Today's Wall Street Journal featured an article concerning GE's breakup. It's in the middle of the Money & Investing section's front page. The headline is a complimentary "For GE, No Lack of Ideas."
As I wrote recently, here, even as the Journal touches this potential third rail topic, it is doing so gingerly. Here are some of the more forgiving (of Immelt and GE) quotes:
But some shareholders and analysts argue that GE's sprawling businesses are better off together than apart. GE's big umbrella, these investors say, can balance differing product and economic cycles, while helping all its businesses financially. And that would boost the stock price over the longer term.
The "keep GE together" crowd appears to have a strong ally in Mr. Immelt, who has resisted past calls to sell NBC Universal. Mr. Immelt has repeatedly expressed his frustrations with GE's stock price, which is down 7% since he took over in September 2001, while the Dow Jones Industrial Average is up 35% over the past five years.
What's more, splitting off big pieces of GE could ultimately lower the entire company's valuation. If, for example, it divested itself of NBC Universal, the company would be even more heavily weighted toward financial-services businesses, which generally get lower valuations than the industrial units. In the first quarter, financial services already accounted for more than 60% of GE's profit.
What I noticed about the above-cited text was that no salient, sage investors were actually named as the 'some shareholders' who 'argue that GE's sprawling businesses are better off together.' Who are these shareholders- seasoned hedge fund managers, or your great aunt Hilda, who has held GE in her portfolio since 1980?
To say that GE CEO Immelt 'appears' to want to keep GE whole is an understatement. After six years presiding over this failed conglomerate, do you really think he's ready to throw in the towel and fire himself? Because that is the logical conclusion of beginning any divestiture, or the complete breakup into all its six constituent units.
I wrote about a GE breakup here, last August. Contrary to the sentiment expressed in the third paragraph I cited above from the Journal article, I think a split up would result in more value all around for shareholders. If one unit becomes valued as a financial service company, so be it. That's what it is. Shareholders would be free to sell shares of that spun off company.
Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen.
In fact, even GE went through such change in the past. Besides publicly available information, I have additional knowledge from my old mentor and boss at Chase Manhattan Bank. He worked for the CPO of GE as it moved between CEOs Fred Borch, Reg Jones, and Jack Welch.
Few today realize how Jones, of whom I have heard it said, "once a beanie (accountant), always a beanie,' stripped much of the strategic vision from GE that Borch had instilled through his business unit investments. Jones retooled the company to be a cash machine because, well, he was an accountant. He liked cash.
Welch, upon taking the helm from Jones, faced an unprecedented period of high inflation and a wide array of non-strategic businesses at GE. He rapidly cut and pruned the company's businesses, earning the now-forgotten moniker "neutron Jack." I can't believe it's so long ago that I probably need to explain the meaning of this nickname to younger readers. At the time, the neutron bomb was under development. Its salient characteristic was to 'kill the people but leave the buildings standing." You can figure out the reason for the nickname from that.
Today's large firms are usually focused on a particular product/market. Diversified conglomerates are pretty much a thing of the past. Mediocre analysts and fund managers might confuse large focused global firms, such as Intel, Cisco, or ExxonMobil, with yesteryear's broadly diversified giants. You should not. I don't think investors do, either. That's why GE's stock is in suspended animation. Everyone can diversify more cheaply today than they can by paying an enormous tax on operating earnings of GE's business units in order to keep them under one administrative regime.
What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled.
In the past, the company was led by CEOs who were unafraid to put a significant personal stamp upon the shape of GE. Immelt, however, eschewed that approach. Instead, he's pretty much kept the cards Welch left on the table. Too bad it's evidently not the right hand for today's business environment.
As I've argued in prior posts (which you may find by searching on the label 'GE,' and following links to even earlier posts), Immelt has been paid far too much for simply keeping Welch's seat warm, but not even managing to beat the S&P. How many of Immelt's own managers do you think he would keep for six years if they had his performance record?
Where's the business media's outrage at Immelt's egregious overcompensation? Oh, yes, that's right- GE is a big advertiser. Wouldn't want to offend a company that lines the coffers of so many print, network and cable media firms. Same with most of the financial service firms.
However, I firmly believe that, now, lurking somewhere in the shadows, are the private equity wolves. Perhaps they are beginning to form a pack and slowly circle the ailing, misled GE. It may take a private equity offer to loosen the business media's collective tongue on this matter, but don't expect too much until they are pretty sure that GE is well on the way to some sort of break up before they feel it's safe to agree with everyone else and proclaim the wisdom of a GE dissolution.
Wednesday, May 09, 2007
Tuesday, May 08, 2007
Dana Telsey v. Warren Buffett on Wal-Mart
Yesterday on one of CNBC's morning programs, retail analyst Dana Telsey gave a wonderfully informed, sensible analysis of Target as preferential to Wal-Mart. It happened to coincide with an excellent interview of the company's leaders in that day's Wall Street Journal.
As is often done, the network placed a Wal-Mart booster opposite Ms. Telsey. All he could really do, though, was reiterate that he hoped Wal-Mart CEO Lee Scott might be fired by year's end, leading the stock to be 'value priced' for some sort of hoped-for turnaround.
As it happens, Warren Buffett had recently (perhaps at his Berkshire Hathaway annual meeting last weekend?) proclaimed himself a buyer of Wal-mart stock.
Thus, Mark Haines of CNBC ceaselessly hectored Dana Telsey with comments like, 'so you think Buffett's wrong,' and 'so you're disagreeing with Buffett' throughout pauses in her remarks.
Hey, Buffett has made his share of mistakes- US Air and Salomon Brothers, to name a few. I believe Mark Haines is wrong to deify the guy. In fact, yesterday on CNBC, one critic described Buffett as basically over the hill, with less-than-stellar recent returns.
He characterized the current search for a new CIO as essentially much ado about nothing, counseling viewers to find the 'next Warren Buffett.' With many billions of dollars to allocate, the commentator (I wish I could recall his name) rather irreverently, but, I believe, correctly suggested that Buffett isn't the same as he was when he was younger, with less money to invest, and that his successor will be unlikely to keep the assets around for long.
With that in mind, I pulled the Yahoo-sourced chart on the left (please click on chart to see a larger version) comparing Berkshire vs. the S&P500 for the past five year. The firm appears to pay no dividends on its stock. Thus, this price chart is essentially a picture of total returns as well. Frankly, I was stunned at what I saw. Berkshire has not significantly outperformed the index over the entire period. For most of the years, it tracks nearly on top of the S&P, with a less pronounced dip in 2002, and a less pronounced rise in 2004. Lately, it's paced the index. Not exactly the kind of return performance that would draw attention, were it any other company than the one Buffett operates.
Back to Target vs. Buffett's pick, Wal-Mart. Dana Telsey noted that a buy of Wal-Mart is for turnaround, but that Target is poised to perform much better. On that note, the Journal interview revealed a stunningly smart, confident team of executives who don't look at their business as cost-cutting discount retail, but, rather, designer-brand and unique-retail experience marketing to selected customers.
Furthermore, they regularly take a common consumer problem and make it part of "The Big Idea" contest. To quote the article, Michael Francis, EVP of Marketing said,
"I challenge my team to solve a problem or see things a new way. We've done everything from what's the next consumable product that we would like to repackage to what product in your pantry frustrates you the most. The winner gets a cash prize, recognition and sometimes we create the product or campaign.
I have people who are brilliant all over the country and they feed in ideas on a regular basis. I probably have about a dozen of them- trend people, movie people, advertising people. We pay them. And we get monthly missives- emails or letters.....it's people who we trust, who we know have the right taste level, who understand our brand."
On that subject of brand, CEO Bob Ulrich said,
"We created the whole trend of designers making products for discounters, starting with architect Michael Graves in 1999....These things keep evolving. You can't just be unique in one category. You can't be really mundane in small electrics if you're trying to be innovative in textiles. You can't be really forward in linens and beat down in shoes, so you have to start to get more consistency across the board....our guests, who are on average about 20% more affluent, more highly educated, come from more sophisticated areas."
As is often done, the network placed a Wal-Mart booster opposite Ms. Telsey. All he could really do, though, was reiterate that he hoped Wal-Mart CEO Lee Scott might be fired by year's end, leading the stock to be 'value priced' for some sort of hoped-for turnaround.
As it happens, Warren Buffett had recently (perhaps at his Berkshire Hathaway annual meeting last weekend?) proclaimed himself a buyer of Wal-mart stock.
Thus, Mark Haines of CNBC ceaselessly hectored Dana Telsey with comments like, 'so you think Buffett's wrong,' and 'so you're disagreeing with Buffett' throughout pauses in her remarks.
Hey, Buffett has made his share of mistakes- US Air and Salomon Brothers, to name a few. I believe Mark Haines is wrong to deify the guy. In fact, yesterday on CNBC, one critic described Buffett as basically over the hill, with less-than-stellar recent returns.
He characterized the current search for a new CIO as essentially much ado about nothing, counseling viewers to find the 'next Warren Buffett.' With many billions of dollars to allocate, the commentator (I wish I could recall his name) rather irreverently, but, I believe, correctly suggested that Buffett isn't the same as he was when he was younger, with less money to invest, and that his successor will be unlikely to keep the assets around for long.
With that in mind, I pulled the Yahoo-sourced chart on the left (please click on chart to see a larger version) comparing Berkshire vs. the S&P500 for the past five year. The firm appears to pay no dividends on its stock. Thus, this price chart is essentially a picture of total returns as well. Frankly, I was stunned at what I saw. Berkshire has not significantly outperformed the index over the entire period. For most of the years, it tracks nearly on top of the S&P, with a less pronounced dip in 2002, and a less pronounced rise in 2004. Lately, it's paced the index. Not exactly the kind of return performance that would draw attention, were it any other company than the one Buffett operates.Back to Target vs. Buffett's pick, Wal-Mart. Dana Telsey noted that a buy of Wal-Mart is for turnaround, but that Target is poised to perform much better. On that note, the Journal interview revealed a stunningly smart, confident team of executives who don't look at their business as cost-cutting discount retail, but, rather, designer-brand and unique-retail experience marketing to selected customers.
Furthermore, they regularly take a common consumer problem and make it part of "The Big Idea" contest. To quote the article, Michael Francis, EVP of Marketing said,
"I challenge my team to solve a problem or see things a new way. We've done everything from what's the next consumable product that we would like to repackage to what product in your pantry frustrates you the most. The winner gets a cash prize, recognition and sometimes we create the product or campaign.
I have people who are brilliant all over the country and they feed in ideas on a regular basis. I probably have about a dozen of them- trend people, movie people, advertising people. We pay them. And we get monthly missives- emails or letters.....it's people who we trust, who we know have the right taste level, who understand our brand."
On that subject of brand, CEO Bob Ulrich said,
"We created the whole trend of designers making products for discounters, starting with architect Michael Graves in 1999....These things keep evolving. You can't just be unique in one category. You can't be really mundane in small electrics if you're trying to be innovative in textiles. You can't be really forward in linens and beat down in shoes, so you have to start to get more consistency across the board....our guests, who are on average about 20% more affluent, more highly educated, come from more sophisticated areas."
And, again, Michael Francis, on brand advertising and promotion,
"I don't want to be on a billboard along some freeway in some dense metropolitan area. I want to be where there is a smart, sophisticated audience, who's experiencing that venue for reasons other than brand awareness......(the buzz is) a powerful, powerful component of what we do. Buzz has had an astonishingly important ability to amplify our entire marketing message."
What struck me about these comments in the Journal interview is how much Target's management and strategy is about consumer needs satisfaction and problem solution, not just logistical cost-cutting. They practice a flair for dramatic, exciting retailing that Wal-Mart never had. So when the latter saturated its market segment, going upmarket, as I wrote in a post in late 2005, was very difficult, if not impossible (as I predicted). Target, on the other hand, has kept a finger on the pulse of its more upscale market segment, and continued to give them reasons to return to its stores.
