Friday, October 28, 2011

Alan Mulally On Pent-Up US Car Demand

I caught Ford CEO Alan Mulally on one of the two business cable networks, CNBC or Bloomberg, earlier this week on the occasion of the firm's earnings release.

Mulally was excited about the average age of the US auto fleet, which was somewhere in the 10 year range. He noted that this was an all-time high.

Fair enough, but is that really a fair historic comparison?

I drive a Subaru that is by no means new. But it's in infinitely better condition at its 7+ years than its predecessor, a 1986 Subaru, was at the same point in its life. My current car has had fewer serious problems than the earlier one. For example, my older one lost a timing belt, which is a car-stopping problem, after about 7 years. My present Subaru hasn't suffered that. Instead, it had a leaky fuel injector, which was, while annoying and not inexpensive to repair, not a problem which caused the car to cease functioning.

Today's cars are much more difficult, both stylistically and condition-wise, to gauge in terms of age. Bodies don't rust as easily, the quality of design and assembly are higher. Overall, a ten year old car doesn't look the same today as a ten year old car did, well, ten years ago.

So I wonder if Mulally's engaging in some wishful thinking. Yes, I understand that recent double-dip recession fears have eased. And I understand that US car sales have been good lately.

Yet I don't see the employment and income growth statistics which would seem to underpin a truly robust growth in US car sales. Moreover, as cars age much better, and, aside from computerized safety and communications systems, which are not essential for driving, have added fewer new systems, like anti-lock brakes, power systems, and such, it's not clear to me that financially-strapped consumers feel the need to replace their cars so quickly.

It would be interesting to know how the average US fleet age has changed with respect to economic conditions and the evolution of cars themselves over the past several decades.

I'd also be curious to know the composition of Ford's and other makers' recent sales growth. My hypothesis is that the growth has probably been among higher-end, higher-priced cars. Bought by upper-income consumers who haven't been affected by the last four years of US economic turmoil.

While it would be nice to accept Mulally's cheerleading about US fleet age and imminent replacement sales at face value, I just can't. There seem to be too many conflicting signals to make such a simple extrapolation.

The Folly of Mortgage Forgiveness

Alan Blinder's editorial in the October 20 edition of the Wall Street Journal, How to Clean Up the Housing Mess, contains shockingly bad recommendations regarding America's housing hangover from the Greenspan era of easy credit.

For example, Blinder contends, in the opening paragraphs of his editorial,

"Sadly, however, we did almost nothing to stop the predicted foreclosure wave, which is now drowning us. The issue at this late date is how we can mitigate the damage.

One oft-repeated answer comes from the intellectual descendants of Andrew Mellon and Herbert Spencer: liquidate, liquidate, liquidate. Let the housing market find its natural bottom, and the chips fall where they may.

I beg to differ. Some of the reasons are humanitarian. Millions of foreclosures are ruining millions of lives and devastating many communities. We can do better than Social Darwinism."

Blinder refuses to acknowledge that the housing foreclosure mess and overbuilding involved borrowers getting themselves into loans which they should have declined, mostly for houses they could not afford. Simply declaring that they must be spared is a pipe dream. Liquidation of foreclosures doesn't necessarily mean evictions, but we must have an attribution of the loss of value to some party. And that party would, according to mortgage contracts, seem to be the borrowers. If they default and the lenders can't recoup all of their loan value, then they, too, will share some of the loss.

Next, Blinder makes a baldface misstatement,

By now, massive underbuilding during the slump far exceeds the overbuilding during the boom. So, by rights, a shortage of houses should be pushing up house prices, incentivizing home builders, and boosting growth in gross domestic product. Instead, actual and prospective foreclosures hang over the housing market like a wet blanket."

On Monday afternoon, two economists who were guests on Bloomberg television agreed that the recent rise in housing starts is bad news. That the US still suffers from a surplus of housing. So Blinder is wrong to claim that there has been a "massive underbuilding during the slump" that "far exceeds the overbuilding during the boom." If that were true, we wouldn't have a foreclosure dilemma, because demand would be supporting housing prices.

