Saturday, March 12, 2011

KKR, TPG & The TXU Private Buyout Fiasco

Tuesday's Wall Street Journal featured an article on the mess that's become of KKR's and TPG's private buyout of TXU.

When you think of private equity, you often think of wealthy, savvy private capitalists buying underappreciated companies and assets, sprucing them up, then spinning them back out to the public, coining money in the process.

Sometimes, of course, we read about one of the leveraged buyouts which essentially just looted the firm of value by loading it up with debt, paying a 'special dividend' to the buyout firms, then letting it go under or stagger under the onerous debt service costs.

But one paragraph of the Journal story gave me pause.  It contained this passage,

"The biggest leveraged buyout of all time has boiled down to an expensive bet on the price of a commodity. Natural gas has fallen 43% since TXU's buyout, and settled at $3.927 a million British themral units on Monday."

Makes you think twice about how smart some of these private equity guys are, doesn't it? Like Cerebrus' purchase of GMAC and Chrysler just before the mortgage-backed mess collapsed in 2008.

Somehow, one is left feeling that TXU should have been left alone, and these private equity guys could have just gone long natural gas futures, if that's really all they were effectively trying to do.

Friday, March 11, 2011

CNBC's On-Air Staff & Yesterday's Equity Market Sell-Off

US equity markets sold off yesterday. We got that.

But if you watched CNBC after 3PM that afternoon, you saw some priceless comedy featuring Maria Bartiromo's breathlessly asking a guest, to paraphrase,

'We've had a two-year bull market during which some have been calling for this pullback. Calling for it for years. Now we finally get it.'

Two years? Are you kidding me? Someone's been predicting an equity market drop for two years, and yesterday they were suddenly heroes? I'd like to see one of those anchors or reporters try to manage a live portfolio where you weren't allowed to just guess that sometime during the next few years the market may decline. You had to go long or short for real.

Around 3:45PM, the network shifted into high gear with a multi-camera'd navel-gazing session that looked, onscreen, like the old Brady Bunch intro. Among the cognoscenti were the network's own David Faber, Sue Herrera, ex-anchor Ron Insana, a few other staffers I can't recall, and one or two guests. The first few participants, of course, were CNBC talking heads.

Why do you suppose a crew of people whose job is to make every day in the markets seem like the most important day ever would have a clue as to what yesterday's equity market decline implied? Didn't occur to any of the CNBC production staff to arrange participation by some respected portfolio managers or equity strategists, rather than their own largely credential-less crew of reporters and talking heads?

Here's a test. Bartiromo wrung her hands over the day's losses. Others decried the rise in volatility.

Since the market's post-2008 crisis bottom on 9 March, 2009, how many days has the S&P500 Index experienced a loss greater than yesterday's?

The answer appears below, in a table of the 50 worst daily percentage declines since the market's bottom. I've highlighted yesterday in red. It's only the 32nd worst day in two years.

The champ? April 1, 2009, at -4.28%

At -1.89%, yesterday's Index decline didn't even make it into the -2% range, of which there 18 days of such magnitude.