Thus, as the Yahoo-source price chart for Target, Wal-Mart and the S&P500 on the left shows, Target has outperformed Wal-Mart over the past five years. However, even Target has not quite surpassed the index, which explains why it's not on my equity portfolio selection lists. Further, Target seemed to be experiencing similar performance pattern as Wal-mart up until late 2004, when it finally deviated from Wal-Mart's downward path, and began to soar. Still, in those two years, Target has only just would have outpeformed the index.
So, personally, I'd side with Telsey, although Target is not in my selection list. I've seen Telsey for years on retail and luxury beat, and she appears to know her stuff. Combining Buffett's recent performance, and the pictures of Target's and Wal-Mart's recent performances, along with information about Target's more consumer-focused strategy, I would be inclined to back Dana Telsey's prediction that Target will continue to outperform Wal-Mart in the years ahead.
Monday, May 07, 2007
Motorola v. Carl Icahn
The Wall Street Journal carried a short piece on the back of its Money & Investing section, in the 'breaking views.com' column. The writers, listed as Robert Cyran, David Vise, and Dwight Cass, are on record as stating,
"Carl Icahn doesn't deserve a Motorola Inc. board seat. His ability to bellow isn't enough of a justification to give him a directorship. He has already repudiated his one big idea for the cellular-telephone maker. Now he appears fresh out of ideas- and he is overbooked."
Further on in the piece, the authors selectively cite Blockbuster's loss of 'close to half' of its value since Icahn arrived on the board. In contrast, they provide one example, that of Nelson Peltz influencing Heinz to take actions, the alleged results of which boosted the stock's price 40%.
I don't propose to do an extensive analysis of Icahn's investing track record. However, by Googling Carl Icahn, I came across two interviews which suggest, in Icahn's own words, why the Journal writers are just plain wrong. One is this interview dated yesterday in Time Magazine. Here are some excerpts from that piece,
Do you accomplish anything besides making money?
(Icahn) Yes. America is going to lose its economic hegemony if we don't do something along the lines of what I'm doing, where you make managements accountable. Our companies are really not competitive with Asia, and this is the great new threat.
You're trying to get on the board of Motorola, which you think has too much cash on its books. Does CEO Edward Zander need to go?
(Icahn) I'm not looking to remove Motorola's board. I'm only saying that there's no reason for that company to be sitting with $12 billion of cash that would be better used by shareholders.
Why are you buying car-parts maker Lear?
(Icahn) I thought the American auto industry was dying. When most investors, including the pros, all agree on something, they're usually wrong. The number of cars being bought, with Asia coming on so strongly, will increase substantially over the next decade.
Last year you pushed for big change at TIME's parent, Time Warner--breaking up the company, ousting CEO Dick Parsons--but none of that happened.
(Icahn) Dick Parsons agreed to do what we wanted most--a $20 billion buyback of the stock. He did what he promised, and the stock is up 30%. That helps all shareholders. Our fund made $250 million. It's a nice way to lose.
I also found this transcript of CNBC's David Faber interviewing Icahn on Friday(Evidently done via some sort of voice-to-text program, given the errors. That's also why it is all caps.). It's worth using the link and reading all three pages of the transcript, but here are some pertinent passages, for purposes of my post,
FABER: IS MOTOROLA NOT BEEN LISTENING TO YOU, CARL? MY SENSE IS --
ICAHN: THAT'S NOT THE PROBLEM, DAVID. THE PROBLEM WITH MOTOROLA IS IT WAS SUCH A SURPRISE. EARNINGS WERE SO, WERE SO BAD, IT WORRIED ME A GREAT DEAL THAT, THE COMPANY HAD NO MEASURE WHAT THEY WERE DOING. JANUARY 9th THEY SAID MARGINS 8% WHICH IS HUGE. AND IN MARCH, ONLY TWO MONTHS LATER. THEY WERE NEGATIVE FIVE. MEANING THEY LOST 500 DRAL MILLION IN THE FOURTH QUARTER ON, THE, HANDHELD BUSINESS. THAT MADE ME WORRY QUITE A BIT ABOUT THIS COMPANY, ABOUT THIS BOARD. THEY CHANGED DIRECTIONS SEVERAL TIMES. AND, WHAT'S INTERESTING THEY KEEP COMING OUT, TODAY, FOR INSTANCE, AND TALKING ABOUT THE FACT THAT, THEY HAVE HAD, A GOOD RECORD BUT IF YOU LOOK AT IT THEY HAVE SORT OF OBFUSCATED FACTS. IN DECEMBER 04 AFTER THEY SPUN OFF FREESCALE. IF YOU PUT $100 IN MOTOROLA IT WOULD BE STILL WORTH, 100 MAYBE A LITTLE LESS. IF YOU PUT $100 IN NOKIA YOU WOULD BE WORTH $160. THEY HAVE DONE A TERRIBLE THE JOB AND THE BOARD HAS NOT DONE A DAMN THING ABOUT IT IN MY OPINION.
FABER: ORIGINALLY WHEN YOU AND I SPOKE ABOUT THIS WHEN YOU FIRST TOOK YOUR POSITION SEEMS LIKE YOU WERE LOOKING AT BALANCE SHEET SEEING AWFUL LOT OF CASH AND POSSIBILITY OF RETURNING THAT CASH TO SHAREHOLDERS. YOU SAID TO ME AT TIME. THESE GUYS ARE NOT MONEY MANAGERS. THEY SHOULD GO TO WALL STREET. THAT'S OFF THE TABLE RIGHT NOW, RIGHT?
ICAHN: IT'S OFF THE TABLE THE NUMBERS THEY SAID THEY WOULD COME UP WITH IN JANUARY THEY DID NOT COME UP WITH. IT'S A TREMENDOUS DIFFERENCE I CAN'T UNDERSTAND HOW THEY DIDN'T KNOW IT. IN JANUARY, THEY WERE TALKING ABOUT EIGHT, 9% MARGINS. TALKING ABOUT 3 1/2, 4 MAYBE YOU NEED SOME OF THE MONEY TO WATCH WHAT THE HECK IS HAPPENING ON HOME FRONT.
FABER: WE HAVE MORE TIME WE'LL GET TO THAT. LET'S TALK ABOUT THIS.
ICAHN: THE NAMES WOULD BE THE SAME. YOU JUST DON'T NEED ANOTHER BIG NAME GUY IN THE MOTOROLA BOARD, SORT OF FROM THE SAME COOKIE CUTTER. YOU KNOW THE BOHEMIAN CLUB, AUGUSTA GOLF CLUB. MAYBE I WON'T BE INVITED. MAYBE MY SECRETARY LOST MY INVITATION.THAT'S WHAT, THEY'RE TALKINGABOUT.AND YOU DON'T NEED THATHERE. THE -- INVITATION. THE TROUBLE IN THE COUNTRY THESE BOARDS DON'T HOLD THE EXECUTIVES ACCOUNTABLE. I DON'T THINK THEY DO THE JOBS AT ALL. ISSUE SAID HEY, IF YOU DON'T REALLY WANT ME ON I WOULD PUT ANOTHER LARGE SHAREHOLDER ON. THEY DOESN'T WANT THAT. SO, YOU KNOW SORT OF HAS TO BE ME EVEN THOUGH I FEEL I'M HELL OF A NICE GUY AND I FEEL THEY WOULD GET TO LIKE ME.
FABER: ALL RIGHT. ON THE, SUBJECT OF CORPORATE GOVERNANCE WE HAVE ABOUT A MINUTE LEFT. YOU AND I HAVE HAD MANY CONVERSATIONS ABOUT IT, YEARS AGO, I'M HEARING YOU SAY MANY OF THE SAME THINGS. YOU DON'T REALLY BELIEVE THINGS HAVE CHANGED AT ALL OR IMPROVED ALL OVER LAST LET'S SAY FIVE YEARS?
ICAHN: DAVID, IT'S ONE OF THE THINGS I WANT TO REALLY TALK ABOUT FOR A MINUTE. I THINK THIS IS A WATERSHED EVENT FOR CORPORATE AMERICA AND CORPORATE GOVERNANCE. I THINK THERE IS NO SUCH THING CORPORATE DEMOCRACY. WHAT YOU HAVE TOO MANY BIG COMPANIES ARE SORT OF FRATERNITIES. I'VE SEEN IT SO MANY TIMES. THEY'RE SO MANY COMPANIES IT JUST BADLY RUN. I MEAN THE FACT I CAN GO INTO THE MEDIMMUNES, TIME WARNERS, AND, FAIR MONTH, JUST TO NAME A FEW, KERR-McGEE, MAKE MONEY FOR ALL SHAREHOLDERS, WE MADE OVER $50 BILLION FOR SHAREHOLDERS SINCE I STARTED THE HEDGE FUND. REASON YOU CAN DO IT --
From Icahn's remarks in both interviews, we see that he has an overriding concern with lax and ineffective American corporate management and its putative overseers, their boards. From Faber's interview, which occurred Friday, and to which the Journal writers could have had access, we know that Icahn had already dismissed the funding/cash dividend aspect of Motorola's situation, turning instead to a management so out of touch with its own financials as to suffer a financial disaster in one quarter, and be surprised by it. I heard one CNBC on-air guest today, in defense of Icahn, describe Motorola has having blown 'several' recent quarters.
For some perspective, I've pasted three price charts for Motorola vs. the S&P500 for the past two, five, and thirty years. In the two-year view on the left (please click on charts to see a larger version), it's clear that the company's performance has been anemic for at least two full years, sliding steadily since last September, and having more or less stalled prior to that, after a brief upturn in early 2005.
So, in rereading the Wall Street Journal piece, I find that it is mostly way off base. The authors offer no comprehensive track record of Icahn's investment performances via his public battles at firms such as Kerr-McGee, Blockbuster, Time-Warner, and Motorola. Icahn himself alleges that they've earned $50B for 'shareholders,' presumably all those present when he bought into those corporate situations, since he began his hedge fund. Again, from a CNBC source, charted on-air today, it looked as if Icahn's record is overwhelmingly positive amidst his several corporate crusades of the past few years.
Second, the Journal writers mistakenly attribute Icahn's focus and value to just arguing over Motorola's cash hoard. In fact, Icahn is concerned by the lack of effective management and, further, the even more out-of-touch board. It's no surprise, given Icahn's invective for boards in general, that the entire Motorola board came out against him joining them.
Looking at the five-year price chart above, Icahn's attitude is well based. The firm's longer term performance is decidedly erratic and anemic. It features a drop off a cliff in 2002, followed by the Razr-led recovery. Since then, it's stalled.
In the Faber interview, Icahn notes that he has left several boards, because his work there was complete. Further, he explained, in the cited passage, that he didn't need to join the board of Time-Warner to have impact. Overall, given Icahn's effect on the value of the corporate situations to which he has turned his attention, I would venture to believe that most intelligent shareholders would and should welcome his board membership at their underperforming companies. The Journal article writers seem to miss Icahn's sort of 'global' effect on company boards and managements. Not every time, but most times, and for significant total return impact.
To me, Icahn's most persuasive arguments for a Motorola board seat are two-fold. First, he's a large shareholder. I don't know the exact percentage, but evidently he feels he is proportionately significant enough to merit the seat. Second, he's documented recent management ineptitude, compounded by board member complacency and complementary ineptitude. At this point, simply shouting "what's going on here? does anybody know why this place is out of control and underperforming," would apparently be a breath of fresh air for shareholders. The board seems to have abdicated its responsibility to that group.