Blinder claims the following regarding federal mortgage relief,

"The first is money. Given the huge magnitude of the aggregate gap between house values and mortgage balances, a comprehensive anti-foreclosure solution requires hundreds of billions of dollars. (Note, however, that this money would be lent, not spent.)"

How does he know the money would "be lent, not spent?" Losses will eventually have to be realized, which means 'spent' money which artificially paid for value that just isn't there.

"The second barrier is a host of legal complications—stemming from such things as securitizations, second mortgages, and the like—that make it difficult to design and execute a comprehensive plan. The details would put you to sleep. But the bottom line is that most serious solutions entail modifying somebody's property rights—which is something we don't do lightly in America, and for good reason."

So Blinder doesn't take this lightly, but, what the heck, let's do it anyway. We'll just say, you know, that we 'didn't do it lightly.'

"The third barrier may be the biggest: politics. Apparently, many Americans view it as unfair to bail people out of unaffordable mortgages. Do you remember the famous Rick Santelli rant on CNBC in February 2009—the one that gave the tea party movement its name? Mr. Santelli was griping about President Obama's new foreclosure mitigation programs—the ones I just characterized as half-hearted. It would have been a brave politician indeed who pushed to make those programs larger and more generous.
Most economists see principal reductions as central to preventing foreclosures. That takes money, of course—plus ignoring the Rick Santelli rant. Perhaps the cost to taxpayers could be reduced by giving the government—or even private investors—some of the upside when house prices finally start climbing."

For some reason, perhaps because he's a liberal, and Rick Santelli is not, Blinder delights in demonizing the CNBC on-air staffer. Calling the process of saddling taxpayers with the losses of injudicious borrowers for homes they could not afford "politics" is a convenient way to disguise and endorsement of moral hazard, as well as bad policy.

"Many vacant houses could be converted into rental units by enterprising developers. The government could make such investments more attractive, e.g., by using mechanisms similar to what the Federal Reserve and the Treasury did during the worst of the financial crisis. Back then the government lent money to investors who were willing to buy mortgage-backed securities; this time it could lend money to investors who are willing to invest in certain rental properties."

Ironically, Lew Ranieri complained on CNBC earlier this year that such federal loan programs for small investors, which were a key part of the 1980s S&L crisis recovery, were not offered in the most recent mortgage-related crisis. Once again, though, one has to ask, who will have born the losses on these houses as they return to the market at lower prices?

Blinder is all for mandated loan forgiveness, forgetting that such losses will make banks take losses, further imperiling their capital adequacy. Large US banks wouldn't even be at the table discussing the issue, had the federal government not intimidated them with baseless litigation as the price of declining to join the talks.

As I explained to a friend the other day, housing value losses are a fact. There are only three groups which can absorb them- homeowners, banks and taxpayers. Blinder wants banks to absorb the losses. That will, as I have explained in this piece, cause capital adequacy issues, as well as reward borrowers for taking excessive risk. If homeowners are left to follow available legal options, including bankruptcy, then housing prices will fall to market-clearing levels and others who can now afford such houses will buy them. If the government, either directly or through GSE pass-through securities, assumes the losses, that means, in effect, taxpayers are bailing out homeowners.

That's no way to treat a private sector, nor to resolve the US housing problems. Blinder's ideas for dealing with the housing sector's woes and coming foreclosure boom should be ignored.

Thursday, October 27, 2011

The European So-Called "Solution"

Having been wary of equity market performance and a host of troubling contextual factors for most of this month, I would, in light of this morning's US GDP and spending data, and the investor reaction to the suspect 'solution' to the European debt crisis, return to a fully-invested long position in my portfolios.