       Date      Level      Return

1 4/20/2009 832.39 -4.28%

2 5/20/2010 1071.59 -3.90%

3 3/30/2009 787.53 -3.48%

4 6/4/2010 1064.88 -3.44%

5 5/6/2010 1128.15 -3.24%

6 2/4/2010 1063.11 -3.11%

7 6/29/2010 1041.24 -3.10%

8 6/22/2009 893.04 -3.06%

9 7/2/2009 896.42 -2.91%

10 7/16/2010 1064.88 -2.88%

11 8/11/2010 1089.47 -2.82%

12 10/30/2009 1036.19 -2.81%

13 5/13/2009 883.92 -2.69%

14 10/1/2009 1029.85 -2.58%

15 8/17/2009 979.73 -2.43%

16 4/7/2009 815.55 -2.39%

17 5/4/2010 1173.6 -2.38%

18 6/15/2009 923.72 -2.38%

19 4/27/2010 1183.71 -2.34%

20 1/22/2010 1091.76 -2.21%

21 9/1/2009 998.04 -2.21%

22 5/11/2009 909.24 -2.15%

23 2/22/2011 1315.44 -2.05%

24 3/27/2009 815.94 -2.03%

25 3/24/2009 806.33 -2.02%

26 4/14/2009 841.5 -2.01%

27 3/20/2009 768.54 -1.98%

28 7/7/2009 881.03 -1.97%

29 10/28/2009 1042.63 -1.95%

30 5/27/2009 893.06 -1.90%

31 1/21/2010 1116.48 -1.89%

32 3/10/2011 1295.11 -1.89%

33 5/14/2010 1135.68 -1.88%

34 1/28/2011 1276.34 -1.79%

35 11/27/2009 1091.49 -1.72%

36 6/1/2010 1070.71 -1.72%

37 8/19/2010 1075.63 -1.69%

38 6/24/2010 1073.69 -1.68%

39 5/21/2009 888.33 -1.68%

40 4/30/2010 1186.68 -1.67%

41 11/16/2010 1178.34 -1.62%

42 4/16/2010 1192.13 -1.61%

43 6/22/2010 1095.31 -1.61%

44 10/19/2010 1165.9 -1.59%

45 3/1/2011 1306.33 -1.57%

46 5/7/2010 1110.88 -1.53%

47 8/30/2010 1048.92 -1.47%

48 8/24/2010 1051.87 -1.45%

49 11/23/2010 1180.73 -1.43%

50 5/18/2010 1120.8 -1.42%

What about volatility? Well, everyone has their favorite measure. By mine, yesterday's volatility value isn't even close to levels that should worry you about a significant, short-selling type of market sell-off. In fact, volatility was more than twice as great while the market rebounded in March of 2009. There were at least two more periods of higher volatility since then.
So before you get all shook up by Bartiromo's breathy rhetoric and anxious tone, never mind her typical loss for words and inability to get her sentences enunciated properly, check the facts.
As market hurricanes go, this isn't even a tropical storm yet.

A Twitter-Based Hedge Fund

I saw one of the most unusual segments on CNBC a few days ago involving a hedge fund announcing it will use Twitter-based inputs for trading.

If I recall correctly, a psychology professor and his grad student played with data and found an alleged leading indicator of Tweets, classified by sentiment, to the Dow's performance 3-4 days later.

Then a British guy with money from some other, distinctly non-financial venture, the exact nature of which I've forgotten, but think it had something to do with hair care, together with his colleague or brother, is investing some millions of pounds in a hedge fund- and promptly arranged to use the Twitter-based approach. The investor was presented in a brief clip extolling the importance of jumping on such a hot, 'leading edge' concept as Tweet-based trading.

This is almost too funny for words, isn't it? If it were three weeks from now, I'd think it was an April Fool's Day joke.

There are so many things about this story that don't make sense that it makes you wonder how it even made it onto CNBC a few afternoons ago.

First, it's clearly a high-frequency trading strategy. That means it's expensive. We learned nothing about how much and how rigorous was the backtesting the creators did on the strategy.

Of course, being psychologists, selling or licensing their technique to novice hedge fund owners, one wonders if any of them- concept originators or hedge fund owners- actually have any idea how professionals actually test these things?

Then there's the rather non-trivial question of just how it works. Believe it or not, most sophisticated investors don't want to invest with novice fund managers who operate a total black box investing strategy. Think, well, Bernie Madoff.

Especially one which relies, we are told, on the daily attitudes of the tweets of samples of several million users. Which are then, we're told, classified into one or more of six sentiment buckets, the disposition of which apparently creates a signal to buy or sell the Dow in anticipation of its level 3-4 days hence.

The actual example given in the interview on CNBC was a Tweet by a person stating that they were going to their gym to work off some excess weight. The psychologist sagely intoned that this was a negative market indicator.