Lastly, the thirty-year price chart, above, tells a stunningly unusual story about this technology firm. When you post this type of long-term chart for most tech firms, they more or less handsomely outperform the index over such a long timeframe. While nobody has this kind of foresight, the ultimate 'buy and hold' would have generally served most investors well for companies like Dell and Microsoft, recent travails notwithstanding. Motorola is different. For all its erratic performances of the last fifteen years, investors would have not been rewarded for this risk, relative to simply holding the S&P500. Over fifteen or thirty years, Motorola has failed to outperform the market, even though it tends to engage in rather higher-risk, allegedly higher-growth businesses. That's a shocking legacy that ought to give shareholders pause before they vote against adding Carl Icahn to their board.
"Carl Icahn doesn't deserve a Motorola Inc. board seat. His ability to bellow isn't enough of a justification to give him a directorship. He has already repudiated his one big idea for the cellular-telephone maker. Now he appears fresh out of ideas- and he is overbooked."
Further on in the piece, the authors selectively cite Blockbuster's loss of 'close to half' of its value since Icahn arrived on the board. In contrast, they provide one example, that of Nelson Peltz influencing Heinz to take actions, the alleged results of which boosted the stock's price 40%.
I don't propose to do an extensive analysis of Icahn's investing track record. However, by Googling Carl Icahn, I came across two interviews which suggest, in Icahn's own words, why the Journal writers are just plain wrong. One is this interview dated yesterday in Time Magazine. Here are some excerpts from that piece,
Do you accomplish anything besides making money?
(Icahn) Yes. America is going to lose its economic hegemony if we don't do something along the lines of what I'm doing, where you make managements accountable. Our companies are really not competitive with Asia, and this is the great new threat.
You're trying to get on the board of Motorola, which you think has too much cash on its books. Does CEO Edward Zander need to go?
(Icahn) I'm not looking to remove Motorola's board. I'm only saying that there's no reason for that company to be sitting with $12 billion of cash that would be better used by shareholders.
Why are you buying car-parts maker Lear?
(Icahn) I thought the American auto industry was dying. When most investors, including the pros, all agree on something, they're usually wrong. The number of cars being bought, with Asia coming on so strongly, will increase substantially over the next decade.
Last year you pushed for big change at TIME's parent, Time Warner--breaking up the company, ousting CEO Dick Parsons--but none of that happened.
(Icahn) Dick Parsons agreed to do what we wanted most--a $20 billion buyback of the stock. He did what he promised, and the stock is up 30%. That helps all shareholders. Our fund made $250 million. It's a nice way to lose.
I also found this transcript of CNBC's David Faber interviewing Icahn on Friday(Evidently done via some sort of voice-to-text program, given the errors. That's also why it is all caps.). It's worth using the link and reading all three pages of the transcript, but here are some pertinent passages, for purposes of my post,
FABER: IS MOTOROLA NOT BEEN LISTENING TO YOU, CARL? MY SENSE IS --
ICAHN: THAT'S NOT THE PROBLEM, DAVID. THE PROBLEM WITH MOTOROLA IS IT WAS SUCH A SURPRISE. EARNINGS WERE SO, WERE SO BAD, IT WORRIED ME A GREAT DEAL THAT, THE COMPANY HAD NO MEASURE WHAT THEY WERE DOING. JANUARY 9th THEY SAID MARGINS 8% WHICH IS HUGE. AND IN MARCH, ONLY TWO MONTHS LATER. THEY WERE NEGATIVE FIVE. MEANING THEY LOST 500 DRAL MILLION IN THE FOURTH QUARTER ON, THE, HANDHELD BUSINESS. THAT MADE ME WORRY QUITE A BIT ABOUT THIS COMPANY, ABOUT THIS BOARD. THEY CHANGED DIRECTIONS SEVERAL TIMES. AND, WHAT'S INTERESTING THEY KEEP COMING OUT, TODAY, FOR INSTANCE, AND TALKING ABOUT THE FACT THAT, THEY HAVE HAD, A GOOD RECORD BUT IF YOU LOOK AT IT THEY HAVE SORT OF OBFUSCATED FACTS. IN DECEMBER 04 AFTER THEY SPUN OFF FREESCALE. IF YOU PUT $100 IN MOTOROLA IT WOULD BE STILL WORTH, 100 MAYBE A LITTLE LESS. IF YOU PUT $100 IN NOKIA YOU WOULD BE WORTH $160. THEY HAVE DONE A TERRIBLE THE JOB AND THE BOARD HAS NOT DONE A DAMN THING ABOUT IT IN MY OPINION.
FABER: ORIGINALLY WHEN YOU AND I SPOKE ABOUT THIS WHEN YOU FIRST TOOK YOUR POSITION SEEMS LIKE YOU WERE LOOKING AT BALANCE SHEET SEEING AWFUL LOT OF CASH AND POSSIBILITY OF RETURNING THAT CASH TO SHAREHOLDERS. YOU SAID TO ME AT TIME. THESE GUYS ARE NOT MONEY MANAGERS. THEY SHOULD GO TO WALL STREET. THAT'S OFF THE TABLE RIGHT NOW, RIGHT?
ICAHN: IT'S OFF THE TABLE THE NUMBERS THEY SAID THEY WOULD COME UP WITH IN JANUARY THEY DID NOT COME UP WITH. IT'S A TREMENDOUS DIFFERENCE I CAN'T UNDERSTAND HOW THEY DIDN'T KNOW IT. IN JANUARY, THEY WERE TALKING ABOUT EIGHT, 9% MARGINS. TALKING ABOUT 3 1/2, 4 MAYBE YOU NEED SOME OF THE MONEY TO WATCH WHAT THE HECK IS HAPPENING ON HOME FRONT.
FABER: WE HAVE MORE TIME WE'LL GET TO THAT. LET'S TALK ABOUT THIS.
ICAHN: THE NAMES WOULD BE THE SAME. YOU JUST DON'T NEED ANOTHER BIG NAME GUY IN THE MOTOROLA BOARD, SORT OF FROM THE SAME COOKIE CUTTER. YOU KNOW THE BOHEMIAN CLUB, AUGUSTA GOLF CLUB. MAYBE I WON'T BE INVITED. MAYBE MY SECRETARY LOST MY INVITATION.THAT'S WHAT, THEY'RE TALKINGABOUT.AND YOU DON'T NEED THATHERE. THE -- INVITATION. THE TROUBLE IN THE COUNTRY THESE BOARDS DON'T HOLD THE EXECUTIVES ACCOUNTABLE. I DON'T THINK THEY DO THE JOBS AT ALL. ISSUE SAID HEY, IF YOU DON'T REALLY WANT ME ON I WOULD PUT ANOTHER LARGE SHAREHOLDER ON. THEY DOESN'T WANT THAT. SO, YOU KNOW SORT OF HAS TO BE ME EVEN THOUGH I FEEL I'M HELL OF A NICE GUY AND I FEEL THEY WOULD GET TO LIKE ME.
FABER: ALL RIGHT. ON THE, SUBJECT OF CORPORATE GOVERNANCE WE HAVE ABOUT A MINUTE LEFT. YOU AND I HAVE HAD MANY CONVERSATIONS ABOUT IT, YEARS AGO, I'M HEARING YOU SAY MANY OF THE SAME THINGS. YOU DON'T REALLY BELIEVE THINGS HAVE CHANGED AT ALL OR IMPROVED ALL OVER LAST LET'S SAY FIVE YEARS?
ICAHN: DAVID, IT'S ONE OF THE THINGS I WANT TO REALLY TALK ABOUT FOR A MINUTE. I THINK THIS IS A WATERSHED EVENT FOR CORPORATE AMERICA AND CORPORATE GOVERNANCE. I THINK THERE IS NO SUCH THING CORPORATE DEMOCRACY. WHAT YOU HAVE TOO MANY BIG COMPANIES ARE SORT OF FRATERNITIES. I'VE SEEN IT SO MANY TIMES. THEY'RE SO MANY COMPANIES IT JUST BADLY RUN. I MEAN THE FACT I CAN GO INTO THE MEDIMMUNES, TIME WARNERS, AND, FAIR MONTH, JUST TO NAME A FEW, KERR-McGEE, MAKE MONEY FOR ALL SHAREHOLDERS, WE MADE OVER $50 BILLION FOR SHAREHOLDERS SINCE I STARTED THE HEDGE FUND. REASON YOU CAN DO IT --
From Icahn's remarks in both interviews, we see that he has an overriding concern with lax and ineffective American corporate management and its putative overseers, their boards. From Faber's interview, which occurred Friday, and to which the Journal writers could have had access, we know that Icahn had already dismissed the funding/cash dividend aspect of Motorola's situation, turning instead to a management so out of touch with its own financials as to suffer a financial disaster in one quarter, and be surprised by it. I heard one CNBC on-air guest today, in defense of Icahn, describe Motorola has having blown 'several' recent quarters.
For some perspective, I've pasted three price charts for Motorola vs. the S&P500 for the past two, five, and thirty years. In the two-year view on the left (please click on charts to see a larger version), it's clear that the company's performance has been anemic for at least two full years, sliding steadily since last September, and having more or less stalled prior to that, after a brief upturn in early 2005.So, in rereading the Wall Street Journal piece, I find that it is mostly way off base. The authors offer no comprehensive track record of Icahn's investment performances via his public battles at firms such as Kerr-McGee, Blockbuster, Time-Warner, and Motorola. Icahn himself alleges that they've earned $50B for 'shareholders,' presumably all those present when he bought into those corporate situations, since he began his hedge fund. Again, from a CNBC source, charted on-air today, it looked as if Icahn's record is overwhelmingly positive amidst his several corporate crusades of the past few years.
Second, the Journal writers mistakenly attribute Icahn's focus and value to just arguing over Motorola's cash hoard. In fact, Icahn is concerned by the lack of effective management and, further, the even more out-of-touch board. It's no surprise, given Icahn's invective for boards in general, that the entire Motorola board came out against him joining them.Looking at the five-year price chart above, Icahn's attitude is well based. The firm's longer term performance is decidedly erratic and anemic. It features a drop off a cliff in 2002, followed by the Razr-led recovery. Since then, it's stalled.
In the Faber interview, Icahn notes that he has left several boards, because his work there was complete. Further, he explained, in the cited passage, that he didn't need to join the board of Time-Warner to have impact. Overall, given Icahn's effect on the value of the corporate situations to which he has turned his attention, I would venture to believe that most intelligent shareholders would and should welcome his board membership at their underperforming companies. The Journal article writers seem to miss Icahn's sort of 'global' effect on company boards and managements. Not every time, but most times, and for significant total return impact.
To me, Icahn's most persuasive arguments for a Motorola board seat are two-fold. First, he's a large shareholder. I don't know the exact percentage, but evidently he feels he is proportionately significant enough to merit the seat. Second, he's documented recent management ineptitude, compounded by board member complacency and complementary ineptitude. At this point, simply shouting "what's going on here? does anybody know why this place is out of control and underperforming," would apparently be a breath of fresh air for shareholders. The board seems to have abdicated its responsibility to that group.Lastly, the thirty-year price chart, above, tells a stunningly unusual story about this technology firm. When you post this type of long-term chart for most tech firms, they more or less handsomely outperform the index over such a long timeframe. While nobody has this kind of foresight, the ultimate 'buy and hold' would have generally served most investors well for companies like Dell and Microsoft, recent travails notwithstanding. Motorola is different. For all its erratic performances of the last fifteen years, investors would have not been rewarded for this risk, relative to simply holding the S&P500. Over fifteen or thirty years, Motorola has failed to outperform the market, even though it tends to engage in rather higher-risk, allegedly higher-growth businesses. That's a shocking legacy that ought to give shareholders pause before they vote against adding Carl Icahn to their board.
