Friday, January 08, 2010

Google's Misunderstood Android Phone

Since the launch of Google's Android cell phone recently, much discussion has focused on Google vs. Apple. On how big a lead the iPhone has, how many units sold, users, applications downloaded, etc.

This all misses the point.

In fact, the Android provides an example of what my old boss at Chase Manhattan, Gerry Weiss, and his team at GE, in the 1960s, identified as 'arena competition.'

Portraying GE's businesses in arenas, they noticed way back in that era how cable and other entertainment forms could and would have impacts on GE's television and related businesses. The most damaging sorts of competition, they found, were when one company inadvertently entered another arena other than its own, typical product/market, in order to support business strategies in its core areas.

These new entrants often undercut the profitability of the business models of the existing competitors because their main focus was on another sector.

Google is following online eyeballs from PCs to cell phones. In order to control the environment, they want to control the operating system. To do that, they simply added the commodity platform, too. A new cell phone.

Because they don't want to earn all, or even most of their profits from the cell phones, they represent a danger to other cell phone makers. And, as one pundit noted, to Microsoft, by reducing that company's market for mobile operating system sales.

Apple? Google probably doesn't really care that much about the iPhone, per se. Rather, they care about extending their advertising business to the cell phone market.

If they can support healthy growth in ad revenues on cell phones with minimal outlays for Android, or break even, they have probably met their objectives.

In the process, they are reducing the carriers to "operators," teaching people to buy a phone, then choose the network, and disrupting a product/market they don't really even see as central to their profitability, except as it supports and facilitates continued ad revenue growth.

Rather like IBM cannibalizing all manner of products, services and labor as mainframe computing applications marched out of the first areas, into more accounting, inventory and other business processes. How many purveyors of supplies and services to old-fashioned offices of the early 1960s were put out of business by IBM, while IBM only saw rising mainframe and applications software revenues?

It's the same for Google and its Android.

Thursday, January 07, 2010

More Reflections On AOL, TimeWarner, & Steve Case's Understated Brilliance

On Monday, I wrote this post regarding the appearance of both Steve Case and Gerald Levin, the co-architects of arguably the absolute worst merger in the past 10 years.

As I discussed the post, and the event, with my business partner over lunch yesterday, more nuances came out which I honestly don't think I've ever seen mentioned about the ill-fated deal.

What I wrote earlier this week,

"Let's be really frank here. In 1999, nobody wrote blogs, and I didn't write this one. But at the time, I verbally declared to all who would listen that the TimeWarner-AOL merger was simply a case of the latter cashing in on its temporary valuation surge, at the expense of the former. Nothing more, nothing less.

There was zero business reason for the merger. I immediately sold the shares I held by virtue of my AOL position when the merger closed.
Levin isn't some accomplished graybeard former CEO. He is a failed wannabe-CEO. Steve Case induced Levin to snooker his own board and rob his own shareholders' wealth to give it to investors in AOL."

My partner asked whether I thought AOL, now spun off, had actually declined in value by more than, say, Yahoo, from its 1999 highs.

As the nearby price chart shows, Yahoo is down significantly from its 2000 high. For purposes of this post, a rough estimate is sufficient. It looks like Yahoo peaked in 2000 at around 100. Today, it's trading at 16-17. That's about a 84% decline on the $50 base.

By 2002, one news article of the day noted that the combined AOL-TW had already plunged by some 70% in value.

Looking at the TW price chart, we see the company's equity price fell from the $300 range to around $29 now, ex-spin off of the remaining stump of AOL. The per-share numbers for the old and new AOL wouldn't be meaningful, until adjusted for number of shares, so a straight market value comparison would be appropriate.

However, here's where the real genius of Steve Case becomes apparent. When we got to this point, I suggested to my business partner that there wasn't really much point in comparing the two values, because cable internet access had, would have, destroyed the core value of AOL anyway.

And this is where you have to give Steve Case credit far, far beyond what anyone has even hinted at so far.