Then there's the ease with which this could probably be cloned, with the market inefficiencies beaten out of it within a year- or less.

Or perhaps a competitor will clone it, then go one step further and poison the general Twitter feeds, while retaining their own pristine stream, the better to confuse others trying to trade on such sentiment.

Having been introduced to adapting what a novice equity strategist thinks is an investment-ready approach to actual operational status by experienced fund managers, I speak from experience when I say that I am sceptical of the Twitter-based fund concept. There just don't seem to be any experienced adults in sight to vet the idea.

But I guess time will tell whether we'll hear more about this one.

Thursday, March 10, 2011

BofA's Moynihan Proves My Point

You have to laugh at BofA's CEO, Brian Moynihan, trying to make a virtue out of a vice.

As the chart in this recent post illustrated, BofA has performance problems. It has no business even thinking about expansion and acquisitions. And Moynihan, being a lawyer, is probably over-matched as it is trying to run such a large, diverse company. Remember the last time a lawyer ran a large US commercial bank?

That's right- Chuck Prince tanked Citicorp so badly the government had to step in and buy part of it to keep it from dissolution.

Anyway, back to our story. Moynihan gave a carefully-timed interview to CNBC the other afternoon, echoing a recent Wall Street Journal article announcing his "peace dividend." That's Moynihan's term for the value he plans to return to shareholders by not pursuing acquisitions. Considering the last two large BofA acquisitions cost Moynihan's predecessor, Ken Lewis, his job, you can understand his attitude toward expansion.

Laughably, according to the article, BofA thinks it will break new ground trying the oldest large commecial bank trick of all- cross-selling.

The short story on this vain attempt is that the customers with money know better than to give all their business to one giant mediocre banking firm, while the customers who want to do this aren't profitable enough to make it worthwhile.

Of course, being new to managing a bank, Moynihan probably doesn't realize this yet.......

Meanwhile, the firm is buying back its equity and closing branches. That sounds like a bank that acknowledges the over-banked nature of the US market.

Hardly a reason to invest, is it? I stand by my conclusions of the prior, linked post.

Groupon & Its Competitors

I was very intrigued by a recent Wall Street Journal article discussing competitive risks for Groupon, the company that combines couponing, social networking and local business.

The article cites Groupon as potentially earning $1B in revenue for 2011, but then notes that the online couponing business has low barriers to entry. The trick, it contends, is pairing large pools of email addresses/subscribers with large pools of merchants. For that, it names Google and Amazon as the two most obvious potential competitors to Groupon.

Google's $6B offer wasn't sufficient to buy Groupon, but it does have the necessary pools of potential customers, as well as existing merchant relationships. Amazon, the Journal piece notes, currently backs LivingSocial, Groupon's most significant existing competitor, with 20 million subscribers to Groupon's 60 million.

The article mentions a national coupon deal LivingSocial did for movie tickets through the online service Fandango. It drew a million responses as of noon of the day the article went to press. It also cited Groupon's largest offer, which was with Barnes & Noble, garnering 700,000 respondents.

What struck me about this was just how low the barriers to entry may well be in this product/market. I hadn't really given the business a whole lot of thought until I read this piece. Frankly, it just seems to be a tactic- couponing- that no business can afford to do too much of, without suffering serious pricing policy challenges for the long term. There's something about teaching customers to expect discounts that becomes corrosive over time.

Regardless, it's clear that by starting with national vendors, an online coupon competitor can rapidly build a subscriber base, then slowly move, locale by locale, into individual markets. Of course, once you have even three competitors, the revenue split becomes a weapon to be used to lure vendors to a specific competitor.

As the Journal article noted in closing, perhaps the Groupon owners should hurry along on an IPO, while they still have such a high market value. Once large competitors really get rolling, that value could shrink surprisingly quickly.