Friday, May 04, 2007
Microsoft & Yahoo Merge? You've Got To Be Kidding
It's all over the business news today. Microsoft and Yahoo are in formal talks, allegedly via Goldman Sachs, to merge.
The pundits are on the air, waxing eloquently about this putative deal. Per my earlier post, here, nobody whom I've heard has the courage or temerity to bluntly assess just how awful this combination would be.
To clarify, let's state what is supposed to be the obvious: Microsoft and Yahoo have both failed miserably, over the past few years, at competing with Google. The first Yahoo-sourced chart (please click on the chart to view a larger version) demonstrates this. It's a two year view of Google, Apple, Yahoo, Microsoft and the S&P500 Index. Since these are all technology stocks, it's reasonable to view the price chart as a very good approximation of a picture of total returns.
The picture is clear- Microsoft and Yahoo haven't even been able to beat the index over two years, even with the former's pop from releasing the new Office and Vista software systems. Yahoo has actually declined in value. In contrast, Google has been doing much better, with a slight flattening since early 2006. I have included Apple as an example of a transformational technology company's potential performance. This is what one would presume MSFT/YAHOO aims to mimic.
Looking a little further into the past, here's a five year Yahoo-sourced price chart of the same entities. This time, Yahoo looks better, but both it's and MSFT's performances have clearly flattened in the past several years. Neither looks to be an engine of value-creation that is primed to rival Google.
However, to do so, on Google's playing field of online value-added services, several questions need to be considered.
First, doesn't one of the partners usually have to be successful already for this sort of combination to work? Remember the Time Warner/AOL merger? AOL turned out to be more fragile than expected, while TW was stuck in neutral.
In the case at hand, Microsoft still dominates a rather unexciting sector- PC software. Online-based software is the hot item. Oh, right. Google does that already. Meanwhile, as I've written so many times (search my blog for, or click on the label for "Yahoo."), Yahoo is the 'used car' of the internet. It's not a standout for anything. This recent post, just over two months ago, details my views on some of Yahoo's strategic mistakes. With neither MSFT, nor Yahoo in a position of superiority in a relevant product/market which competes with Google, I think this combination fails the test of having at least one partner actually being successful.
Second, why would a merger of these two huge, lumbering companies create more than a more focused, nimbler marketing alliance agreement between the two? The latter would be far more likely to succeed, in my opinion. These two technology giants are already past their prime and too sluggish to have a high probability of combining in a manner that can yield a consistently superior total return performer. The companies are not similar in their product/markets, so there won't be much in the way of cost savings, yet they will spend considerable time and money attempting to mesh and reorganize post-merger. I suspect it is a recipe for disaster.
Third, Yahoo is, in my parlance, the 'used car of the internet.' This is going to be Bill's/Steve's new ride? Hardly an inspiring last act for the software titan. Can't they do better than a bumbling online-oriented hodgepodge of businesses mismanaged by a former entertainment executive?
Fourth, together, these two still probably won't catch Google. It's not about the software....it's about the ideas. Neither has shown themselves capable of generating successful new ideas which have driven consistently superior total returns in the past five years. How will just mashing the two mediocre firms together change that?
Lastly, as one pundit reminded me, there is US anti-trust regulation and the EEC's animosity for all things MSFT. Thus, he felt that perhaps all that will result is some sort of marketing venture.
Actually, that might be a blessing. But I still feel that there's precious little the two can conceive and execute in time to affect Google's hegemony in areas that matter in the next two years.
As a parting view, here's a Yahoo-sourced chart of the five data series over roughly the past decade. While Yahoo is the second-best value creator, it's been sliding for several years, with an overall erratic pattern. Apple, for example, reflects what a radical product/market transformation would resemble, and neither Yahoo nor MSFT remotely looks like this. Instead, MSFT has been flatlining for over six years. Just looking at the chart suggests a dynamism in Google and Apple that Yahoo and MSFT now lack.
If this combination materializes, I will go on record predicting that it will not result in a firm that can regain a pattern of consistently superior total return performance. It will, over time, fail shareholders, relative to their option of simply buying the S&P index.
The pundits are on the air, waxing eloquently about this putative deal. Per my earlier post, here, nobody whom I've heard has the courage or temerity to bluntly assess just how awful this combination would be.
To clarify, let's state what is supposed to be the obvious: Microsoft and Yahoo have both failed miserably, over the past few years, at competing with Google. The first Yahoo-sourced chart (please click on the chart to view a larger version) demonstrates this. It's a two year view of Google, Apple, Yahoo, Microsoft and the S&P500 Index. Since these are all technology stocks, it's reasonable to view the price chart as a very good approximation of a picture of total returns.The picture is clear- Microsoft and Yahoo haven't even been able to beat the index over two years, even with the former's pop from releasing the new Office and Vista software systems. Yahoo has actually declined in value. In contrast, Google has been doing much better, with a slight flattening since early 2006. I have included Apple as an example of a transformational technology company's potential performance. This is what one would presume MSFT/YAHOO aims to mimic.
Looking a little further into the past, here's a five year Yahoo-sourced price chart of the same entities. This time, Yahoo looks better, but both it's and MSFT's performances have clearly flattened in the past several years. Neither looks to be an engine of value-creation that is primed to rival Google.However, to do so, on Google's playing field of online value-added services, several questions need to be considered.
First, doesn't one of the partners usually have to be successful already for this sort of combination to work? Remember the Time Warner/AOL merger? AOL turned out to be more fragile than expected, while TW was stuck in neutral.
In the case at hand, Microsoft still dominates a rather unexciting sector- PC software. Online-based software is the hot item. Oh, right. Google does that already. Meanwhile, as I've written so many times (search my blog for, or click on the label for "Yahoo."), Yahoo is the 'used car' of the internet. It's not a standout for anything. This recent post, just over two months ago, details my views on some of Yahoo's strategic mistakes. With neither MSFT, nor Yahoo in a position of superiority in a relevant product/market which competes with Google, I think this combination fails the test of having at least one partner actually being successful.
Second, why would a merger of these two huge, lumbering companies create more than a more focused, nimbler marketing alliance agreement between the two? The latter would be far more likely to succeed, in my opinion. These two technology giants are already past their prime and too sluggish to have a high probability of combining in a manner that can yield a consistently superior total return performer. The companies are not similar in their product/markets, so there won't be much in the way of cost savings, yet they will spend considerable time and money attempting to mesh and reorganize post-merger. I suspect it is a recipe for disaster.
Third, Yahoo is, in my parlance, the 'used car of the internet.' This is going to be Bill's/Steve's new ride? Hardly an inspiring last act for the software titan. Can't they do better than a bumbling online-oriented hodgepodge of businesses mismanaged by a former entertainment executive?
Fourth, together, these two still probably won't catch Google. It's not about the software....it's about the ideas. Neither has shown themselves capable of generating successful new ideas which have driven consistently superior total returns in the past five years. How will just mashing the two mediocre firms together change that?
Lastly, as one pundit reminded me, there is US anti-trust regulation and the EEC's animosity for all things MSFT. Thus, he felt that perhaps all that will result is some sort of marketing venture.
Actually, that might be a blessing. But I still feel that there's precious little the two can conceive and execute in time to affect Google's hegemony in areas that matter in the next two years.
As a parting view, here's a Yahoo-sourced chart of the five data series over roughly the past decade. While Yahoo is the second-best value creator, it's been sliding for several years, with an overall erratic pattern. Apple, for example, reflects what a radical product/market transformation would resemble, and neither Yahoo nor MSFT remotely looks like this. Instead, MSFT has been flatlining for over six years. Just looking at the chart suggests a dynamism in Google and Apple that Yahoo and MSFT now lack.If this combination materializes, I will go on record predicting that it will not result in a firm that can regain a pattern of consistently superior total return performance. It will, over time, fail shareholders, relative to their option of simply buying the S&P index.
Thursday, May 03, 2007
Sarbanes Oxley- Good or Bad? It Depends On Your Metric
Now we have a case of dueling studies regarding the effects of the notorious Sarbanes-Oxley Act of 2002.
Robert Grady, a partner who runs the venture capital arm at the Carlyle Group, wrote a long op-ed piece in last Thursday's Wall Street Journal on the evils of Sarbox. In his opinion, it has depressed the creation of small, high-potential, economically desirable smaller tech IPOs. Grady believes that, in a Sarbox world, companies like Intel, Cisco and E*Trade would not have been able to go public. The cost and effort required by Sarbox would have discouraged their IPOs, relegating them instead to being purchased by some larger companies, thus dampening their eventual entrepreneurial success.
On Friday, the Journal published an article about two university finance professors who insist that Sarbox hasn't hurt the US in terms of its pre-eminence as a financial hub. They cite price premiums of companies listed here and overseas, versus those dual-listed in london.
The two authors come to different conclusions because they are measuring different phenomena. However, I think Grady is right. The damage to the US economy results from the manner in which Sarbox strangles innovation and new-company formation. This has been the engine of innovation, growth and American economic leadership since the early days of the space race in the 1960s. Sarbanes-Oxley is threatening to destroy that leadership by hampering the creation of new, young, innovative companies due to its burdensome requirements.
The effect of Sarbox on existing, large-company listings is rather less important. They are not the main engines of continuing US global economic leadership.
Innovation is.
Robert Grady, a partner who runs the venture capital arm at the Carlyle Group, wrote a long op-ed piece in last Thursday's Wall Street Journal on the evils of Sarbox. In his opinion, it has depressed the creation of small, high-potential, economically desirable smaller tech IPOs. Grady believes that, in a Sarbox world, companies like Intel, Cisco and E*Trade would not have been able to go public. The cost and effort required by Sarbox would have discouraged their IPOs, relegating them instead to being purchased by some larger companies, thus dampening their eventual entrepreneurial success.
On Friday, the Journal published an article about two university finance professors who insist that Sarbox hasn't hurt the US in terms of its pre-eminence as a financial hub. They cite price premiums of companies listed here and overseas, versus those dual-listed in london.
The two authors come to different conclusions because they are measuring different phenomena. However, I think Grady is right. The damage to the US economy results from the manner in which Sarbox strangles innovation and new-company formation. This has been the engine of innovation, growth and American economic leadership since the early days of the space race in the 1960s. Sarbanes-Oxley is threatening to destroy that leadership by hampering the creation of new, young, innovative companies due to its burdensome requirements.
The effect of Sarbox on existing, large-company listings is rather less important. They are not the main engines of continuing US global economic leadership.
Innovation is.
Wednesday, May 02, 2007
Observations on Actively-Managed vs. Passive Mutual Funds
Last Wednesday, Eleanor Laise of the Wall Street Journal wrote an interesting piece in the Money & Investing section concerning actively managed funds.
Typically, actively-managed funds are downplayed by many commentators, because the likelihood of any one fund manager consistently outperforming the market for many years is small. Investors frequently end up chasing last year's hot fund, and good returns, only to, in effect, 'buy high' and 'sell low,' only with funds, rather than individual equities.
Still, as Ms. Laise writes, while the average of actively managed funds may underperform the market, there are a few stellar managed funds in virtually any category.
The article provides some research data, mostly on small-cap funds, suggesting that, at best, perhaps a little more than one in three managers will beat style-specific indices.
However, at the end of her column, Ms. Laise suggests the following,
"Instead of picking active managers based on sector, you should look for low costs and a long-term consistent track record. Since fund expenses reduce returns, lower fees mean managers must clear a smaller hurdle to beat the index."
In effect, she is saying that, while most fund managers cannot beat the market average over time, it's worth finding the few that can, and investing in them. The key is to look for consistency, rather than specific style or sector descriptors.