It's not that any of the concerns which roiled the equity markets in early October have disappeared. But there is a sense of unfulfilled, self-fulfilling market behavior. Instead of moving down to a level of 1050 or so, the S&P has fitfully moved higher, then, after news overnight of some sort of initial Greek debt accord in Europe, S&P futures were already at around 1260 this morning. The 8:30AM release of third quarter GDP and spending further boosted investor optimism.

Thus, with market levels well away from those which would signal being out or short, I'd return to full investment levels at this time.

I don't think anyone actually believes the European situation has been resolved in any real sense. The description of the process for handling bond losses provided by a CNBC correspondent this morning was positively laughable. Banks are supposed to take earnings hits to cover writedowns. Then, if necessary, raise capital in public markets. If that doesn't fulfill their needs, then a combination of national treasuries and the EFSF are supposed to provide the necessary capital.

This sounds exactly like what Kyle Bass and others have warned against. It's mostly hope, smoke and mirrors. Spain, Portugal and Italy weren't even mentioned, yet everyone knows they are far larger and share Greece's sovereign debt problems.

Meanwhile, in the US, with unemployment remaining high and real median income down for the past decade, it's tough to see from where the rise in Q3 spending is coming. But when equity markets move decisively in a direction, it's usually foolish to completely ignore that.

In this case, since there are some developments of a non-negative nature in key contextual variables influencing my outlook on equities, their change can lead to a change in my decisions.

Citigroup's Mortgage Fraud Case

Thursday's Wall Street Journal reported that Citigroup will pay $285MM to settle fraud charges involving the bank's selling mortgage-backed securities to investors while simultaneously shorting some of those same instruments.

This is the same sort of behavior for which Goldman Sachs was excoriated before a Congressional committee, and settled related charges for $550MM.

In Citigroup's case, it seems rather odd to me that the US taxpayer rescued this firm. In effect, rather than let such a management fail, our government saw fit to rescue the management team responsible for such fraud. Something seems very wrong with that.

Wouldn't it have seemed more sensible, given the overcapacity of the financial sector, and the many mistakes made by management in some very large firms, to put those which failed into an orderly Chapter 11 process?

Instead, we have our government using our tax dollars to prop up and revive a management which actively engaged in large-scale fraud of investors in its mortgage-backed securities.

More Upward Failure- MF Global's Jon Corzine

Yesterday morning's Wall Street Journal featured an article in the Money & Investing section detailing MF Global's troubles stemming from newly-hired CEO Jon Corzine's drive to turn the firm into a replica of the old Goldman Sachs which he once ran.

Two days ago, on Bloomberg television, Corzine was described as stumbling at MF Global, and having lost his last gig as governor of New Jersey. That was before he led MF Global to a 48% drop in its market value after announcing the firm's quarterly loss earlier this week, as well as an out sized risk exposure to European securities for a paltry $12MM of related earnings.

But Corzine's been on an upward failure trajectory for much longer than that.

A one-time bond group head, Corzine was co-head of Goldman Sachs with the less-remembered Stephen Friedman. The latter has recently attained prominence for his alleged conflict of interests during the financial crisis of 2008, when he was chairman of the board of the New York Fed.

As I began writing this post, I remembered that I wrote about Corzine's arrival at MF Global early this year, and his connection with private equity mogul J. Christopher Flowers. In that post, I described the Wall Street Journal's sarcastic asides regarding Corzine's being run out of his job as co-head at Goldman Sachs.

His next post, which he bought, was the job of US Senator from New Jersey. For a Democrat, a veritable walk-in. But Corzine showed poor judgement, leaving the Senate just before the Democrats regained the majority which would have put the former fox in regulatory control of the financial hen house.

Perhaps Corzine had presidential ambitions, because he won election as New Jersey governor after leaving his Senate seat. But, as the Bloomberg anchor noted, Corzine only lasted one term before his poor performance caught up with him by way of Chris Christie.

Now, one imagines at the behest of Chris Flowers, Corzine's attempt to morph MF Global into a miniature version of the Goldman Sachs he and his backing partner once knew, has managed to chop half the market value from the firm.