As my colleague and I discussed why we were members of AOL back in the 1990s, we agreed it was the simplicity of access. The site's content was never very important to either of us. In fact, as we remembered those days, I pointed out that the content was added mostly as a freebie to give subscribers something more than bare-bones dial-up access. It differentiated AOL from the other ISPs of the day which only provided simple web access and an email address.

But by 1999, any really smart industry player or observer could see that AOL's very success was already about to undermine its business model. To wit, the huge subscriber base it had created was rapidly learning to stay logged in all day.

Remember when modem speed was an important feature on your desktop PC? When your local phone company had to create new area codes just to generate new telephone numbers for second phone lines dedicated to online access? I cancelled mine only about seven years ago, when I elected to use my main landline as a dial-up backup access mode, should my high-speed cable connection fail.

Who even bothers with that anymore? How many are already just closing their landline accounts?

So, back to AOL and Steve Case.

By 1999, I think Steve Case already saw the flattening of growth in AOL's subscriber base, as people began to migrate to their local cable television's high-speed internet service. Even if AOL's membership and revenue hadn't actually declined, the slowing of its growth would have immediately poppled the company's equity price bubble.

Remember, we're talking about the final days of the famed 'tech bubble' in equity markets.

I think Steve Case, by early 1999, or perhaps even mid-1998, knew he had about 24 months to find someone willing to monetize the incredible bubble of temporary, excess franchise value inherent in AOL's equity price. Left on its own, AOL would have become another Yahoo.

But Steve Case managed a masterful sleight-of-hand trick. By convincing TimeWarner's Gerald Levin that AOL's content and distribution, married with TW's content, would make for the first great internet content-plus-access giant, he successfully off-loaded his shareholders' price risk to TW's hapless owners.

Case exited the combined company rather quickly. It was fairly easy, as a former AOL shareholder, to immediately sell TW shares at a decent price.

To see how big a con game Case managed to pull on Levin and his board, note how tepid the market's response has been to Comcast's purchase of NBC from GE. Yesterday's Wall Street Journal editorial by Holman Jenkins castigates Comcast for being late and myopic in understanding what is at stake. How fast the movement of viewing platforms has moved, so that the real game is already beyond television, and onto laptop and cell phone screens.

Steve Case managed to convince Gerald Levin ten years earlier that there was value in combining distribution and content. A concept about which I've written in prior posts over the past years, as have others in other media. It's never worked. It's always been a flawed strategy.

In the case of AOL-TW, as I mentioned to my colleague, when he asked, neither Case nor Levin addressed the price issue on CNBC Monday morning. Neither did any of the co-anchors. Amazingly, everyone simply bought the story of implementation failure, electing to ignore the obvious overpayment by TW for fleeting value temporarily resident in AOL's equity price at the time of the merger.

Case solemnly spoke to issues of implementation with a straight face!

What an actor! What a magician! He duped Levin into overpaying for a dial-up based internet access firm about to be crushed by high-speed cable. He adroitly invited Levin on air to confess to his errors, leaving Case to avoid the spotlight.

The truth is, Case delivered for his shareholders, then moved on to new ventures. By inviting Levin to appear with him and take all the blame, as well as conveniently ignore his own culpability in even doing the merger, Case publicly shut the door on ever being viewed as a charlatan.

Credit Steve Case with continuing brilliance. He saw the end of AOL's dominance long before anyone else, and, unusual for a CEO, actually accepted reality and moved to get ahead of it. He found a dupe to pay full price in advance of the decline of value in AOL's business model. He rewarded his own shareholders, then smartly left the scene, moving on and away from the developing disaster at TW-AOL.

The best part of the story Monday morning, and probably forever, about the AOL-TW merger, will never emerge from Case's lips. He's much too smart and clever for that.
didn't go far enough. Or give Steve Case due credit.

Wednesday, January 06, 2010

The Nature of Risk In 2010 & Beyond

As a new year begins, people are prone to attempting forecast coming events which may be major opportunities or threats to expected 'business as usual' flow.