From a theoretical viewpoint, what Ms. Laise appears to be contending is that, although the probabilities of the average active fund manager beating the index over time is small, there do exist managers who have done this, and their existence means it can be worthwhile to identify and use such managers. So, rather than throw all active managers out and, instead, resign yourself to choosing passive index and sector funds, you can and should find managers who have consistently outperformed the market over many years, and invest with them, not letting the averages blind you to the existence of a few significantly better-performing managers.
Ironically, I would normally agree with the passive fund allocation advice, too. My own equity strategy consistently outperforms the S&P, but I wouldn't invest in most other actively-managed funds, were I not already actively managing equities. Since I already have access to my own strategy, which fits Ms. Laise's description, I'm content to invest in my own, and don't have to go looking for the other few managers who can consistently outperform the S&P500 over time.
Typically, actively-managed funds are downplayed by many commentators, because the likelihood of any one fund manager consistently outperforming the market for many years is small. Investors frequently end up chasing last year's hot fund, and good returns, only to, in effect, 'buy high' and 'sell low,' only with funds, rather than individual equities.
Still, as Ms. Laise writes, while the average of actively managed funds may underperform the market, there are a few stellar managed funds in virtually any category.
The article provides some research data, mostly on small-cap funds, suggesting that, at best, perhaps a little more than one in three managers will beat style-specific indices.
However, at the end of her column, Ms. Laise suggests the following,
"Instead of picking active managers based on sector, you should look for low costs and a long-term consistent track record. Since fund expenses reduce returns, lower fees mean managers must clear a smaller hurdle to beat the index."
In effect, she is saying that, while most fund managers cannot beat the market average over time, it's worth finding the few that can, and investing in them. The key is to look for consistency, rather than specific style or sector descriptors.
From a theoretical viewpoint, what Ms. Laise appears to be contending is that, although the probabilities of the average active fund manager beating the index over time is small, there do exist managers who have done this, and their existence means it can be worthwhile to identify and use such managers. So, rather than throw all active managers out and, instead, resign yourself to choosing passive index and sector funds, you can and should find managers who have consistently outperformed the market over many years, and invest with them, not letting the averages blind you to the existence of a few significantly better-performing managers.
Ironically, I would normally agree with the passive fund allocation advice, too. My own equity strategy consistently outperforms the S&P, but I wouldn't invest in most other actively-managed funds, were I not already actively managing equities. Since I already have access to my own strategy, which fits Ms. Laise's description, I'm content to invest in my own, and don't have to go looking for the other few managers who can consistently outperform the S&P500 over time.
Tuesday, May 01, 2007
GE Breakup Discussion Today on CNBC
In fairness to my post yesterday, there was an accidental, spirited discussion this morning on CNBC regarding its parent, GE, being split up within two years.
Guests on the program, fund manager Mike Holland and Andrew Ross Sorkin, of the New York Times, along with CNBC reporter David Faber, began by discussing whether private equity firms are the new conglomerates. All missed the fundamental difference between the operating models.
Faber waxed nostalgically as to how GE has 'operating acumen,' while private equity funds just 'buy companies cheaply and sell them more dearly.' Not quite, David.
In fact, GE has shown an inability to operate its business units in a manner that has drawn investor reactions which result in consistently superior total returns. In contrast, private equity firms buy ailing or undervalued businesses, make necessary changes to increase their value, then, typically, resell them and reap a return for the value they have added.
Joe Kernen then asked why NBC/Universal should not be sold, and nobody disagreed. Fabe's first comment was 'why are you doing this to me,' followed by some mumbling about losing his job. The video of this whole exchange is available today, for free, on CNBC's site, but I won't paste the link, as it will become inoperable by tomorrow.
Sorkin predicted that GE will sell its entertainment unit after the Chinese Olympics, when its value may be at a maximum. Mike Holland seconded Sorkin, and predicted that it was likely to be sold or spun-off at the end of two years. However, nobody went further, castigating Immelt for failing to create value from the various parts of GE. The focus remained simply on CNBC/Universal, stay or go?
So, my hats off to CNBC's Squawkbox for having the guts to discuss splitting up its parent, beginning with the unit of which the network is a part. However, lets be clear- the conversation topic was one comparing private equity to large corporations, and Kernen simply made a sharp left turn in the discussion to toss out the GE situation. But to their credit, the producers didn't cut suddenly to a commercial and end the segment.
Not surprisingly, since last week, CNBC has covered the alleged call to break up CitiGroup more than the CitiGroup analyst's call to break up GE.
Guests on the program, fund manager Mike Holland and Andrew Ross Sorkin, of the New York Times, along with CNBC reporter David Faber, began by discussing whether private equity firms are the new conglomerates. All missed the fundamental difference between the operating models.
Faber waxed nostalgically as to how GE has 'operating acumen,' while private equity funds just 'buy companies cheaply and sell them more dearly.' Not quite, David.
In fact, GE has shown an inability to operate its business units in a manner that has drawn investor reactions which result in consistently superior total returns. In contrast, private equity firms buy ailing or undervalued businesses, make necessary changes to increase their value, then, typically, resell them and reap a return for the value they have added.
Joe Kernen then asked why NBC/Universal should not be sold, and nobody disagreed. Fabe's first comment was 'why are you doing this to me,' followed by some mumbling about losing his job. The video of this whole exchange is available today, for free, on CNBC's site, but I won't paste the link, as it will become inoperable by tomorrow.
Sorkin predicted that GE will sell its entertainment unit after the Chinese Olympics, when its value may be at a maximum. Mike Holland seconded Sorkin, and predicted that it was likely to be sold or spun-off at the end of two years. However, nobody went further, castigating Immelt for failing to create value from the various parts of GE. The focus remained simply on CNBC/Universal, stay or go?
So, my hats off to CNBC's Squawkbox for having the guts to discuss splitting up its parent, beginning with the unit of which the network is a part. However, lets be clear- the conversation topic was one comparing private equity to large corporations, and Kernen simply made a sharp left turn in the discussion to toss out the GE situation. But to their credit, the producers didn't cut suddenly to a commercial and end the segment.
Not surprisingly, since last week, CNBC has covered the alleged call to break up CitiGroup more than the CitiGroup analyst's call to break up GE.
Michael Dell's New Thoughts On Direct Sales
The New York Times' writer Damon Darlin wrote a piece on Saturday discussing a recent memo from Michael Dell to his employees. It appears that I called it right last September, in this post, when I bought a laptop from a competitor, HP, at a Staples store, and wrote about why I had checked Dell first, and declined to buy one of their machines. My sense then was that Dell had missed a sea change in computer purchasing among many consumers. Dell's memo, as related in Darlin's piece, supports this.
Mr. Darlin wrote, in part,
Michael S. Dell, the chairman and chief executive of Dell, who built his business by selling direct to his customers, is now thinking about changing the way the company markets its computers.
“The direct model has been a revolution, but it is not a religion,” Mr. Dell wrote in a memorandum sent on Wednesday to 80,000 Dell employees.
It is the first time that Mr. Dell or any other senior executive has publicly conceded that the business model that was crucial to the company’s success could — and should — be altered. Until now, the company responded with an adamant no when Wall Street analysts or customers asked whether the company would consider other ways of selling.
While Mr. Dell’s memo was short on specifics, he also told employees, “We will continue to improve our business model, and go beyond it, to give our customers what they need.”
“We know our competitors drive complexity and needless cost into customers’ environments,” he wrote. He said their “so-called service divisions” create a never-ending buying cycle with no clear return on investment.
“We intend to break this cycle,” he wrote.
I'm not so sure about Dell's last comment. I have yet to call H-P regarding the laptop we bought. It's performed flawlessly. Frankly, I've had far more trouble from my Dell desktop over the years I've owned it.
However, the important point is that, as is typical, it takes the original leader of a cult to allow for directional change. The acolytes, like the Dell employee who commented on that September post of mine, tend to simply, mindlessly, follow and believe the original, received wisdom of the founder.
Whether any of this will return Dell to its years of consistently superior total return performance is open to question. Based upon my analysis of technology-based companies, it's unlikely Dell will repeat its prior return performance, unless it somehow morphs, like Apple, into a much different product purveyor.
If all Dell does is ally itself with one or more retailers, or opens its own outlets, I doubt that will affect its ability to achieve consistently superior total returns. It might raise revenues, but it's still in a commodity products game. And that doesn't look to change any time soon, with or without Michael Dell.
Mr. Darlin wrote, in part,
Michael S. Dell, the chairman and chief executive of Dell, who built his business by selling direct to his customers, is now thinking about changing the way the company markets its computers.
“The direct model has been a revolution, but it is not a religion,” Mr. Dell wrote in a memorandum sent on Wednesday to 80,000 Dell employees.
It is the first time that Mr. Dell or any other senior executive has publicly conceded that the business model that was crucial to the company’s success could — and should — be altered. Until now, the company responded with an adamant no when Wall Street analysts or customers asked whether the company would consider other ways of selling.
While Mr. Dell’s memo was short on specifics, he also told employees, “We will continue to improve our business model, and go beyond it, to give our customers what they need.”
“We know our competitors drive complexity and needless cost into customers’ environments,” he wrote. He said their “so-called service divisions” create a never-ending buying cycle with no clear return on investment.
“We intend to break this cycle,” he wrote.
I'm not so sure about Dell's last comment. I have yet to call H-P regarding the laptop we bought. It's performed flawlessly. Frankly, I've had far more trouble from my Dell desktop over the years I've owned it.
However, the important point is that, as is typical, it takes the original leader of a cult to allow for directional change. The acolytes, like the Dell employee who commented on that September post of mine, tend to simply, mindlessly, follow and believe the original, received wisdom of the founder.
Whether any of this will return Dell to its years of consistently superior total return performance is open to question. Based upon my analysis of technology-based companies, it's unlikely Dell will repeat its prior return performance, unless it somehow morphs, like Apple, into a much different product purveyor.
If all Dell does is ally itself with one or more retailers, or opens its own outlets, I doubt that will affect its ability to achieve consistently superior total returns. It might raise revenues, but it's still in a commodity products game. And that doesn't look to change any time soon, with or without Michael Dell.
Monday, April 30, 2007
More on Speaking Truth To Power
Back in the first month or so of this blog, in the fall of 2005, I wrote this post predicting severe, near-bankruptcy conditions for at least one of the Big Three Detroit auto manufacturers.
Shortly thereafter, I wrote this post, wherein I asked,
I now wonder if GM, even in its last acts as a sustainably profitable enterprise, wields enough financial leverage to silence any significant, honest appraisal of its situation.
Do analysts worry that they will be shut out of conference calls if they point to GM’s revenue problems as insoluble? Do the bankers worry that they won’t get invited to participate in any subsequent last-ditch financings? Do the various media outlets worry that they will have seen the last GM ads in/on their medium, should they report candidly about the company’s prospects? Perhaps fund managers are concerned that candid remarks will lose them possible business with GM's pension funds or treasury functions.
It’s now beginning to seem to me that all these parties, “stakeholders,” if you will, literally have more to gain from a fatally bleeding GM than they do from a merged/acquired/failed GM.
Last fall, when I bought a new laptop for my daughters, I wrote this post discussing why I didn't buy one from Dell, and why I thought the company had seriously erred in keeping its business model current. That post garnered a reply from a Dell staffer admonishing me for my comments, and assuring me that the direct sales model was alive, well, and prospering!
It's taken until this past week for Michael Dell himself to announce that maybe the direct sales model needs to be revisited at Dell. In the interim, there wasn't a whole lot of criticism of the firm, other than it changed CEOs. Perhaps the word "gingerly" describes the business media's attitude toward the struggling computer maker during this time of poor performance.
I've written about GE's need to be split apart, back in August of 2006, but it took until last week for an analyst to have the courage to suggest the same remedy. Even then, he's been doubted by most other pundits, or just ignored.
