Friday, September 18, 2009

About The Kodak-KKR Financing Deal

I read of the Kodak-KKR financing deal yesterday with mixed feelings. It wasn't until today, reading another, more analytical piece in the Wall Street Journal, that I settled on a final opinion of the matter.

It seems to me that Kodak's CEO and senior management are probably guilty of some poor corporate governance behavior.

In retrospect, the Journal's Thursday edition headline, "Kodak Gets Financial Lifesaver from KKR," should have immediately tipped me off. Yet another management team of a publicly-held company enriches lenders at the expense of its own shareholders.

The way the deal is structured, KKR comes out much like Warren Buffett in his GE financing deal. KKR gets a 10% rate on its loan of up to $700MM, warrants that are already in the money, and senior status to all other Kodak debt.

The article, and this morning's analysis, note that KKR has, predictably, feathered its nest on both the upside and downside. They get a hard 10% income stream and the best protection available on the balance sheet. If Kodak miraculously improves its condition, KKR then gets to convert warrants to own up to 20% of the company.

You have to ask, as I did this morning, reading that second piece, out of whose hide do these generous terms come?

Why, the Kodak shareholders', of course. And I didn't notice any changes in management compensation. You know, like tying bonuses or large parts of salaries to Kodak's total return.

No, the management is basically rolling the dice with their owners' money, after having pissed away so much of it over the past five years, as I noted in this recent post.
Schumpeterian dynamics, as I noted in that post, have gutted this company's ability to function in a manner that would deliver its shareholders consistently superior total returns.
What does management do? Does it explore avenues to reap gains on sale of assets to those who could more profitably use them? Or at least stem the losses? No.
Instead, they are doubling down with borrowed money. Expensively-borrowed money, at that. Paying 10% in an era of 0% Fed funds.
Am I the only person who wonders why those choosing to remain as shareholders in this hapless has-been aren't suing to block the KKR deal?
As for me, I simply don't own this pig.

Thursday, September 17, 2009

Michael Porter Is Over The Hill

I regretfully sat through too much of Harvard professor Michael Porter's visit on CNBC this morning.

If Porter isn't emeritus yet, he should be. If that.

I have never actually held Porter in very high regard. The 'competitive strategy' books for which he became known in the late 1970s were, in fact, merely rehashed microeconomics, with generous dashes of findings from the Strategic Planning Institute's PIMS database. Friends of mine from that organization related that Porter had spent months over at their shop, due to its historic tie to Harvard Business School, using their then-current and copious business-unit level database.

Now, with time and thinning hair, Porter is introduced as a 'competitive strategy expert.'

On what basis, I still ask? His books provided no new information. To my knowledge, no one ever hired Mike as a VP of competitive strategy, and then announced some heretofore unachieved total returns over time. Or share gains. Profit. Etc.

You get the idea.

This morning, Mike launched into now-typical accusations against and descriptions of the US medical/health insurance sector, with nary a statistic nor fact within sight.

He began by declaring various European countries to have 'superior' health care systems, and ours to be of inferior 'quality.' Then he held forth on the inadequacy of US health care distribution and lack of universal coverage, declaring those to be worth rating US medical care as subpar.

Apparently, I wasn't the only viewer who had misgivings about Mike's rather loose and cavalier manner of evaluating the US health care sector.

About fifteen minutes later, co-anchor Joe Kernen, in response to many emails which had flooded the program in that time period, asked Porter to clarify his earlier comments.

At which point Porter backtracked, suddenly declaring that, for serious illness, US medicine was, and is, in fact, on a par with, if not superior to that of other countries. He then sharpened his criticism to that of 'delivery' and 'coverage.'

Well, that's fair. But he's not known as a medical care delivery and coverage expert. And Mike provided not a shred of comprehensive, non-anecdotal evidence to support any of his statements this morning. And his little intellectual two-step made him look old, doddering and unable to communicate his thoughts. If he even clearly understood them himself, in the first place.

They may as well have had him on to opine about financial regulation or energy policy. Neither of which is he known for having studied, either.

In fact, it was extremely disappointing to see the program's anchors completely avoid asking Mike some questions that would have taxed his supposed expertise.

For example:

-Given your years studying industry structure, Mike, what do you think is the most likely competitive structure of the health care sector, consistent with sustainable profitability and competitive total returns?

-How do you think some of the proposed new regulations will alter what would be, in their absence, an optimal, terminal competitive industry structure in this sector?

-What do you think of current expense and profitability levels in the health care sector, as compared with; other US economic sectors, long run sustainable profit levels, global comparables.

-How would eliminating or relaxing policy mandates, and allowing inter-state health insurance competition, affect competitive structure, profits, total returns, and overall performance in the sector?

-If the government eviscerates profit in this sector, either through regulation, and/or a government-owned competitor, how do you envision that type of 'competition' comparing with competition from relaxing interstate marketing and policy mandates?

I'd have really appreciated hearing Porter's thoughts on those topics. Sadly, nobody thought to have prepared such a list to ask him. What a waste.