If you are unlucky enough to be an MF shareholder, perhaps you are now wondering just how a private equity guy has managed to take control of your firm, then ruin it, within a calendar year.

The only thing that could top this week's MF Global news is to learn that, as rumors swirl regarding the firm now being an acquistion target, we learn that Chris Flowers' private equity shop is involved in such an acquisition. I don't know what portion of MF's equity is owned by Flowers, but it's just possible that half the value of the rest of the firm, which would now not be paid to own 100% of the firm, might well be more than the losses Flowers has just taken on his share of MF Global.

That would be just too much, wouldn't it, if it occurred? Watching a private equity guy install a partner in a firm on the board of which one of his representatives sits as CEO of the company. Then seeing said CEO dramatically and quickly lop off half the value of the publicly-held firm. Followed by the private equity guy opportunistically buying the now-tainted firm for half of what it would have cost him last year.

Perhaps people should be wary when a failed CEO of a financial firm is installed in the same job in their firm.

Upward failure- it seems more widespread than many people realize.

Wednesday, October 26, 2011

Inane Forecasts On Business Cable Channels

I saw a couple of examples in the last 24 hours of some truly inane market and company forecasting on CNBC and Bloomberg.

Yesterday afternoon, Citigroup equity strategist Tobias Lefkovitch was on Bloomberg pontificating about equity market moves.

He followed an interview with a guy whose name I did not catch, but was something like 'Mark,' who is allegedly famous for making S&P Index top and bottom calls. According to the Bloomberg anchor/interviewer, the guy had correctly called the recent index bottom, around 1090, and top of a few days ago of 1255. The rest of the interview descended into fairly incomprehensible technical lingo. Even the anchor tried to sum up the guy's remarks in something resembling plain English. It left me wondering how many other market calls this guy has made that have been forgotten or ignored because they weren't correct.

Then Lefkovitch appeared. After discussing various topics involving sectors, the anchor, of course, asked the Citi strategist for his US equity outlook. Incredibly, Lefkovitch, after his own brand of obfuscation, finally uttered what I will try to closely paraphrase,

'So we're looking for equity markets to rise sometime in the next 12 months.'

That's it? Incredible.

Reminds you of the stopped watch aphorism, doesn't it? Just exactly what good is someone telling you that they expect the S&P to rise significantly sometime in the next 12 months?

For individual, self-directing investors, sure, that may offer hope that a continuously-long, dollar-averaged approach to S&P ownership will pay off, if they can remain patient. But for anyone purporting to follow even a semi-active equity strategy, it's a useless market call.

Sophisticated investors don't like to sit still for a year's worth of losses, in hopes that eventually things will turn around. They sure don't pay monthly management fees to professional managers for that sort of performance.

Makes you wish the Oracle of Delphi was still around, doesn't it? So that you could compare some of these so-called strategists' market calls with an appropriate peer?

My own take away is how desperate Bloomberg must be to fill air time that it invites these guys on to give nearly useless forecasts on market trends.

Then I watched a few minutes of CNBC's 9AM program, before Cramer's preening, self-congratulatory remarks turned me stomach enough to send me back to Bloomberg. Prior to that, he was extolling Boeing and ATI for what he forecasts as Boeing's coming seven-year fat phase. Never mind David Faber's sobering question regarding investors already discounting this outlook in the price of the equity. One wonders the same regarding ATI, Boeing's titanium alloy supplier.

For what its worth, Boeing has never entered my quantitatively-selected equity portfolios for over twenty years. It's just too erratic, with its boom and bust cycles and ruthless price competition with Airbus, and, prospectively, China's own budding airplane manufacturer.

Amazon's big earnings miss last night didn't faze Cramer. He praised Jeff Bezos for damning near term performance in order to continue building the world's largest online good provider. This morning, the company's equity price is down more than 10% as I write this at 10AM. It's been in some of my equity portfolios over the past year, but, as always, its performance will keep it there. Not promises of uncertain future developments.