As I discussed this with my partner yesterday, we came to the conclusion that this is simply the result of the structure of business media.
For instance, my partner noted that, because politicians crave coverage and publicity, commentators, analysts, et.al., think nothing of savagely attacking them. In fact, they are paid to do that. The more detailed their criticisms of politicians and elected officials, the better. Their targets don't have enough money to really affect the media covering them, and, besides, the politicians have to have that coverage.
Not so in the business world. Because most business media depend upon advertising revenues, large corporations wield an important, potent weapon. By withholding advertising, as well as refusing to grant interviews or access to events for members of an offending publication, broadcast or cable network, large corporations seem to be relatively immune to honest, factual, blunt criticism.
As my recently-added link to my prior predictions illustrates, there are several instances in which the signs of trouble were obvious for some time (GM, GE, Dell), yet the business media refused to report on the issues.
In GE's case, it's actually laughable, because the company owns CNBC. So when David Faber tried to soft pedal the Citi analyst's report on the air last week, he looked ridiculous. While noting GE's flat performance under Immelt, he never the less alleged that 'some people would say he (Immelt) has actually performed better than his predecessor.' Ha! Who, besides Immelt and his board, believes that?
It seems to me that, anymore, the only really trustworthy business coverage is that which does not require corporate target spending (on, e.g., advertising, consulting, brokerage, underwriting, etc.) to exist. Like....well....blogs!
However, if you are waiting for Wall Street analysts, media columnists, or business television network reporters to break major stories, before the fact, about serious problems at many large companies, don't hold your breath.
Shortly thereafter, I wrote this post, wherein I asked,
I now wonder if GM, even in its last acts as a sustainably profitable enterprise, wields enough financial leverage to silence any significant, honest appraisal of its situation.
Do analysts worry that they will be shut out of conference calls if they point to GM’s revenue problems as insoluble? Do the bankers worry that they won’t get invited to participate in any subsequent last-ditch financings? Do the various media outlets worry that they will have seen the last GM ads in/on their medium, should they report candidly about the company’s prospects? Perhaps fund managers are concerned that candid remarks will lose them possible business with GM's pension funds or treasury functions.
It’s now beginning to seem to me that all these parties, “stakeholders,” if you will, literally have more to gain from a fatally bleeding GM than they do from a merged/acquired/failed GM.
Last fall, when I bought a new laptop for my daughters, I wrote this post discussing why I didn't buy one from Dell, and why I thought the company had seriously erred in keeping its business model current. That post garnered a reply from a Dell staffer admonishing me for my comments, and assuring me that the direct sales model was alive, well, and prospering!
It's taken until this past week for Michael Dell himself to announce that maybe the direct sales model needs to be revisited at Dell. In the interim, there wasn't a whole lot of criticism of the firm, other than it changed CEOs. Perhaps the word "gingerly" describes the business media's attitude toward the struggling computer maker during this time of poor performance.
I've written about GE's need to be split apart, back in August of 2006, but it took until last week for an analyst to have the courage to suggest the same remedy. Even then, he's been doubted by most other pundits, or just ignored.
As I discussed this with my partner yesterday, we came to the conclusion that this is simply the result of the structure of business media.
For instance, my partner noted that, because politicians crave coverage and publicity, commentators, analysts, et.al., think nothing of savagely attacking them. In fact, they are paid to do that. The more detailed their criticisms of politicians and elected officials, the better. Their targets don't have enough money to really affect the media covering them, and, besides, the politicians have to have that coverage.
Not so in the business world. Because most business media depend upon advertising revenues, large corporations wield an important, potent weapon. By withholding advertising, as well as refusing to grant interviews or access to events for members of an offending publication, broadcast or cable network, large corporations seem to be relatively immune to honest, factual, blunt criticism.
As my recently-added link to my prior predictions illustrates, there are several instances in which the signs of trouble were obvious for some time (GM, GE, Dell), yet the business media refused to report on the issues.
In GE's case, it's actually laughable, because the company owns CNBC. So when David Faber tried to soft pedal the Citi analyst's report on the air last week, he looked ridiculous. While noting GE's flat performance under Immelt, he never the less alleged that 'some people would say he (Immelt) has actually performed better than his predecessor.' Ha! Who, besides Immelt and his board, believes that?
It seems to me that, anymore, the only really trustworthy business coverage is that which does not require corporate target spending (on, e.g., advertising, consulting, brokerage, underwriting, etc.) to exist. Like....well....blogs!
However, if you are waiting for Wall Street analysts, media columnists, or business television network reporters to break major stories, before the fact, about serious problems at many large companies, don't hold your breath.
A New Link to Old Posts
In light of my correct prediction on the structure of Harman International's buyout, noted in this post, today, my partner suggested that I begin to catalogue the cases in which I have been prescient on some issue or company event.
Thus, I've added a link entitled Early Trend & Issue Identifications In This Blog to my link list on the right of the main page. In this post, which, for my own convenience in locating it, I have dated as the first post of the blog, from September, 2005, I will list the issues or topics on which I wrote a clear prediction or conclusion, and the corresponding date and nature of the same realization in the market at large, or among other published pundits/analysts/CEOs, etc.
Thus, I've added a link entitled Early Trend & Issue Identifications In This Blog to my link list on the right of the main page. In this post, which, for my own convenience in locating it, I have dated as the first post of the blog, from September, 2005, I will list the issues or topics on which I wrote a clear prediction or conclusion, and the corresponding date and nature of the same realization in the market at large, or among other published pundits/analysts/CEOs, etc.
Harman's Buyout Structure Follows My Proposal
Friday's Wall Street Journal piece on Harman International's (the old Harman Kardon) proposed private equity buyout echos my own concept of offering current shareholders a chance to remain as passive owners on the same terms as the buyout group. I wrote about it here, last August, in the wake of the Kinder-Morgan buyout. At the time, my theme was corporate governance.
My partner and I discussed this, and he wondered aloud why this structure has appeared now? Surely, he said, outfits alike KKR and Goldman must have kicked this around for years.
My sense is that, with the recent publicity accorded buyout firm CEOs like Steve Schwarzman (of Blackstone), there is a growing fear of some sort of regulatory backlash. The last thing Blackstone, TPG, Silverlake Partners, Bain, KKR, et.al., need now, is for a Democratically-controlled Senate Finance Committee to legislate curbs to their buyouts, or attach deal-killing 'protections' for current shareholders.
Thus, the harmless, and even secretly helpful, tactic of allowing current shareholders to remain, at a discounted percent ownership, and with complete passivity (i.e., no voting power), to share in the flow of post-buyout gains, while contributing their capital in the bargain.
In truth, this allows the shareholders who remain to experience the best of what I informally call 'corsair capitalism.' I wrote about it here, in February. My closing thought in that post was,
"Now, for a prediction as to a form of solution which may develop. What is to stop private equity firms from issuing securities of participation in their ventures, in small denominations, as limited equity partners? Would not brands such as Texas Pacific, KKR, and Silverlake command a premium in the market? By attracting investor capital to their privately-held efforts, these partnerships could effectively begin to drain capital from poorly-run public firms, and then slowly, inexorably, pull them into the private equity world, where the value they add would accrue to the small, limited partner.
Truth is, the worst part of the structure of today's publicly-traded firms is that the board-CEO governance mechanism mitigates against the effective management of the firm for consistently superior total returns. Read Murray's passage quoting Mr. Conde of Sungard. Conde essentially says that he could not run the company 'right' in the public markets. So the small investor has no chance, currently, to enjoy the fruits of really top-notch corporate management or governance.
Maybe they'll get a break, when some of the better private equity firms begin to add investment vehicles for the smaller investor."
Perhaps, going forward, the price for some of these buyouts will come down, when existing shareholders realize they can effectively sell the firm's governance to a top-notch private equity group, and reap a decent share of the resultant gains.
My guess is that the Harman buyout structure marks the first instance of what may become a saving grace for the private equity sector, and the beginning of a significant new form equity investing.
My partner and I discussed this, and he wondered aloud why this structure has appeared now? Surely, he said, outfits alike KKR and Goldman must have kicked this around for years.
My sense is that, with the recent publicity accorded buyout firm CEOs like Steve Schwarzman (of Blackstone), there is a growing fear of some sort of regulatory backlash. The last thing Blackstone, TPG, Silverlake Partners, Bain, KKR, et.al., need now, is for a Democratically-controlled Senate Finance Committee to legislate curbs to their buyouts, or attach deal-killing 'protections' for current shareholders.
Thus, the harmless, and even secretly helpful, tactic of allowing current shareholders to remain, at a discounted percent ownership, and with complete passivity (i.e., no voting power), to share in the flow of post-buyout gains, while contributing their capital in the bargain.
In truth, this allows the shareholders who remain to experience the best of what I informally call 'corsair capitalism.' I wrote about it here, in February. My closing thought in that post was,
"Now, for a prediction as to a form of solution which may develop. What is to stop private equity firms from issuing securities of participation in their ventures, in small denominations, as limited equity partners? Would not brands such as Texas Pacific, KKR, and Silverlake command a premium in the market? By attracting investor capital to their privately-held efforts, these partnerships could effectively begin to drain capital from poorly-run public firms, and then slowly, inexorably, pull them into the private equity world, where the value they add would accrue to the small, limited partner.
Truth is, the worst part of the structure of today's publicly-traded firms is that the board-CEO governance mechanism mitigates against the effective management of the firm for consistently superior total returns. Read Murray's passage quoting Mr. Conde of Sungard. Conde essentially says that he could not run the company 'right' in the public markets. So the small investor has no chance, currently, to enjoy the fruits of really top-notch corporate management or governance.
Maybe they'll get a break, when some of the better private equity firms begin to add investment vehicles for the smaller investor."
Perhaps, going forward, the price for some of these buyouts will come down, when existing shareholders realize they can effectively sell the firm's governance to a top-notch private equity group, and reap a decent share of the resultant gains.
My guess is that the Harman buyout structure marks the first instance of what may become a saving grace for the private equity sector, and the beginning of a significant new form equity investing.
Friday, April 27, 2007
CitiGroup Analyst Calls for GE Breakup
Last summer, I wrote this post regarding the reasons why GE should not exist in its current state as a conglomerate. As has happened with some other early predictions of mine, now others are coming late to this party.
Now a CitiGroup analyst has published a call for breaking up GE by spinning off its finance, real estate and media assets. He provided estimates of the value of each of the units apart from their current parent, such that the separated values sum to more than the current value of GE's stock.
Last August, I wrote,
"The days of Thomas Edison's end-to-end electrical system supply enterprise are long, long gone. I contend that each of these business units, and perhaps even more, at lower levels, could be spun off independently, to GE's investors' benefit. It's hard to believe that this collection of such different businesses can realistically derive value from being in a common corporate domicile, let alone generate excess returns because of that common home to pay for the lush compensation of the various senior executives.I can't see any downside to breaking up GE into its component businesses. Does anyone else?"
Clearly, I am no longer alone in this view, although I articulated it in detail eight months ago. Similarly to how Warren Buffett recently echoed my thoughts on Dell, discussed in this post, and the business media took six months or more, last year, to echo my own views on GM and Ford, first posted in this blog in the fall of 2005, now there's the beginning of a drumbeat to dissolve GE into its more sensible, constituent parts.
For what it's worth, the CitiGroup piece merited an on-air acknowledgement and discussion by no less than David Faber, a CNBC reporter. CNBC, of course, is owned by GE, so Faber had to be, and was, very guarded in his remarks.
On the plus side, he explicitly acknowledged GE's dismal performance under Immelt. Then, he inexplicably, and with a straight face, intoned that 'some say' Immelt has actually performed even better than Welch at the helm of GE. I have absolutely no idea how Faber would justify this, and he didn't try.