The guy has one alleged speciality, competitive structure analysis, and the CNBC co-anchors and staff couldn't even be bothered to tap it in an intelligent fashion while Porter spent about half an hour on the set.

Wednesday, September 16, 2009

Two Contrasting Views of The Impact of Lehman's Failure

Today's Wall Street Journal presented two starkly differing anniversary reviews of the failure of Lehman Brothers.

Two finance professors from the University of Chicago, John Cochrane and Luigi Zingales, argued, with hard, credible quantitative evidence, that it wasn't Lehman's demise, but Hank Paulson's and Ben Bernanke's panicked testimony to Congress a few days later, that caused financial markets to begin to fail, too.

On the other side of the argument, with little but hearsay and a few top-line numbers sizing the mutual fund market, is the Journal's own financial columnist, James B. Stewart. Augmenting Stewart's piece in the paper was an afternoon appearance on CNBC, wherein he went beyond his Journal article, contending that Lehman's failure was a financial system near-death event, and that no firm like Lehman should, or could, now, ever be safely allowed to fail.

Whom to believe?

Well, first, let's review the academics' piece. Cochrane and Zingales present a graph showing clearly that shortly after Lehman's bankruptcy, spreads of instruments like Libor-OIS rose only 18 points, whereas it rose more than three times that within two days after the Treasury Secretary and Fed Chairman sounded the general financial alarm and demanded that the TARP legislation be passed.

Since the TARP was never actually used as described, it wasn't even the source of any significant calming of the financial markets.

As to the importance of the Lehman failure, or its rescue, they wrote,

"Would a Lehman bailout have averted a panic? The news would still be that Lehman failed, and markets knew bailouts would not last forever. After all, the Bear Stearns rescue in February had just postponed worse trouble."

Cochrane and Zingales go on to contend that the real lesson in Lehman's bankruptcy "cannot be that the government must always bail out every large financial institution."

They cite the 1984 Continental Bank rescue, and others that followed, including LTCM, to demonstrate that none of these rescues have positively or constructively affected financial firms' appetite for risk. They write, near the end of their piece,

"The blame-it-on Lehman story leads to a dangerous complacency. If we can persuade ourselves that the fault was just one policy mistake, forced on the feds by silly legal restrictions and not enough bailout power, everything can go back the cozy way it was before.

This is a convenient story for large banks that dominate the lobbying and communication effort. And it absolves the Fed and Treasury of facing up to their long string of policy mistakes."

The two Chicago professors conclude that, while they don't claim to have the perfect answer, they would trust markets before trusting an overly-powerful government which has serially increased the stakes of each financial crisis which it has spawned through 25 years of bailouts.

In contrast to Cochrane's and Zingales' use of actual data to demonstrate that Lehman's failure did not panic markets, Journal writer James Stewart continues his usual misunderstanding of financial markets by claiming that Lehman's debt obligations, stuffed into so many mutual funds, required the government to guarantee those assets. Thus, by Stewart's reasoning, allowing Lehman to fail was a huge mistake which necessitated the assumption by the government of $4 trillion of mutual fund value.

On CNBC this afternoon, however, Stewart babbled on incessantly about how necessary it was that Lehman had been saved. That no similarly-sized financial firm can ever be allowed to fail again, because, although markets would have eventually corrected, Stewart solemnly judged that such correction would have taken us 'back to the iron age.'


That's precisely what the two professors convincingly demonstrate would not have happened. And did not happen.

The fact is that mutual fund investors take risks for extra return. Holding those assets meant investors chose to bet on the managements of those funds.

Have those funds now been cleansed of inept managers? No. The federal safety net saw to that. Just as Ken Lewis and Vik Pandit still run BofA and Citigroup, their incompetence notwithstanding.

I don't know if anyone else happened to notice this bizarre coincidence in today's Journal. It makes for an interesting comparison between savvy, analytical observers of last year's financial crisis, and a fear-mongering, large-government and -bank supporting financial beat flack with little in the way of evidence to sustain his contentions.