Ron Paul's Sensible Reminders of Central Bank Limits

Ron Paul, Texas Republican Representative and presidential candidate, wrote a well-reasoned editorial in Thursday's edition of the Wall Street Journal entitled Blame the Fed for the Financial Crisis.

Without getting into mind-numbing detail, let me focus on one key passage of his piece,

"The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.

The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.

In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.

Nothing could be further from the truth. No attitude could be more destructive. ...the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.

The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West's (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.

The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.

If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free."

It's an instructive and, I believe, correct analysis of what the Fed has done to the US economy for nearly a century since it was created by Congress. In response to populist pressure for a dispersed federal authority, unlike the old First and Second Banks of the US, the regional organization of the Fed was designed to represent the interests more than simply the US financial sector.

Rather than trying to exercise more control over the monster which Congress created, it could, instead, follow the advice of the late Milton Friedman and replace the institution's monetary policy authority with a  rule-based approach to monetary base management. John Taylor has suggested a rule which assumes the existence of the Fed, but provides an interest rate-setting formula.

But what Congressman Paul so correctly emphasizes is that the Fed, having a staff and budget, has come to believe it can manipulate the money supply to some good effect, rather than simply adjust its growth to relevant factors involving population and GDP.

As with other governmental institutions, once chartered and funded, the Fed is unlikely to ever unilaterally relinquish its powers and/or admit it is mistaken in its ability to beneficially attempt to fine-tune monetary policy.

Tuesday, October 25, 2011

Netflix's About Face On Splitting Services

According to its stock price history, it is clear that Netflix has yet to recoup the massive shareholder value damage which occurred when the firm's CEO first announced the splitting of the firm into online and physical dics video delivery. The nearby 3-month price chart for NFLX and the S&P500 Index, through Friday, clearly displays that. It got worse after the close yesterday when Netflix released earnings and reduced projections for the fourth quarter.

Now about a month old, the furor which the move touched off among investors and customers prompted the firm to reverse its decision a few weeks ago. I wrote in this post a little over a month ago,

"Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.

As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.

As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates."

Looking at a 6-month chart of the same two series, and noting Hasting's reference, in his September 20 email to customers, that the firm had announced its new pricing structures a few months earlier, one can see that the firm's equity price stopped rising at that point. The formal announcement of a split caused a cliff-like drop in the share price.

Contrary to my own hopes, Netflix has totally reversed itself on splitting, but kept the pricing changes. Probably the worst of all worlds.

Now we'll never know how the online component would have fared alone, although, as I originally noted, there would have been some short term challenges to cost allocations of content acquisition deals.

Unlike the initially-disastrous New Coke introduction decades ago, which ultimately resulted in a new flavor becoming permanent, and more shelf facings for Coke products, I think the longer term consequences of Hastings' dithering, then reversing his company-splitting decision will be negative.

To me, Hastings' actions reflect one or both of two negative components of his decisions as the firm's CEO. To reverse himself on such a crucial customer service issue as splitting the company into online and disc suggests that either Hastings and/or his staff didn't possess a high level of confidence in their knowledge of their customers. One would hope they would have conducted some primary research with a sample of their customers, chosen by usage patterns, to get a good sense of their reactions before even announcing the price changes. That's profoundly poor general and marketing management.

For Hastings to compound this with his missteps regarding splitting the firm shows weakness as Netflix's CEO in understanding what is essential for the firm, going forward, in order to continue to deliver total return to shareholders. Because the decision involved not just investors, but customers, as well, that, too, should have been researched. The reversal of the decision again suggests it was not.

Prior to this past summer, Netflix appeared to be a dominant, well-managed video content delivery firm. In the wake of its actions since the summer involving pricing structure changes, and then corporate structure changes, the core competence of its management team is now in question.

That's reason enough for an investor to be open to reassessing the firm's attractiveness as an investment.

