course, is how the Taleb-inspired fund will do in the coming months. Yesterday's Journal piece noted,

"He also helped start a hedge fund, Universa Investments L.P., which bases many of its strategies on themes in the book, including how to reap big rewards in a sharp market downturn. Like October's.

Assets under management at Universa have neared $2 billion since the fund launched early last year with $300 million under management. While Mr. Taleb frequently consults with Universa's traders, the Santa Monica, Calif., fund is owned and managed by Mark Spitznagel, who worked for several years in the 1990s as a pit trader on the Chicago Board of Trade.

The strategy, which keeps more than 90% of assets in cash or cash equivalents such as Treasury bonds, either breaks even or loses small amounts in most months while waiting for periodic, infrequent spikes in volatility.

While the black-swan strategy has paid off handsomely this year, it hasn't always. Mr. Taleb's previous fund, Empirica Capital, which used similar tactics, shut down in 2004 after several years of lackluster returns amid a period of low volatility. The strategy may face another test after the current bout of market turmoil."

The piece goes on to question whether investors will remain with the fund, once the prospect of more deep market downdrafts has lessened.

My partner and I have considered this question, of course. It's a variant the one which was resolved for me years ago by a wealthy private investor during a brief stint doing research with him. A former economics professor who ventured out on his own and made a tidy fortune, he was interested in developing the equity strategy engine for a potential hedge fund group, and wanted to assess my strategy for that purpose.

While not putting it into quite these words, this investor was unequivocal in noting that, in some market conditions, one simply has to be out or short. Long-only strategies get so badly mangled in a downturn like the one of the last two months that they struggle to repair the resulting damage. Especially since most equity strategies which outperform in up markets tend to lose a lot more in serious down markets.

This brings me to Taleb's work, because he has a viable approach for the rare, but spectacularly damaging sudden bear equity market of short duration.

Few investors correctly saw the sudden wind shear-like drop coming, thinking, instead, that the evolving financial markets troubles and looming recession would temporarily dampen equity returns.

Truly, these past two months were the sort of 'black swan' event for which Taleb is so well-known.

The trick to being able to maintain a long-running equity or derivatives strategy is to have functioning approaches for both healthy, upwardly-trending market periods, and the few, dramatically falling periods. Effective transition between these two different types of market conditions is key.

It seems that Taleb's huge gains in short periods of tremendous market declines are not matched by his provision of any type of reasonably competitive long-oriented equity or derivative strategy. But investors will look for either a strategy capable of switching gears to match market conditions, or will simply switch allocations out of such single-market condition funds.

Monday, November 03, 2008

Gasparino's Strange Behavior Last Week On CNBC

Quite a few readers were searching recently for a CNBC video of Charlie Gasparino 'losing it' on air.

After a few days, this clip surfaced on YouTube. I think it is the one for which those readers have been searching.

Les Moonves' Missteps At CBS

Friday's Wall Street Journal featured Les Moonves' CBS in its 'Heard On The Street' column. It's an instructive piece because it describes how much of a step up the job of CEO can be, and frequently is, from merely running a business unit within a multi-business company.

In Moonves' case, he was unhappy being cast as CEO of the slow-growth component that was spun out of Sumner Redstone's Viacom when that conglomerate failed to generate promised returns.
The nearby, Yahoo-sourced price chart for CBS and the S&P500 Index shows how badly Moonves has performed at the helm of CBS since its 2005-06 spin off from Viacom. A 50% loss in price, with a significantly faster decline in the recent market turmoil than the S&P hardly provides evidence of his successful leadership of the one-time radio and television network.

As the Journal piece notes,

"With radio and TV ad revenues declining sharply amid the slump, analysts are questioning whether CBS can maintain its generous dividend that has the stock currently yielding 11%. CBS dismisses such concerns. Indeed, CBS's indebted chairman, Sumner Redstone, can ill-afford a dividend cut.

Still, that the question is being raised at all suggests CBS hasn't husbanded its cash resources as well as it should.

Since splitting from Viacom at the end of 2005, CBS has generated more than $4 billion in free cash flow. Prudently managed, and together with well-timed asset sales, CBS should by now have accumulated a decent cash hoard to tide it comfortably through a downturn.

But CBS Chief Executive Leslie Moonves never made any secret of his impatience with CBS's slow-growth image. So while he raised more than $2.3 billion selling small radio and TV stations as well as theme parks, he has spent about as much buying digital businesses, including CSTV, and the $1.8 billion all-cash acquisition of CNET last summer.

Moreover, he squandered $3.4 billion on ill-timed stock buybacks last year, paying an average of $32, which was only a little below the stock's high point of $35 since the split and more than three times the approximately $9.40 where the stock is now trading.
Along the way, he also steadily raised the dividend. CBS is now paying $1.08 a share at an annual cost of roughly $725 million.

If Mr. Moonves wanted to build a growth business, he would have been better off jettisoning the "high dividend" promises. He then could have been more aggressive at reshaping the CBS portfolio, potentially through the complete sale of the fast-declining radio group two years ago.