However, the day-in, day-out business of risk management, such as it is, at financial services firms, revolves around various mathematical models involving variance and various derivations thereof.

As I mentioned to a colleague recently, even after financial markets in 2007-2008 exhibited quite exceptionally above-average volatility and experienced some generational failures of institutions, what most people mean by 'risk management' at a bank, trading or investment firm continues to be dominated by these intricately-modeled approaches.

To me, however, the big lesson of the past two and a half years, beginning with the failure of two mutual funds at Bear Stearns in the summer of 2007, is that of large-scale, unmodelable events which overwhelm those intricately-calibrated, position-by-position, trader-by-trader or instrument-by-instrument, quantitative risk management systems throughout various financial institutions.

In early September of 2008, just days before the equity market took a dramatic, once-every-twenty-year plunge in value, my business partner and I, having blithely begun to invest in long-dated equity options about a year earlier, apprised the risk of buying calls as minimal.

Talk about risk.

That event set off a continuing, evolutionary process of development of risk monitoring tools for our options investments. We learned that the speed and nature of market impacts on options is distinctly different than it is on equities.

As with our equity risk tools, we explored and designed options risk monitoring tools to signal directional changes, rather than point-estimates of value or forecasts of indices.

Personally, I would venture to guess that such global risk indicators actually provide more value than the minutae generated by the complex mathematical risk management systems at major institutions.

It appears, in retrospect, that John Paulson's hedge fund, and Goldman Sachs, used such rudimentary approaches to place their investments on the more profitable side of the steep equity sell-off of 2008.

To me, that sort of correct macro move is, although simpler, more important than the very complex and higher-order risk management systems which hold so much sway at financial institutions.

I commented to my business partner this weekend that our conversations about risk are much richer, better-informed and useful now than they were on that fateful day in September of 2008.

For example, in the fall of 2008, I noted, we could have easily observed the mounting problems in CDO valuations, as well as the looming basic economic woes of the US economy.

Of course, we didn't have the options risk monitoring tools we now possess. Had we had them at our disposal that September, we'd have already been positions in puts, ready for the ensuing roller-coaster ride down with the S&P500.

The point is, now we have useful, effective monitoring tools which draw our attention to the things which might account for the indicators which we observe.

The risk monitoring tools don't explain why they are indicating the actions, or inactions, they do, but they give us a context in which to assess the information, usually qualitative, which we have at hand.

To me, that's what risk identification and management is really about. It's not the detailed minor decisions, so much as the sweeping, large-scale market inflections that so often surprise investors.

Tuesday, January 05, 2010

When Jobs Go Away, Do They Come Back Again?

So much focus over the past twelve months has been put on job losses and hopes for their return that it has apparently become the be-all and end-all of US economic policy.

On that note, a colleague and I discussed the recent equity market reactions, never mind the cheerleading pundits, over the recent slowing of job losses and new jobless claims.

Let's take a moment to view job losses over the past few years.

We've known for about a year that the NBER declared the US economy to enter recession in late 2007. Here's a pdf file from the US Dept. of Labor containing a very clear, easy-to-read chart of monthly payroll changes from November 2007. Job losses peaked a year ago at a rate of over 600,000/month. By last August, the rate was back under 200,000/month.

The US experienced a recession brought on, in large part, by a long term explosion of bad real estate lending, brought forth by Congressional mandates and suasion of two GSEs, Fannie Mae and Freddie Mac, to buy, package and distribute marginally-creditworthy mortgage loans. The plummeting value of bonds containing those loans, and their subsequent repackagings, caused financial service firms to lose equity, slash lending and, by extension, create downward economic pressure. Coincidentally, the marginal mortgage loans began experiencing high losses, which caused loan defaults, foreclosures, and subsequent losses of value in various US locales which had recently experienced such heated residential property value growth.

After this two-pronged blow to the US economy began in late 2007, consumer spending and net worths plummeted, as job losses mounted. To be sure, 2008 was a year of maximal effects of these trends.