Monday, October 24, 2011

More Puzzling US Equity Market Behavior

As I write this, it's a little after noon on Monday. The S&P500 Index has moved above 1250. Earlier this morning, one pundit opined that if the index moved above that level- probably closed, I would guess- then the US equity market is in fine shape and will continue to rise. For now, the index's return for October is in excess of +10%. Quite substantial.

Meanwhile, last week, another pundit described this October's S&P rebound as a bear-market rally.

Whom to believe?

Well, consider that the vaunted weekend Euro summit to solve their sovereign debt and related bank solvency problems didn't provide a resolution. That got kicked to later this week. As if that would matter. What, exactly, in the year and a half since April of last year, when Greece's debt problems first roiled markets, has changed? What new solution will occur in the next 3-4 days which will magically avoid defaults, write-downs, and the loss of value across a range of European assets?

Other news this morning included a concern that Europe is slipping back into recession. And that's before the effects of whatever value loss recognition will finally occur.

All this and the S&P has climbed back from below 1100 this month. Is this credible and sustainable?

I took a look at how the S&P monthly returns behaved after past triggering of my proprietary equity signal to get out of equities and/or go short.

In 2008, there were no significant positive monthly returns after June, when the signal was triggered, until the fall, when equities collapsed. However, back in 2001, things were different.

The signal was activated in January of that year, but April and November exhibited S&P monthly returns of over 7%. Never the less, the year's total return for the index was nearly -12%.

We often hear that equity markets, to rise, must "climb a wall of worry." And there are other aphorisms, to be sure, for various market situations.

But if you recall 2001 and 2008, there were enough concerns to more than qualify as a wall of worry. Yet the S&P subsequently collapsed. The index posted more than a +20% return in 1999, then flattened to about -1% for 2000, before plunging for the next two consecutive years. In 2008, the S&P lost 36%, then, after a stunning bottom below 1,000 in March, managed to return roughly +26% for the whole year.

My point is that equity market descents of a long and/or excessively severe nature don't necessarily start predictably and monotonically. There can be some healthy monthly index returns amidst what has, in retrospect, become a serious decline.

So far in 2011, the first two S&P monthly returns were each above average. March was flat, followed by April's +3% return. May through September have all been negative, the last month returning worse than -7%.

Wall of worry, or prelude to a plunge?

To me, as I've observed in prior posts on this topic, prudence is a wise course. I became cautious when an early October's intra-day S&P dipped below 1100. That hasn't changed yet, largely due to the context of large, unresolved structural economic and financial problems which exist globally.

When I hear those who argue for a strengthening US economy, I wonder just what about a 9% narrowly-defined unemployment rate is a positive omen to them? I've already explained, as have others, that strong US corporate results reflect global business exposure more than US activity.

Despite today's continuing robust S&P performance, I still would remain cautious for the longer term of at least the rest of the year, pending resolution of some of the existing problems which left the S&P relatively unaffected.

Shareholder Lawsuit In The Wake of Kinder Morgan's Privatization

A little over five years ago, Richard Kinder took Kinder Morgan private. At the time, I wrote this post about it and, later, one about the inherent unfairness of a management self-dealing against other shareholders in such a gone-private transaction. And what could be done to mitigate this,

"I reasoned something like the following would work. A sort of reverse greenmail. If a management tendered to take the firm private, regulation should provide for the offering of a similar ownership share in the newly-private firm, without voting rights, but with equity rights equal to that of the management's holdings. In effect, whatever management deals itself in for would be available to any shareholders who wished to stay on board for the ride. It would be interesting to see how such a change in the law to mitigate gross underpayment to existing shareholders by the buyout group would affect future private equity deals."

Harman Kardon actually did something like this when it went private in 2007.

So it was with interest that I read, amidst the heavy media coverage of Kinder Morgan's proposal to acquire El Paso, that some disenfranchised shareholders sued over the privatization that closed in 2007. According to a Wall Street Journal article,

"Angry shareholders filed a class action lawsuit contending he had structured the deal to his own benefit, shortchanging them. The company settled last year for $200 million.

