Friday, August 20, 2010

Intel's Bid For McAfee

Intel made a big splash with its offer yesterday for McAfee, the computer security/anti-virus firm.

The $7.7B deal merited two separate articles in this morning's Wall Street Journal Marketplace section, as well as the lead front-page story.

The Journal reports that the deal sports a 60% premium to McAfee's stock price. And it's Intel's largest acquisition ever.

Let's review the usual checklist governing the advisability of an acquisition like this.

First, the odds of such a combination working, knowing nothing more about the acquisition than that it is occurring, is, I believe, no more than 1 in 5.

Second, Intel is in a rather special business, with a unique culture. I've known a long-time, retired Intel multi-millionairess in the past, and her stories conveyed a most unusual business culture. It would be very surprising to me if the 'Intel way' worked with or at McAfee.

Between semiconductor boom and bust periods, heavy investment requirements, and sprawling manufacturing and design centers, Intel's core business has very different dynamics and attributes than I expect does McAfee's.

Then there's my favorite aspect of critiquing such a deal: what does owning the target provide the new owner that a close marketing or joint venture tie-up would not? This is especially relevant for firms which serve a common product/market, but aren't actually in the same product/market themselves. In this case, the intersecting product market is the personal computer/digital device. But what Intel and McAfee do is so different.

For example, consumers and, for that matter, corporate buyers, don't actually choose Intel. It's an embedded component of a larger device. But end users do often choose between McAfee and Symantec. So the focus of the two companies is very different in terms of serving users who may, or may not, choose their product.

Why couldn't Intel dedicate a business unit to working closely with McAfee, which could do the same, in order to technically knit their products and service together as closely as if they were the same firm? Even perhaps, if justified, mutually capitalize a separate entity to contract with each firm to design, manufacture and market separate, integrated products using the two parent firms' technologies?

It's one thing for Intel to allocate capital to such an effort, or just building a "McAfee Inside" line of chips. It's quite a different matter for Intel to allocate $7.7B to buy and then be responsible for managing a firm which is in a very different product space than is Intel. And managing it to achieve consistently superior total returns.

One Journal article reports,

" 'Is there a lot of downside' Probably not,' a Wall Street analyst said of the deal. 'But is there enough upside to justify the premium?' "

Just so. And a look at the nearby 5-year price chart for Intel, McAfee and the S&P500 Index shows that McAfee has been out-performing Intel and the Index for the past year, and over five years. Intel isn't even beating the Index.

So how's a firm that can't manage to be more attractive than the S&P500 going to continue McAfee's better-than-average performance? Is Paul Otellini going to suddenly become smarter in the area of anti-virus product management?

I don't think so. So there actually is some non-zero downside risk, if only because McAfee's operations could deteriorate, relatively, under Intel's new supervision.

Don't kid yourself. No operating firm spends $7.7B to keep its hands off its new toy. Maybe Warren Buffett or other portfolio investors do, but operating companies typically do not behave in that manner.

In contrast, I recently had a discussion with a retired senior oil industry executive. He pointed to the successful merger of his company and a competitor, which facilitated greater access to capital to develop the former's assets, while cutting costs. By all measures, the meger, now years old, has succeeded. But the cultures, businesses and operations were very similar, unlike the situation involving Intel and McAfee.

The Journal's in-depth piece on the deal cites Otellini as saying that McAfee will be run separately and that he's received commitments from the anti-virus firm's senior management to stay in place "for many years."

Intel shareholders should be worried about this, and this morning's drop in the firm's share price shows they well may be. It's a "damned if you do, damned if you don't" situation.

If Otellini tries to manage McAfee, he may ruin it. If he doesn't, why'd he pay a 60% premium?

See why joint ventures or very deep and close marketing relationships, in such circumstances, are less risky, but can deliver the same, or perhaps even more benefits, with less downside risk to shareholders?

Intel hasn't appeared in my equity strategy's portfolio for well over a decade. Its performance has mitigated against that. I don't think the McAfee deal will put it on a path back to consistently superior performance anytime soon.

Thursday, August 19, 2010

Confusion Over GM's Imminent IPO

As I continue to catch up on Wall Street Journals from my absence two weeks ago, I have come across two nicely contrasting pieces on August 2 and 4 by, respectively, my old friend Paul Ingrassia, and Holman Jenkins, Jr.

Paul's column lauds the current administration for its part in rescuing GM, but pointedly entitled his piece Two Cheers for the Detroit Bailout. Not three.

Paul wrote,

"Others understandably feared that General Motors would become Government Motors.

But what alternative, really, did Mr. Obama have? Had GM and Chrysler collapsed and been liquidated, investors would have picked up some of the pieces. That would have taken years. Meanwhile, the parts makers that supply GM and Chrysler would have collapsed too. Those same parts makers also supply Ford, Honda, Toyota and others, whose U.S. factories would have faced havoc.