Thus, nobody would have expected 2009 to necessarily be as bad as 2008. And the deep job losses of late 2008 did, indeed, attenuate and slow to a trickle last month.

But as we stand at a point of seeming inflection, ask yourself,

"Where will new jobs appear?"

Do you really think what happens now is that companies that cut workers start calling them up to return to offices, production lines, etc.?

Do you think that companies which spent the last 24 months re-engineering operations, boosting productivity with fewer employees, and enjoying higher margins amidst low revenue growth, are simply going to issue calls for more people?

Or do you think those components of the US economy, in a Schumpeterian manner, have evolved and improved to a degree that what was normal for them no longer is?

It would be a set of incredibly inept managements to have stood still for two years amidst a slumping economy and made no changes whatsoever to business models, staffing, operations, etc., so that current production levels would require the same numbers of employees as before 2007.

And the most recent quarterly productivity data did indeed show some incredible growth. If memory serves, more than +5%. Or some other, totally unexpected number.

So, where will new jobs appear in the US economy?

My colleague and I quickly ascertained, having been in business for a combined total of more than 50 years, that they will appear in new businesses.

Don't expect great job growth from a propped-up, failed, government- and UAW-owned GM. Or Chrysler. Don't expect the recent Congressional health care bill to spur hiring in pharmaceutical firms. Or health insurers.

No, it's much more likely that new hiring after recessions, since 1982, come from new businesses in the economy.

Given the improvements since the mid-1980s in usable technology, it's clear that startups don't engage in as much physical goods creation, metal-bashing, and high employment levels to create market value. For example, Google has a market capitalization of nearly $200B, but employs only about 20,000 people full-time.

That equates to roughly $10MM of market value and $1.1MM of revenue per employee. On only $250K of PPE/employee.

Hardly a steel or auto company, is it?

Yet that's where non-commodity, high value-added, defensible competitive-advanted jobs are created in our economy now.

Think about that again and reread it.

If you created another GOOGLE, you'd only add 20,000 workers to the US economy! And that's a well-run, long-lived, successful knowledge-oriented US business.

So, don't hold your breath on employment growth in the US economy anytime soon. With so much government-induced uncertainty and consumer spending declines, there's just no longer a linkage between a recession's technical end and the robust growth of jobs.

That seems to have ended with the last pre-Reagan recession-recovery cycle.

Monday, January 04, 2010

Misunderstanding Inflation

Tyler Matheson, CNBC's program director, was filling in for an anchor this afternoon.

As such, he showed remarkable ignorance of a debate on his own network when he pontificated that,

'in order to have inflation, wages or spending have to go up!'

For the millionth time, let's get it straight.

Friedman. Inflation. Monetary phenomenon.

"Inflation is always and everywhere a monetary phenomenon."

Sheesh. Can't these guys get anything right?

Only a committed Keynesian would still believe that inflation must always and only be demand-push in nature.

First giving that nitwit Levin a platform to show how inept he was and is this morning.

Now this.

How much worse can CNBC get?

Gerald Levin & Steve Case on CNBC This Morning: TimeWarner-AOL Merger Failure

CNBC had former AOL CEO Steve Case as guest host this morning for several hours. As his guest, Case invited his former co-CEO, TimeWarner's Gerald Levin, to appear and discuss the merger which is now generally regarded as the worst of that decade, or the past ten years, if it's not a formally-demarcated decade.

The exchanges among Case, Levin, and the CNBC co-anchors, as well as Levin's own soliloquy, were amazing. And not in a good way.

First, let me remark on Levin's performance.

If memory serves, Levin's son was murdered in a highway robbery-and-murder case sometime during the aftermath of the TimeWarner-AOL merger. Even back then, I believe Levin gave the event some weight in his decision to leave the company. It's fair to say that it had a profound effect on him.