However, he went on to essentially note that Immelt has said the company won't be split up, so, there. No matter what anyone else says, Jeff likes being paid tens of millions of dollars per year for not providing shareholders even as much as the better-diversified return that they could get in the S&P500, let alone a better actual return under his term as GE's CEO. However, Faber did end his piece by opining that, if the company's stock price doesn't begin to move, relative to the S&P, by year's end, Immelt's job and GE's structure could begin to be in danger. As I've noted in prior posts, I'd love to see a wolf pack of private equity groups do to GE what the European bank consortium is now attempting to do with ABN Ambro- buy it and break up the pieces to add more value among the hunting partners.
Earlier, on CNBC's Squawkbox program, Joe Kernen, one of the co-anchors, and typically very sensible, had read aloud the Citi analyst's estimated business unit values on an as-separated basis. He then asked, to paraphrase,
'well, if we know what the pieces should be worth alone, why is it necessary to split them off? why can't we just have GE's value reflect them?'
It's actually a fair question. Since the values are different, there must be reasons. Here are two that have occurred to me in the past.
First, astute observers realize that these units would behave differently, and probably more competitively and aggressively, if they had not corporate safety net, let alone had to vie internally for investment resources. Thus, on this basis, their different behavior and, probably, performance, would justify a different value.
Second, these units are currently saddled with a sort of corporate "tax" by Immelt and his royal court. Do you think Immelt actually adds value to any specific business unit personally? Doubtful. So, in essence, Immelt, his staff, headquarters operation, and all of the ponderous GE administrative overhead is paid by a tax on the operating earnings of the various GE units. Spin off a unit, and it instantly has more net income, and probably less meddling, time-wasting activities directed upward to the GE corporate staff.
For the record, here is a passage from Immelt's prepared remarks at GE's annual meeting this week, as reprinted in the Wall Street Journal,
"You can only believe one thing if you run GE or own GE stock: consistent earnings and cash flow growth, with expanding returns, increase shareowner value. This is a long-term investment. There are no short-term tricks.
The last few years have been frustrating for all of us. Your company has performed. Our five-year earnings growth rate of 11% matches our performance over the past 25 years. Our total shareholder return was 9% in 2006, 10% over the past three years and 2% over the past five years. But we have under performed the market.
Our challenge is one of historical valuation. GE's PE ratio was 31X in 2001, a 50% premium to the S&P 500. Today, our PE ratio is 17X, equal to the S&P 500. This is a function of a broader market sentiment away from "safer" mega-cap stocks and investors' desire to see GE perform consistently as we changed our portfolio.
We will continue to perform. We may have been over valued at 31X earnings, but we are not today. Our stock should reflect our double-digit earnings growth rate in the future. As we continue to execute, our valuation should improve as well. This is the best time to own GE stock.
I am compensated to meet with your expectations as long-term investors. Approximately 20% of my compensation is in base salary; 60% is at risk based on our financial performance; and 20% is at risk based on the stock price performance versus the S&P 500. I work without a contract. My objectives and compensation are set by our independent directors. My evaluation is transparent. You can read about it on page 41 of the annual report. I own 1.2 million shares of stock, including 100K shares I purchased in the open market over the past year. I will never sell a share of GE stock while I am CEO. Believe me, I am motivated."
Regarding Immelt's remarks, I would note the following.
His observation of GE's historic earnings growth rate being stable, while its stock price has stalled, simply points up Immelt's failure to understand that the game has changed in terms of investors' expectations. First, from my proprietary research, I would note that revenue growth, not earnings growth, is significantly related to concsistently superior total returns. Second, it's Immelt's job as CEO to figure out how to get total returns which exceed those of the market, not to excuse why earnings growth, and he, aren't getting the job done.
Second, Immelt is totally disingenuous in how he portrays his compensation. By expressing his compensation in percentage terms, he hides how much actual cash he has been paid by GE to date. I've covered this in various posts, most recently here, and the number is now at or north of $18MM. If Immelt explained this, than the '20%' figure, and his insistence that he is 'motivated' become pathetically hollow. Further the 80% of his compensation 'at risk' is, in reality, based upon terms he has proposed. The internal performance portion, 60%, is likely a sandbagged number. The 20% related to GE's stock price, in relation to the S&P, is, as I recall, rather complex, rather than simply requiring Immelt to consistently better the S&P's return over several years.
I'm left feeling a bit happier today, after hearing of the Citi analyst's call to begin dismembering GE. With time and continued lackluster leadership at GE, we might just see it be pursued and broken up within the next few years. Pity, though, that Immelt will get to keep what, by then, will be more than $20MM in cash, and probably more than $100MM in additional deferred compensation, all for doing basically nothing during his tenure to add value to GE for shareholders.
Now a CitiGroup analyst has published a call for breaking up GE by spinning off its finance, real estate and media assets. He provided estimates of the value of each of the units apart from their current parent, such that the separated values sum to more than the current value of GE's stock.
Last August, I wrote,
"The days of Thomas Edison's end-to-end electrical system supply enterprise are long, long gone. I contend that each of these business units, and perhaps even more, at lower levels, could be spun off independently, to GE's investors' benefit. It's hard to believe that this collection of such different businesses can realistically derive value from being in a common corporate domicile, let alone generate excess returns because of that common home to pay for the lush compensation of the various senior executives.I can't see any downside to breaking up GE into its component businesses. Does anyone else?"
Clearly, I am no longer alone in this view, although I articulated it in detail eight months ago. Similarly to how Warren Buffett recently echoed my thoughts on Dell, discussed in this post, and the business media took six months or more, last year, to echo my own views on GM and Ford, first posted in this blog in the fall of 2005, now there's the beginning of a drumbeat to dissolve GE into its more sensible, constituent parts.
For what it's worth, the CitiGroup piece merited an on-air acknowledgement and discussion by no less than David Faber, a CNBC reporter. CNBC, of course, is owned by GE, so Faber had to be, and was, very guarded in his remarks.
On the plus side, he explicitly acknowledged GE's dismal performance under Immelt. Then, he inexplicably, and with a straight face, intoned that 'some say' Immelt has actually performed even better than Welch at the helm of GE. I have absolutely no idea how Faber would justify this, and he didn't try.
However, he went on to essentially note that Immelt has said the company won't be split up, so, there. No matter what anyone else says, Jeff likes being paid tens of millions of dollars per year for not providing shareholders even as much as the better-diversified return that they could get in the S&P500, let alone a better actual return under his term as GE's CEO. However, Faber did end his piece by opining that, if the company's stock price doesn't begin to move, relative to the S&P, by year's end, Immelt's job and GE's structure could begin to be in danger. As I've noted in prior posts, I'd love to see a wolf pack of private equity groups do to GE what the European bank consortium is now attempting to do with ABN Ambro- buy it and break up the pieces to add more value among the hunting partners.
Earlier, on CNBC's Squawkbox program, Joe Kernen, one of the co-anchors, and typically very sensible, had read aloud the Citi analyst's estimated business unit values on an as-separated basis. He then asked, to paraphrase,
'well, if we know what the pieces should be worth alone, why is it necessary to split them off? why can't we just have GE's value reflect them?'
It's actually a fair question. Since the values are different, there must be reasons. Here are two that have occurred to me in the past.
First, astute observers realize that these units would behave differently, and probably more competitively and aggressively, if they had not corporate safety net, let alone had to vie internally for investment resources. Thus, on this basis, their different behavior and, probably, performance, would justify a different value.
Second, these units are currently saddled with a sort of corporate "tax" by Immelt and his royal court. Do you think Immelt actually adds value to any specific business unit personally? Doubtful. So, in essence, Immelt, his staff, headquarters operation, and all of the ponderous GE administrative overhead is paid by a tax on the operating earnings of the various GE units. Spin off a unit, and it instantly has more net income, and probably less meddling, time-wasting activities directed upward to the GE corporate staff.
For the record, here is a passage from Immelt's prepared remarks at GE's annual meeting this week, as reprinted in the Wall Street Journal,
"You can only believe one thing if you run GE or own GE stock: consistent earnings and cash flow growth, with expanding returns, increase shareowner value. This is a long-term investment. There are no short-term tricks.
The last few years have been frustrating for all of us. Your company has performed. Our five-year earnings growth rate of 11% matches our performance over the past 25 years. Our total shareholder return was 9% in 2006, 10% over the past three years and 2% over the past five years. But we have under performed the market.
Our challenge is one of historical valuation. GE's PE ratio was 31X in 2001, a 50% premium to the S&P 500. Today, our PE ratio is 17X, equal to the S&P 500. This is a function of a broader market sentiment away from "safer" mega-cap stocks and investors' desire to see GE perform consistently as we changed our portfolio.
We will continue to perform. We may have been over valued at 31X earnings, but we are not today. Our stock should reflect our double-digit earnings growth rate in the future. As we continue to execute, our valuation should improve as well. This is the best time to own GE stock.
I am compensated to meet with your expectations as long-term investors. Approximately 20% of my compensation is in base salary; 60% is at risk based on our financial performance; and 20% is at risk based on the stock price performance versus the S&P 500. I work without a contract. My objectives and compensation are set by our independent directors. My evaluation is transparent. You can read about it on page 41 of the annual report. I own 1.2 million shares of stock, including 100K shares I purchased in the open market over the past year. I will never sell a share of GE stock while I am CEO. Believe me, I am motivated."
Regarding Immelt's remarks, I would note the following.
His observation of GE's historic earnings growth rate being stable, while its stock price has stalled, simply points up Immelt's failure to understand that the game has changed in terms of investors' expectations. First, from my proprietary research, I would note that revenue growth, not earnings growth, is significantly related to concsistently superior total returns. Second, it's Immelt's job as CEO to figure out how to get total returns which exceed those of the market, not to excuse why earnings growth, and he, aren't getting the job done.
Second, Immelt is totally disingenuous in how he portrays his compensation. By expressing his compensation in percentage terms, he hides how much actual cash he has been paid by GE to date. I've covered this in various posts, most recently here, and the number is now at or north of $18MM. If Immelt explained this, than the '20%' figure, and his insistence that he is 'motivated' become pathetically hollow. Further the 80% of his compensation 'at risk' is, in reality, based upon terms he has proposed. The internal performance portion, 60%, is likely a sandbagged number. The 20% related to GE's stock price, in relation to the S&P, is, as I recall, rather complex, rather than simply requiring Immelt to consistently better the S&P's return over several years.
I'm left feeling a bit happier today, after hearing of the Citi analyst's call to begin dismembering GE. With time and continued lackluster leadership at GE, we might just see it be pursued and broken up within the next few years. Pity, though, that Immelt will get to keep what, by then, will be more than $20MM in cash, and probably more than $100MM in additional deferred compensation, all for doing basically nothing during his tenure to add value to GE for shareholders.
Thursday, April 26, 2007
AstraZeneca Acquires Medimmune: Is Big Pharma Finally Dead?
Over the last decade, we've seen, significant and, at times, rapid consolidation of the pharmaceuticals sector. I can't even begin to recall the various once-independent names from the 1980s anymore. I do recall the latter years of Roy Vagelos' reign at Merck, when it was a paragon of a well-managed company and pharma operation.
Does this week's acquisition of MedImmune by AstraZeneca (one of the big pharma giants that is the resulting combination of some of those firms whose names I can't recall) signal the final bankruptcy, from a total return perspective, of big pharma?
Is bio-pharma finally, legitimately replacing big pharma as the most efficient and effective means of discovering new medicines?
A look at the various Yahoo-sourced charts (please click on each to view a larger version) reveals some of the answer. The first chart depicts AstraZeneca's performance over the past five years, versus the S&P. Not only is AstraZeneca performing worse than the index, but it's inconsistent, as well.