Wednesday, March 09, 2011

Starbucks Again- Still Trying To Talk Itself Back To Growth

I read Starbucks CEO Howard Schultz' Wall Street Journal interview in the Monday edition and immediately headed for a price chart of the firm and the S&P500 Index. Two, actually.

The first shows the two series for the past five years. The second covers a period from the early 1990s, when Starbucks went public. The two charts provide some interesting perspectives on the firm's recent performance.

In the Journal piece, much is made of revenue and profit growth from 2009, as well as even more recent growth statistics. That's all well and good if you are a prescient market timer. Few investors- even professionals- are successful at that.

What the first chart actually reveals is that Starbucks' performance collapsed much more deeply than the Index during the recent recession. It's pretty clearly become highly correlated with economic activity.

Schultz, in the interview, admits that "we were growing the company with such speed and aggression that we lost sight of the customer experience."

Translation: Starbucks won't be even attempting such levels of growth, apart from riding economic cycles, again.

Over the past five years, owning Starbucks basically got you a return not significantly different from the S&P, but with far more risk.

The second chart provides a larger view of just how volatile the firm's returns have become. Looked at since inception, we see the predictable rocket-like trajectory as the firm grew across the nation, changing coffee consumption habits during some periods of economic growth. But 2005 clearly marked a watershed year.

After that, monotonic share price growth ended. Volatility arrived on an unheard of scale, making the stock a much different type of issue than it had been. Prior price declines were nothing, in retrospect, compared to the cliff off of which the stock price fell for about three years.

Thus, the recent rebounds in fundamentals which have powered a seeming-comeback may mislead investors. Perhaps even Schultz, too.

Tuesday, March 08, 2011

Wilbur Ross vs. Liesman on CNBC This Morning

This morning, on CNBC, viewers were treated yet another example of why the network must fire Steve Liesman.

Under discussion was the proposition that the Dodd-Frank law has solved nothing, and only added to regulatory costs and uncertainties. Wilbur Ross opined that nothing in Dodd-Frank that was new would have prevented any of the of the recent mortgage-related financial excesses. Another guest echoed Ross' comments.

Leave it the networks senior economic idiot, Liesman, to begin yelling over and at Ross, claiming that he disagreed. Not once, but two or three times, did Liesman interrupt or shout over guests with actual, successful experience in the sector, to object to their opinions and tell them they were wrong.

When he finally sputtered to a stop, the uncredentialed reporter uttered some barely-comprehensible, feeble and, frankly, unbelievable reason that he felt Dodd-Frank would have improved upon prior regulatory schemes. I seem to recall him repeatedly yelling,

'but Fannie and Freddie......,'

so it's likely his mistaken belief had something to do with safeguards involving the GSEs.

You had to see this exchange, though, to truly appreciate just how clueless and pompous Liesman has become. It would have been one thing for him to ask Ross and the other guest a question focused on what he believed was a feature of the recent regulatory law that may have had a positive effect on the crisis. But without any credible basis for his comments, to simply try to shout down two more involved and experienced businessmen on the topic, was just deplorable.

Liesman has become a glaring liability for CNBC. It would not surprise me if Ross conditioned his next appearance upon Liesman being banned from the set for the duration of his visit.

Evolution of Equity Portfolio Selections

I recently had the opportunity to focus on how my quantitatively-driven portfolio selection process has captured current trends in business.

It began when I noticed a former business partner using selections from a prior month for which he had not compensated me. Without going into the details of the situation, suffice to say he continued to buy equities and options, in January, based upon two-month old portfolio selections.

With his old portfolios, and using only some of the prior selections, for comparison, I have noted how the February and March portfolio selections have, in just those several months, begun to shift into new areas.

For example, one new holding is a cloud computing firm. Another is in solar energy.

Since its inception in 1997, the selection process has included various energy firms- Royal Dutch Shell at the outset, and, over time, natural gas, oil exploration and service firms. Now, reflecting the economy and government subsidies to alternative energy production, a solar-related firm has performed well enough to become part of the portfolio.