That said, Levin's new persona is, to be blunt, stomach-churning. He now sports a goatee/beard and moustache, jacket and open-collared dress shirt, and a whole new, evidently therapist-supplied vocabulary of kindness and gentility.

Levin took total responsibility for the merger's failure, absolving Case, who sat only a few feet away, as well as the TimeWarner board.

This is ridiculous. As I said to colleagues at the hedge fund with which I worked at the time, the TimeWarner board should have engaged an investment bank, economist and valuation consultant to build a case that TW's shareholders would be harmed in the long term by being forced to buy a temporarily overvalued AOL with TW equity. It wouldn't have taken too much to construct a reasonable defense that would have allowed Levin and his board to contest the merger bid from Case's AOL.

In any event, Levin's statements merely add to the view that corporate boards are meaningless. Not to mention that he implied that he would have, or did, simply ignore whatever his board, as shareholder trustees, wanted, and forged ahead regardless.

Thus, I think Levin marked himself this morning as simply a poor, inept CEO.

However, Levin then took questions and pontificated on large mergers, TimeWarner-AOL's subsequent inept merger implementation, and various other managerial topics.

His comments were peppered with soft, touchy-feely phrases which really do suggest he's spent a lot of time and money on therapy. The phrases, which I can't recall exactly, truly sounded like a well-rehearsed mantra which emanated from his therapist's mouth.

Essentially, Levin alleged that the post-merger challenges were all about people, expectations, fears, etc., and that he and Case were required to satisfy "Wall Street" expectations. Thus, Wall Street was the villain, and poor Levin and Case were just babes in the woods as they tried to merge and then manage the two companies.

Case chimed in similarly, which isn't surprising. He has taken his winnings and moved on to another web-based business. It's easy for him to now declare that it was really always about people, not technology.

That's not what he said at the time of the merger.

Further, Levin now confesses that the performance that he and Case promised in the first merged year was, in reality, unrealistic.

Sounds like fraud and incredibly naive management, doesn't it? I mean, Levin didn't stop the deal because he couldn't commit to the performance he believed was required by shareholders or analysts. Neither did Case. Neither resigned or said they really wouldn't be up to the task.

No, they both took lavish compensation and then, much later, declare that it was never really possible to meet investors' expectations anyway.

Pardon me, but who exactly set those expectations in the first place? Wasn't it Case and Levin, to justify a merger that few thought was really worthwhile?

Let's be really frank here. In 1999, nobody wrote blogs, and I didn't write this one. But at the time, I verbally declared to all who would listen that the TimeWarner-AOL merger was simply a case of the latter cashing in on its temporary valuation surge, at the expense of the former. Nothing more, nothing less.

There was zero business reason for the merger. I immediately sold the shares I held by virtue of my AOL position when the merger closed.

To see Levin now denounce GE, Citigroup, and a host of other companies as lacking in focus and managerial sensitivity, or whatever it was he babbled about, was almost embarrassing.

Equally embarrassing was that nobody on CNBC even pretended to question, challenge or otherwise call Levin, and, for that matter, Case to account for the mess they created.

It was shameful. Instead of grilling the two in front of business viewers, they just lobbed softball comments and occasional helpful, nearly adulatory questions.

From what I saw, Levin is just one of at least two lawyers who inherited large, unwieldy companies and mismanaged them into disaster. The other, of course, is Citi's Chuck Prince.

To suggest that Levin has anything worthwhile to tell anyone else, or any other CEO, except,

'Don't be a lawyer and try to pretend to be CEO at a large, complex, already-undperforming company,'

is just plain silly.

Levin isn't some accomplished graybeard former CEO. He is a failed wannabe-CEO. Steve Case induced Levin to snooker his own board and rob his own shareholders' wealth to give it to investors in AOL.

CNBC does a great disservice to business and investors everywhere by giving Levin and Case this platform, sans critical questioning. Levin and Case then proceeded to compound the mistake by behaving like they were somehow victims, themselves.

All in all, a disgusting, nauseating performance this morning on CNBC.