Tuesday, September 15, 2009

BofA, Merrill Lynch, Ken Lewis, Bernanke, Paulson et. al.- Redux

The big news out of always-litigious New York state is that gubernatorial hopeful AG Andrew Cuomo is expected to file charges against BofA CEO Ken Lewis and perhaps his CFO, Joe Price, over the tortured purchase by the ailing bank of Merrill Lynch late last year.
I wrote these two posts, here and here, earlier this year, regarding the conflicting stories emanating from former Treasury Secretary Hank Paulson, Fed Chairman Ben Bernanke, and BofA CEO Lewis.
As I reread the first post, I found myself ironically delighted that a suit may actually be brought over this issue. Reviewing my impressions of Lewis' testimony before Congress, as well as recalling Paulson's and Bernanke's later remarks, also in on Capitol Hill, I'm looking forward to seeing this whole mess hashed out in a courtroom.
Serendipitously, Judge Jed Rakoff rejected the SEC's settlement in the case, pointing out that it is patently unfair to require injured shareholders of BofA to pay a fine for said injury.
Somehow, it seems appropriate that this entire affair is barrelling toward a more formal legal event.
The nearby 2-year price chart for BofA, Chase, Wells Fargo, Citigroup and the S&P500 Index shows that the entire sector hasn't done any favors for investors lately.
As you'd expect, the worst of this sorry bunch are Citi and BofA.
BofA is off more than 50% in the past two years, which hardly constitutes effective stewardship of shareholder assets. It's too simplistic to associate all of the loss in shareholder value in late 2008 with BofA's agreement to acquire the nearly-failed brokerage firm, Merrill Lynch. Still, the bank's equity price dropped an additional 20 or so percentage points through early 2009.
Having heard Lewis, Paulson and Bernanke tiptoe around the issue of whether, and how strongly the two federal officials intimidated and coerced the bank CEO, I, for one, welcome seeing them retell their stories under oath in a courtroom.
I'm not a lawyer, so I can't cite specific laws of which any of the three may be guilty. That said, as I alluded to in my prior posts, I think it's just possible that Lewis could be found guilty of violating Sarbane-Oxley and some other SEC rules. Bernanke and Paulson could potentially be charged with perjury and conspiracy to lead Lewis to violate federal laws.
While reading Amity Schlaes' "The Forgotten Man," it has occurred to me that, just as FDR's NRA was brought low by a seemingly-minor lawsuit in New York court, so, too, could recent, bipartisan federal overreaching into the affairs of financial service companies be brought to a halt by some convictions in the BofA-Merrill matter.

Monday, September 14, 2009

Lehman's Dick Fuld's State of Denial

This past weekend's Wall Street Journal carried a front-page article regarding the recent activity of now-defunct Lehman Brothers' last CEO, Richard Fuld.

It's a lengthy article, carrying over from the middle of the front page to half of an inside page. There are a host of details concerning how Fuld is, appropriately, still treated as a pariah by most senior executives in the financial services sector.

Despite that, Fuld has already filed the paperwork to start his new shell of a firm, Matrix Advisors LLC.

One thing the Journal article stresses through numerous anecdotes is that nobody is paying Fuld for anything. He has "given hours of free advice to a firm run by a former Lehman employee," the piece states, and then goes on to remark similarly on other Fuld efforts to stay busy.

Somewhere among the details of his helping to wind down the smoldering ruins of his old firm, this passage appears,

"Yet in these same months, Mr. Fuld would walk down the hall and park himself in Mr. Marsal's office, sometimes asking his new boss: "Is there anything I could have done differently?" "

Gee, let me think.

Take less risk? Try not to intimidate anyone inside Lehman who disagreed with you?

Maybe wake up by late 2007, watch the commercial banks booking hundreds of millions of dollars in mortgage securities write-offs, and figure that debt markets were going to be getting chary? Maybe lengthen your own firm's average funding duration and prepare to shrink your balance sheet, so you would not get hit with an age-old risk of brokerages, which is having your funding commercial banks pull your credit lines?

You see, when the balance sheets of banks that fund your short-term credit needs, out of their aptly-named broker-loan divisions, begin to shrink like balloon suddenly thrust into a deep-freeze, you can pretty much guess that you, as a brokerage and/or investment bank, will be next in line for credit access troubles.

But, I guess, not if you're Dick Fuld.

No, Dick just merrily played Russian roulette with the regulators, lenders, and investors. Never one to look on the gloomy side, or prudently plan for less-than-desirable scenarios, Fuld rammed his firm's operating throttles to the wall as 2008 moved into summer.

In a telling, candid interview nearly exactly one year ago today, described in this post, former Salomon Brothers' CEO John Gutfreund addressed Fuld's actions at Lehman.

I wrote of Gutfreund's remarks,

"Gutfreund was asked how Lehman's demise came about, and he said something to the effect,
"By the over-optimistic actions of the firm's CEO and his senior managers."

Pressed further, he allowed as how the firm was unrealistic, in this era and environment, to believe it could remain independent while grappling with its writedown problems. Gutfreund never used Fuld's name, but pointed out that Lehman had had months in which to gracefully sell itself before coming to Chapter 11."

Maybe Dick Fuld should have asked Gutfreund, rather than a rather innocuous financial rag merchant, how he managed to run Lehman into the ground, and what he could have "done differently."

The Journal article also replays Fuld's now-famous comment before a House committee that he will never understand, until he is buried, why no government rescue was organized to save Lehman.

I find, and have always found, this to be the epitome of chutzpah on Fuld's part. Ever the swaggering, intimidating brute of an investment bank CEO, cutting an image of a swashbuckling, fearless leader, he now asks us to sympathize with his expectation that, having ruined Lehman, someone should have saved him, and his investors, from his own bad judgment.

I'm a bit surprised the Journal even wasted half a page on this treacle. Then, again, as a friend and I observed over the weekend, the paper has morphed heavily toward tabloid business journalism since Murdoch's purchase.

Human interest stories of fallen Wall Street titans probably sells a lot of newspaper subscriptions.