The impact on the broad U.S. economy- including the car dealers in all 50 states, advertising agencies, accounting firms, etc.- would have been somewhere between difficult and disastrous. Nobody really knows. The Detroit bailout was like changing a diaper: a dirty job that had to be done because the consequences were worse."

Really? I think not.

Back in June of last year, I wrote this post, in which I noted,

"Even my one-time friend, Paul Ingrassia, seemed to soft-pedal his opinion about the eventual outcome of the government takeover of GM. The most he would say was, in reply to a direct question, that he would not now buy the firm's equity.

Why gloss over the obvious, and ask pointless questions? Here are the facts:GM mismanaged itself into failure. Between bad political moves, inept handling of its main union, the UAW, and poor product development and pricing, it mishandled every major "stakeholder." As Ingrassia noted, GM essentially managed itself for the UAW's benefit ever since an historic strike at two Flint factories some years ago.

The management team that led GM into this mess is largely intact and in place. According to the UAW's chief, Ron Gettelfinger, his active union members have lost nothing in this bankruptcy. Thus, GM's wage costs continue to be, although lower than before, probably too high to be competitive with other, US-based auto makers in the southern US."

A few months earlier, in April, I wrote this post, in which I contended,

"By propping up GM and refusing to allow it, if necessary, to enter Chapter 11 proceedings, our government- both Congress and the administration- is merely delaying the inevitable market-clearing dissolution of failing and failed companies, the recycling of their resources a la Schumpeter's observations of eighty years ago, and the freeing up of labor to be employed in new ventures.

Government isn't the right institution to select our economy's winners and losers. For that, we have a process which we have trusted for most of our country's life- our freely-operating, private capital and consumer markets. "

Despite Paul Ingrassia's fervent defense of the federal government's actions regarding GM, there's simply no evidence that using conventional bankruptcy would have triggered a depression. People, including Paul, often confuse filing for Chapter 11 with actual liquidation.

As I wrote in at least one prior post, there was ample opportunity for Rick Wagoner or Fritz Henderson to have done so, sold off the good parts of GM to other firms, and then liquidate the remainder. If, as Paul contends, other auto makers so needed the parts makers, then I guess they'd have kept the latter in business. At no cost to taxpayers.

And taxpayers would not have been forced to coerce GM bondholders to hand over 17% of the company to the UAW in lieu of pension and other payments.

But, all this notwithstanding, as I read Holman Jenkins' piece published two days later, I felt reassured in my belief that GM, like Chrysler after Iacocca, is simply marking time before plunging into disaster once again.

First, let's be clear about what isn't happening this fall. You, the taxpayer, are not being made whole on the GM bailout. No, what's happening is that the firm is doing an IPO, reclaiming its old ticker symbol, and allowing the creation of equity for Treasury to begin selling. But it's nowhere near enough equity yet to repay the government bailout. What I believe I read this week is that the firm owes the feds about $50B, and the IPO will provide about $17B.

What's all the celebration about? Why don't we wait for the end of this dubious process, instead of cheering the opening orchestra music?

Jenkins went on to analyze VW's return to the American car market. It's going to the non-union south, of course. Bent on a low-price, high-volume strategy to add heft to its globe-girding size.

Just what GM needs, eh? Another source of excess auto production capacity on US soil, run by managers intent on gaining market share through low prices.

Jenkins wrote,

"The relentless pressure of over-capacity is not cured. The UAW monopoly remains a unique disadvantage to GM, Ford and Chrysler that doesn't apply to foreign-born competitors."


Don't expect a lot of bag-holding investors to queue up for GM shares down the road. Maybe some will appear patriotic and buy the IPO shares. But I don't see GM prospering anytime soon, if ever.

As I noted in a prior post, Chrysler has this image of having been successfully turned around by Lee Iacocca. But that's not true. The firm had a brief stay of execution, then, under Bob Eaton, was forced into Daimler-Benz' arms in 1999. It's been downhill again ever since.

Why should GM be any different, government bailout notwithstanding?

Wednesday, August 18, 2010

Bill Gross' Self-Serving Advice On Fannie & Freddie

Yesterday's business news was filled with various reports concerning the federal government's big Fannie/Freddie conference.

Perhaps the most misrepresented and self-serving of all the comments on the event belonged to PIMCO senior executive Bill Gross.

Appearing on CNBC in the afternoon, after apparently making his views known at/to the conference, Gross, almost alone among financial market participants and pundits, declared that the feds must do more in mortgage finance through Fannie and Freddie, not less.

At least Susan Wachter, whom I remember from my days at Wharton, acknowledged that a GSE-free mortgage market was preferable. But she simply contended it was, for at least the next half-decade, simply no longer feasible.

But Gross went much, much further.