By aiming for two goals at once, he is likely to fall short on both."

What seems clear is that it hasn't been simply Moonves' desire to pursue growth business in media that has caused problems for CBS.
The financial skills of managing balance sheet liquidity and squaring that management with the company's mix of businesses seems to have eluded Moonves.
Even if Moonves' defense is that Sumner Redstone imposed dividend policies, due to his continued role in CBS, that does not excuse the results.
It doesn't take much observation of technology- and growth-oriented companies to see that investors in those enterprises give up dividends in exchange for superior growth in value.
Unfortunately for Moonves, he pumped out cash for dividends and acquisitions just as systemic liquidity are at a record low for at least fifty years. Not only has Moonves gotten the mix of liquidity management and business mix wrong, but he got the timing of that mistake wrong, as well.
It's a good lesson in why it's actually rare to find a CEO and a company which fit together such that the former can manage the latter to consistently superior total returns for shareholders over time.

Sunday, November 02, 2008

Could Dick Fuld Have Been Legally Stopped From Destroying Lehman?

Quite a bit of ink- real and electronic- has been spilled regarding Dick Fuld's failed Lehman Holdings.

Last week, or perhaps the week prior, there was an interesting discussion on CNBC concerning the timeline and actions, or inactions, of various players surrounding the Lehman bankruptcy.

For example, there are stories of several in-person meetings between Fuld and Treasury Secretary Paulson. Some say that Paulson pointedly told Fuld to raise more capital or suffer the consequences. Others say this was not the case.

Fuld is clearly under the microscope for potentially having told his staff and executives one thing about Lehman's capital adequacy and plans to raise more, while telling investors and analysts something different. If this is proven to be true, with bad intent, Fuld could be facing jail time.

Stepping back, the larger question would seem to be this:

Can and/or should the US Federal government, either through cabinet officers or regulators, intercede with financial sector firms and either take possession of them, or direct them to take various actions, prior to a bankruptcy?

Is a concern that a firm's reckless or ill-advised courses of actions will 'cause some problem' or 'cause something bad to happen to the financial system,' of an undefined nature or magnitude, sufficient to justify the taking of personal property in the form of a publicly-held financial services firm?

Several people, including John Gutfreund, former Salomon Brothers CEO, have opined that Fuld should have known sometime late last year that he wasn't going to be able to maintain Lehman's independence for very long into 2008, as a solvent company.

Even if this were true, does that mean the Federal government should have interceded just based on fears, rather than facts?

Was Fuld's continued running of Lehman as an independent firm criminal?

These are not trivial questions.

For example, Treasury, the Fed and the FDIC have all taken actions in the third quarter of this year which would have been totally unacceptable, had they taken place one year earlier. Yet, had they taken place in 2007, the serious meltdown of fixed income and equity markets might not have occurred to the extent they have in recent months.

Was AIG necessary, or an overstepping of legal boundaries? WaMu? Fannie and Freddie?

In the case of the latter two GSE's, given that Congress and at least two Presidents encouraged these firms to securitize problematic home loans, is it fair for citizens to have lost equity value due to government's incompetence?

What is the desirable path in our mixed-economy? What are the appropriate uses of, and curbs on Federal power in maintaining the health of our financial system, while also respecting private property rights?

Motorola's Impressive New CEO

Wednesday's Wall Street Journal featured Motorola's new co-CEO, Sanjay Jha, in an article in the Marketplace section.

Based on what I read, Mr. Jha is one impressive executive.

The article provides details on Mr. Jha's scrapping of a large part of Motorola's existing cell phone line because it uses too may different operating systems. He seems like a very decisive, hands-on co-CEO.

But these passages in the article really got my attention,

"Within days of arriving, Mr. Jha told employees gathered at the mobile-device division's Libertyville, Ill., headquarters, that he was proud to be a part of the pioneer in wireless communications, and asked employees to focus on developing the applications and services that could restore Motorola's leadership.

By late September, however, Mr. Jha noted that the company's problems were more basic, ranging from late deliveries to clumsy user interfaces. Mr. Jha told employees his wife carried an LG Voyager and refused his offer of a Motorola phone. She, like other consumers, didn't want to have to read a user's manual to figure out how to use it. "When my wife switches, then you'll know," he said, according to a person at the meeting.

Mr. Jha has restricted his visits to a few important partners, including Google, calling others by phone to introduce himself. "I'd love to come see you, but first I have to figure out what to tell you," he told the head of a European carrier. "My hands are full." "

I'm a big believer in senior executives being plugged into the real world, and Mr. Jha's story about his wife hit home.

So did the brutally honest phone calls he's made to customers.

You have to love a CEO that blunt and realistic, even with his customers.
One look at the nearby price chart of Motorola and the S&P500 Index for the past five years demonstrates that Mr. Jha both has his work cut out for him, but also has little risk, considering how far the company's stock price has plummeted since its high in late 2006.