Similarly, my very first portfolio included Intel and Microsoft. Over time, the selection process moved to PC manufacturers, other software providers, security firms, network gear providers, then online-oriented firms. Now, with so much content stored off-site and so many programs which are net-based, a cloud computing firm has demonstrated sufficient strength on the necessary attributes to be included in the latest portfolio.

I don't think I could ever make such changes subjectively. Just the other morning, on CNBC, I listened to a portfolio manager bemoan having owned Microsoft, instead of Apple, for several years. I suspect that when one subjectively analyzes forecasts, it becomes very difficult to reshuffle one's portfolio. So much of the decisions become based on quality of estimates or forecasts, or simply emotions concerning old favorites.

Along the lines of that last point, I found it hard to believe a conversation I heard last Friday on CNBC regarding Wal-Mart.

The hapless Maria Bartiromo was asking a guest- either a portfolio manager or buy-side analyst- why Wal-Mart's size and market shares didn't guarantee that it exhibit excellent equity price performance.

I don't really recall the guest's reply. I know what he didn't say. What Bartiromo, with all her presumed experience covering financial markets didn't already understand.

Simply put, Wal-Mart has lost its potential to surprise investors and markets.

Firms like Apple which design and manufacture products can develop radically new, innovative items- then enhance them. But retailers must typically on just store growth. Perhaps occasionally the addition of a new product line or fighting brand. But, for the most part, once they gain lots of attention, are followed by a hundred analysts, and saturate their primary markets, it's hard for them to surprise with results on a consistent basis.

Wal-Mart reach that point about a decade ago, as the nearby price chart indicates. After several decades of torrid total returns which massively outpaced the index, it has settled into maturity. Probably never to regain the performance characteristics of its earlier days. That's why the firm hasn't been among my portfolio selections for over a decade.

How is it that this fairly common phenomenon escaped the understanding of the veteran CNBC anchor and her presumably experienced guest?

Monday, March 07, 2011

US Commercial Banking, Evolution & Commoditization

My years with the Chase Manhattan Bank were spent under the tutelage of Gerry Weiss, SVP of Corporate Planning & Development. It was a privilege to work for such a bright, secure and gifted strategist.

Gerry didn't win a lot of new friends among his senior executive colleagues at the bank for holding the view that banking was one of the most commodity-like businesses in existence. With a few exceptions, most of the businesses at Chase were extremely difficult to differentiate because, at the end of the day, you were either borrowing, lending or processing money. Not exactly a patentable good.

Further, as technology became more important in more banking businesses, any single bank's ability to maintain a competitive edge for very long became increasingly difficult.

With all this in mind, I read a piece in the Wall Street Journal last week regarding federal arm-twisting of the major US banks on mortgage foreclosures. Leaving aside the subject of that article, which was the unwise attempt to force banks to forgive negative equity for borrowers, I was struck by the pedigrees of the few banks mentioned- Chase, Wells Fargo and BofA, and the one absent bank- Citicorp.

I realized, as pondered these names, how few people today probably recall that these, including Citi, are no longer the banks which originally had those names.

For example, Wells Fargo is really just the name of a former San Francisco-based bank acquired by what was once a staid Midwestern outfit- Norwest Bank of Minnesota. If I'm not mistaken, Norwest itself was acquired by a one-time rival, First Bank System. Along the way, it hoovered up the crippled Wachovia during the recent financial crisis, giving it, ironically, the old Golden West S&L, too. That was a product of Ken Thompson's wrong-headed mortgage bank acquisition at the peak of the real estate bubble. It cost him his job.

Meanwhile, BofA is just the surviving name of another San Francisco-based bank that took too many risks and became the prey of another regional US bank- Nationsbank, the renamed North Carolina National Bank. Hugh McColl busily assembled a large group of basic banking franchises beginning in the 1980s. The drive to aggregate assets and relationships culminated in the takeover of the once-proud BofA. McColl's successor, Ken Lewis, overreached when he bought Countrywide and Merrill Lynch during the recent financial crisis. That latter deal's murky details sent Lewis packing early from his CEO job at BofA.