As the guy who is primarily responsible for PIMCO's reportedly huge inventory of GSE paper, he went all in to protect his career and investors, insisting that government guarantees of Fannie and Freddie paper be ironclad, continuing and even more generous in the future.

The amazing part is how reverentially CNBC's anchors treated Gross during his appearance. They lobbed softballs at him, carefully avoiding mention of how he is simply lobbying to protect his book, nevermind the overall health of the financial markets. Instead of exposing this bias, they treat Gross as some sort of expert pundit on the matter.

Why? Probably access. If anyone on CNBC ever really challenged Gross' comments and positions for being as self-serving as they are, he'd likely never return. Then CNBC would be shut out of interviews with the most senior guy at what is arguably the largest, or one of the largest, fixed-income holders of all institutional investors.

So, to retain access, CNBC's on air staff turn a blind eye to Gross' obvious biases when he comments on the structure of the US residential finance sector.

Tuesday, August 17, 2010

Same vs. Different: Mort Zuckerman In The WSJ

Mort Zuckerman's editorial in yesterday's Wall Street Journal concerning the loss of optimism in America reinforced what, to me, is the overriding basis of differing views on the current state and near-term prospects for the US economy. That is, do you believe it's the same as it ever was, or, like David Rosenberg, do you believe things are very different this time?

Zuckerman made it clear that this unusually weak economic recovery is different.

This morning, on CNBC, one of the morning program's contributors from Chicago, Kevin Ferry, contended that so many corporations are tapping capital markets for low-priced debt that this simply must result in robust economic growth down the road a bit.

Really? How about the idea that these CFOs are simply lowering their long term total financing costs while they can. Period. Or that growth will occur in more robust markets, i.e., overseas? Including the concomitant job growth?

My business partner and I have been discussing for months the inevitable weakness of this economic so-called recovery. Thus, we've been amazed at the brief periods of equity market bullishness.

But the recent week's tumble of the S&P from 1127 down to 1079, and longer term drop from 1206 to the latter figure, have produced a high volatility which makes banking on a full-fledged recovery questionable.

Zuckerman's repetition of some frightful labor statistics reinforces my own belief that this time, it is different,

"1.4 million of them have been jobless for more than 99 weeks, 6.5 million have been jobless for over 27 weeks. This is a stunning reflection of the longer-term unemployment we are coping with."

Her also cites a similar statistic to one offered by Rosenberg which I mentioned in the prior, linked post,

"The relationship of household debt to income has proven unsustainable. The ratio is normally established somewhere below 100%, but in 2007, the debt ratio hit 131% of income. It has now fallen to 122%, but at this pace it would take another five years to bring it under 100%. The pre-bubble norm was 70%. To get to this ratio again, debt would have to be reduced by about $6 trillion."

Just so. Private sector deleveraging.

Rosenberg noticed it. So does Zuckerman. It's been a constant theme since late 2008. Despite Fed policies and ill-conceived stimulus spending which adds to the US deficit, deleveraging would seem to be a strong, undeniable force as it reverts to the mean.

Hardly a prescription for near-term healthy US economic growth, including jobs, is it?

Monday, August 16, 2010

Disingenuous Economic Reporting In The WSJ

Before I took a brief sabbatical from writing this blog earlier this month, I had saved a Wall Street Journal front page article on which to comment. The column, from July 27, was entitled Next Step on Economy Hinges on Debate Over Stimulus.

I found the piece entirely disingenuous in that it gave significantly more weight to the pro-stimulus argument, despite absolutely no credible economic research or other evidence that such actions have ever worked in a large, modern economy.

Consider this quote from the article,

"But today, neither side can say with certainty whether the latest stimulus worked, because nobody knows what would have happened in its absence."

Never mind that we know from Amity Schlaes,' and others research, that the gigantic 1930s FDR-led stimulus programs failed. Or that the current programs have failed to meet the few objectives voiced for them.

Some people will continue to apologize for and excuse any and all manner of stimulus spending.

A more recent Journal piece by Alan Meltzer, as well as a statement attributed in the July column by Carmen Reinhart, both focus on modern consumers behaving differently, by expecting higher future taxes, when government deficit spending rises. This was never even imagined by Keynes and his minions.

Another misleading aspect of the article is that it fails to note that, when the US embarked on its failed stimulus programs of the 1930s, the national debt was far smaller, on several measures, than it currently is. And the nation hadn't run an almost constant annual budget deficit, along with legislating ever-greater future social spending promises, for nearly 80 years!

Thus, now, global investors are much better informed about the continual propensity of the US to spend money it doesn't have. Sooner or later, even high T-bill rates won't adjust for the risks of the US simply failing to generate sufficient tax revenues to pay debt interest.

The WSJ is a serious national daily business newspaper. If it can't manage to publish realistic, credible lead stories on its front page, who are we to trust to tell consumers and investors the truth about the recent macroeconomic mistakes of the US federal government?