In February of this year he turned around and spearheaded an initial public offering that issued nearly 110 million shares and raised roughly $3.3 billion."

The Journal piece says that Richard Kinder currently owns 31% of the firm, which "will have an enterprise value of $94 billion after the El Paso deal."

Kinder Morgan went private for $15.2B in 2007. It's paying $21.1B for El Paso, which means the enterprise value of Kinder Morgan before the deal is roughly $73B.

The Journal article doesn't say what percentage of the pre-privatization Kinder Morgan the disgruntled shareholders owned, but this webpage contends that the shareholders are receiving, before legal fees, only $2/share from the settlement, in addition to the original payment of $107.50. That's less than a 2% increase.

But Kinder Morgan insiders saw a roughly five-fold value increase (from $15.2B to $73B) in the firm's value. That's a huge amount of value which non-management shareholders were forced to forgo by Kinder's original private buyout.

With all of the data now available from before and after Kinder Morgan went private, it's evident that those deals by management insiders are unfair to the average shareholder who is not a member of senior management. They are forced to sell to insiders who would not be buying if they thought the price would likely prevent them from realizing their target return, or better.

I'm not a big fan of more SEC-supervised rules regarding the operation of companies or their ownership transactions. But this sort of self-dealing takes advantage of external shareholders and increases the animosity of the average American against those they believe take such unfair advantage.

Would it really have cost Richard Kinder and his team of insiders so much to allow those shareholders, prior to the company's going private in 2007, who wished, to exchange their voting shares for non-voting equity of equal value?

Sunday, October 23, 2011

A Reminder Of The Fundamental Flaw In Government Stimulus Programs

Here's another recent Wall Street Journal Notable & Quotable that deals with current US federal government financial problems. But it quotes someone from quite long ago, reminding us that government stimulus plans typically overlook something:

"Frederic Bastiat on justifying government spending only based on 'that which is seen,' while ignoring 'that which is not seen.'

French economist Frederic Bastiat in "That Which Is Seen, and That Which Is Not Seen," 1850:

I lose patience, I confess, when I hear this economic blunder advanced in support of . . . a project. "Besides, it will be a means of creating labor for the workmen."

The State opens a road, builds a palace, straightens a street, cuts a canal; and so gives work to certain workmen—this is what is seen: But it deprives certain other workmen of work, and this is what is not seen.

The road is begun. A thousand workmen come every morning, leave every evening, and take their wages—this is certain. If the road had not been decreed, if the supplies had not been voted, these good people would have had neither work nor salary there; this also is certain.

But is this all? Does not the operation, as a whole, contain something else? At the moment when M. Dupin pronounces the emphatic words, "The Assembly has adopted," do the millions descend miraculously on a moon-beam into the coffers of MM. Fould and Bineau? In order that the evolution may be complete, as it is said, must not the State organize the receipts as well as the expenditure? Must it not set its tax-gatherers and tax-payers to work, the former to gather, and the latter to pay?
 The sophism which this work is intended to refute is the more dangerous when applied to public works, inasmuch as it serves to justify the most wanton enterprises and extravagance. When a railroad or a bridge are of real utility, it is sufficient to mention this utility."

These latter paragraphs make Bastiat's point- projects worth society's capital need not wait for nor depend upon federal government funding. Excepting cases of military spending and wartime efforts like the Manhattan Project, the long term economic benefits of which, outside of defense purposes, I am not specifically aware, there isn't any significant government spending which can't be undertaken by the private sector instead.

Currently, federal funding is used as a substitute for state and local funding, because the latter two must typically run balanced budgets. Roads, government building such as schools, and even public employees, are all potential uses to which scarce state and local taxpayer dollars must be allocated. To simply declare them all vital and rely on federally-sourced, borrowed money, is to ignore Bastiat's insight that the better projects are already being funded locally.