Chase, as we know it today, is simply the name hung on the agglomeration of assets of most of the old money center banks of New York City, except for Citi and Bankers Trust. Back when I worked for Gerry Weiss, he once referred to Chase Manhattan, Chemical and Manufacturers Hanover Trust as three fairly interchangeable, mediocre banks. When asked about merging them, he snorted derisively,

'All you'd get is a much bigger mediocre bank that would be even more difficult to manage than what we've already got.'

Never the less, Chemical took over MannyHanny, then the two picked off Chase after its CEO, Tom Labrecque, finally ran the latter into the ground and attracted the unwanted attentions of fund manager Michael Price. In time, the CEO job went to Jamie Dimon, who had fled New York City to run the remaining Midwest regional commercial bank, Banc One- by then a product of a merger of the Ohio company of that name and the old First Chicago.

Citicorp wasn't mentioned among those in the foreclosure-related article because it essentially died, only to be resuscitated as a ward of the federal government after 2008. Before that, however, it was taken over from outside banking, when Sandy Weill prevailed upon then-Treasury Secretary Bob Rubin to allow him to 'merge' with John Reed's Citibank. Weill then hip-checked Reed out of the C-suite, hired Bob Rubin, and proceeded to build the most unwieldy, unmanageable financial supermarket ever attempted in the US.

My point is that if you were to have surveyed the national and regional banking field in the mid-1980s, as my colleagues and I did as part of our jobs as corporate and business strategists at Chase Manhattan, you'd have classified BofA, Chase Manhattan and Citicorp as the nation's three most important international money center banks. Chicago had just lost Continental Bank, but still had First Chicago. Bankers Trust and JP Morgan were smaller, more focused money center banks. All of these had senior management which felt and behaved as if their banks were special, different, and able to take risks which other US banks couldn't handle.

Fast forward almost 30 years, and you can see how wrong they were. The three premier US money center banks all lost their managements via takeovers.

In truth, the managements of what we now know as the leading US banks are products of duller, less-ambitious banks. Less ambitious in terms of scope, though, rather than size. And the businesses which are now part of these banking companies which aren't historic mainline banking units- brokerage, underwriting and merger and acquisition advisory- have become, as my old boss Gerry Weiss predicted, less lucrative due to the commoditization of them by the large commercial bank entrants.

In true Schumpeterian form, most of large commercial banking has become commoditized amidst growing competition. Thus, their equity price performances are, for the most part, anemic. Only Wells Fargo has a 35-year price performance which eclipses the S&P500 Index. Chase, BofA and Citi all trail it substantially.

What's different about Wells? Notice, first, that its outperformance slackened significantly around 2000. So it's not a function of recent management skill.

More likely, its earlier outperforming of the S&P resulted from its having avoided combining with any of the leading money center banks- ever. A host of old mid-sized California banking franchises- First Interstate, Crocker, and Security Pacific- if I recall, comprised the Wells Fargo that Norwest snared. As such, while predecessor banks got into some troubles, they tended not to be on the gigantic scale of the messes into which the three largest US money centers stepped throughout the past three decades.

Of the other banks, Chase managed to about match the S&P, while the Citi and BofA plunged noticeably.

So, from a perspective of over thirty years of large US commercial bank performance, it's evident that the risk-taking of the old international money center banking companies didn't result in their consistently superior performance. Rather, to the contrary, that strategy failed, as evidenced by the managements of more cautious, smaller commercial banks ultimately owning the marquees previously associated with their larger one-time rivals.

Now, no matter what you hear on CNBC or read in the Wall Street Journal, for the most part, the four major US commercial banks have become financial utilities which will, for the most part, fail to consistently outperform the S&P500 for any significant period of time. They've become large, slow-moving purveyors of financial commodities.