Considering my latter question regarding big pharma vs. bio pharma, I charted several big pharma staples- AstraZeneca, Novartis, Merck and Glaxo, versus the S&P and Medimmune. With the exception of Novartis, the big pharma names lag both the S&P and Medimmune over the past five years.
Turning to the bio pharmas, we have this result. Gilead (one of my portfolio holdings) and Genentech lead the pack, with Genzyme and Medimmune also leading the S&P. Further, the graphic display demonstrates that Gilead and Genentech have continued to outperform recently, while the other two bio pharmas have coasted back down toward the S&P's return.This would suggest that Carl Icahn has not lost his touch, and is focusing on one of the weaker-performing companies in a sector that is capable of far better performance.
Putting the two pharma sub-sectors together, you get this picture. Big pharma as a group clearly lags bio pharma in generating superior total returns for their shareholders. Thus, AstraZeneca is probably wise to turn to an undervalued bio pharma for help in re-igniting growth and, hopefully, the ability to generate consistently superior total returns.Does this mean we might see additional consolidations of big pharmas chasing bio pharmas? The chart suggests it will continue to be a compelling consideration for the worst performing big pharma, Merck.
Wednesday, April 25, 2007
Trouble Hedging Oil Prices: West Texas Crude
Monday's Wall Street Journal contained a sleeper of an article about the behavior of West Texas crude as oil's benchmark pricing instrument.
While the details of how and why this type of oil has become the instrument on which hedging instruments are built may be rather dull, it turns out that they are important. For, recently, the price of West Texas crude, and the hedging vehicles built upon it, have been moving in the opposite direction from the prices of the bulk of oil traded on world markets.
It goes to show, once again, that hedging is typically built on historical pricing behaviors, but is not always a lock. Right now, airlines and other major institutional consumers of energy hedges are seeing those financial insurance policies double down the wrong way. Instead of offsetting oil's price rise, the West Texas hedges are adding to the damage.
We saw this nine (has it been that long already?) years ago, when the wizards at John Merriwether's Long Term Capital Management, including two Nobel Laureates, misunderstood the behavioral assumptions they had made regarding various instruments used for hedging, and took them, instead, as tautological relationships. When a combination of market forces, including a Russian default, upset past relationships between the financial instruments, LTCM began its four month slide into bankruptcy and dissolution.
Now, we have a view of something similar, although simpler, occurring. The physical site chosen for delivery of West Texas crude-based derivatives is Cushing, Oklahoma. For a variety of reasons, the storage facilities in Cushing are full, thus depressing prices.
So, while attempts are being made to develop new benchmark oil instruments for other grades of crude, in other locations, let's not lose sight of the underlying lesson from this situation.
Relationships between financial instruments are observed behaviors within certain contexts. They are not laws, nor tautological truths. There can be occasions when conditions will be violated, relevant ranges of underlying or associated phenomena may be exceeded, and the relationships upon which hedges built with these financial instruments will fail to behave as expected.
It happened with "portfolio insurance" in the early 1990s. It happened again in 1998. It might be happening again now.
And it's almost certain to happen again, in some instruments, in the future.
While the details of how and why this type of oil has become the instrument on which hedging instruments are built may be rather dull, it turns out that they are important. For, recently, the price of West Texas crude, and the hedging vehicles built upon it, have been moving in the opposite direction from the prices of the bulk of oil traded on world markets.
It goes to show, once again, that hedging is typically built on historical pricing behaviors, but is not always a lock. Right now, airlines and other major institutional consumers of energy hedges are seeing those financial insurance policies double down the wrong way. Instead of offsetting oil's price rise, the West Texas hedges are adding to the damage.
We saw this nine (has it been that long already?) years ago, when the wizards at John Merriwether's Long Term Capital Management, including two Nobel Laureates, misunderstood the behavioral assumptions they had made regarding various instruments used for hedging, and took them, instead, as tautological relationships. When a combination of market forces, including a Russian default, upset past relationships between the financial instruments, LTCM began its four month slide into bankruptcy and dissolution.
Now, we have a view of something similar, although simpler, occurring. The physical site chosen for delivery of West Texas crude-based derivatives is Cushing, Oklahoma. For a variety of reasons, the storage facilities in Cushing are full, thus depressing prices.
So, while attempts are being made to develop new benchmark oil instruments for other grades of crude, in other locations, let's not lose sight of the underlying lesson from this situation.
Relationships between financial instruments are observed behaviors within certain contexts. They are not laws, nor tautological truths. There can be occasions when conditions will be violated, relevant ranges of underlying or associated phenomena may be exceeded, and the relationships upon which hedges built with these financial instruments will fail to behave as expected.
It happened with "portfolio insurance" in the early 1990s. It happened again in 1998. It might be happening again now.
And it's almost certain to happen again, in some instruments, in the future.
Tuesday, April 24, 2007
Financial Academics as Wall Street Fund Managers
"Those who can't do, teach."
That's an old adage from my youth. However, Saturday's Wall Street Journal featured an article concerning academics who teach finance at our nation's universities, and also have developed and/or run asset strategies via hedge or mutual funds.
My initial question is, why would you think finance professors should necessarily know more about developing hedge or mutual funds that outperform the market than anyone else? If they did, and they knew it, wouldn't they be doing it already? Or, perhaps, have done it, become wealthy, and then retired to teach finance at a major university?
Unlike bygone eras before 1990 or so, when universities often had data, computational resources, and a collection of talent that was unmatched elsewhere, it's unclear what competitive edge would exist nowadays in the academic world. What is it that university finance professors have that is now unique? The days of University of Chicago's CRISP data base being unique, or Wharton's Rodney White Center having some edge, are gone. I can't imagine any leading trading or investing operation, let alone an exchange, releasing data in that manner anymore.
Would universities have better research resources, such as people? Probably not. Funds and investment banks with fund management shops are chockablock with young, eager twenty somethings on the make. In fact, my partner and I even pause when offered an opportunity to meet with some financial services concerns, because we don't see benefits to speaking to a room full of young, inexperienced analysts, all of whom are looking for some edge with which to make partner at their firm.
Computing power is cheap and plentiful now. That is not likely to be a source of advantage for a finance professor nowadays
How about innovative concepts? Perhaps the leading finance professors think better thoughts about investing strategies. The article mentions Wharton's Jeremy Siegel, Yale's Robert Shiller, and Princeton's Burton Malkiel. It neglects to name Robert Merton and Myron Scholes, co-recipients of the 1997 Nobel Prize in Economics, who assisted Long Term Capital Management in causing self-immolation, and the loss of $4.6B, back in 1998. Neither does it discuss Robert Haugen, a UCLA finance professor who applied the theories from his book, The New Finance, to mutual funds in the 1980s. As it happens, my colleagues at a hedge fund worked with Haugen in the late 1980s, using his data and models, and were unable to effect any significantly superior returns from the effort.
The article also omits any mention of Fisher Black's and Richard Roll's track records at Goldman Sachs, back in the 1980s and '90s. Black, of course, was hired for his part in the now-famous Black-Scholes options model (he died while at Goldman, so LTCM had to settle for his partner, Scholes), while Roll was instrumental in the application of a rather garden-variety statistical technique, factor analysis, to portfolio management, which was renamed Arbitrage Pricing Theory, or APT.
Whatever asset management vehicles other famous finance professors, such as Eugene Fama, and/or his research colleague, Ken French, have created, are also omitted.
If anything, finance professors may be more likely to be hidebound, since they must teach what has already been vetted. Or, if it's cutting-edge, what they teach becomes the market behavior. You'd expect to find the more successful asset management strategists out of the limelight, and certainly not prostyletizing their concepts to the masses in MBA and PhD programs.
As an example of this, several years ago, I worked with a wealthy private investor who desired to develop his own hedge fund complex. He told me that he and his colleague, Burton Malkiel, managed the money of some associates.
Did they employ some abstruse black-box econometrically-based model? No. Did they engage in esoteric hedging strategies across currencies, durations, and asset classes? They did not.
Their approach was almost comically simple. It used the yield on Treasuries, and a simply-derived proxy of yield for the S&P500 from its forecasted earnings and PE multiple. They then simply moved client funds between two publicly-available, pure index funds based upon the relative values of the two forward-looking yields.
Hardly rocket science.
However, my comments are hypotheses. Anecdotal, if you will.
What we really need to know, in order to determine whether ex- or current finance professors are uniquely talented asset managers, is whether, as a group, finance professors have outperformed their non-academic peers in the marketplace with their hedge, mutual fund, and/or private account strategies. Did they also outperform the average comparable fund or account? How about the S&P500 index, for equities, or other relevant indices for other asset classes?
This would be fascinating work for some financial media company, such as the Wall Street Journal, Barrons, Forbes, or CNBC to undertake or commission. Just using a few high-profile names and some anecdotes isn't sufficient to demonstrate or conclude anything.
For example, as noted above, Long Term Capital Management blew up, losing billions of investor dollars, with the help of two ex-academic, Nobel Laureates. Siegel's strategies, somewhat disingenuously called 'index funds,' have been off to a rocky start at Wisdom Tree, according to a recent Journal article.
There's no clear sense in the literature as to whether academics have done a better job consistently outperforming their respective market indices, or non-academic asset management peers. From that perspective, the Wall Street Journal article is an intriguing start on this topic, but by no means the final word.
That's an old adage from my youth. However, Saturday's Wall Street Journal featured an article concerning academics who teach finance at our nation's universities, and also have developed and/or run asset strategies via hedge or mutual funds.
My initial question is, why would you think finance professors should necessarily know more about developing hedge or mutual funds that outperform the market than anyone else? If they did, and they knew it, wouldn't they be doing it already? Or, perhaps, have done it, become wealthy, and then retired to teach finance at a major university?
Unlike bygone eras before 1990 or so, when universities often had data, computational resources, and a collection of talent that was unmatched elsewhere, it's unclear what competitive edge would exist nowadays in the academic world. What is it that university finance professors have that is now unique? The days of University of Chicago's CRISP data base being unique, or Wharton's Rodney White Center having some edge, are gone. I can't imagine any leading trading or investing operation, let alone an exchange, releasing data in that manner anymore.
Would universities have better research resources, such as people? Probably not. Funds and investment banks with fund management shops are chockablock with young, eager twenty somethings on the make. In fact, my partner and I even pause when offered an opportunity to meet with some financial services concerns, because we don't see benefits to speaking to a room full of young, inexperienced analysts, all of whom are looking for some edge with which to make partner at their firm.
Computing power is cheap and plentiful now. That is not likely to be a source of advantage for a finance professor nowadays
How about innovative concepts? Perhaps the leading finance professors think better thoughts about investing strategies. The article mentions Wharton's Jeremy Siegel, Yale's Robert Shiller, and Princeton's Burton Malkiel. It neglects to name Robert Merton and Myron Scholes, co-recipients of the 1997 Nobel Prize in Economics, who assisted Long Term Capital Management in causing self-immolation, and the loss of $4.6B, back in 1998. Neither does it discuss Robert Haugen, a UCLA finance professor who applied the theories from his book, The New Finance, to mutual funds in the 1980s. As it happens, my colleagues at a hedge fund worked with Haugen in the late 1980s, using his data and models, and were unable to effect any significantly superior returns from the effort.
The article also omits any mention of Fisher Black's and Richard Roll's track records at Goldman Sachs, back in the 1980s and '90s. Black, of course, was hired for his part in the now-famous Black-Scholes options model (he died while at Goldman, so LTCM had to settle for his partner, Scholes), while Roll was instrumental in the application of a rather garden-variety statistical technique, factor analysis, to portfolio management, which was renamed Arbitrage Pricing Theory, or APT.
Whatever asset management vehicles other famous finance professors, such as Eugene Fama, and/or his research colleague, Ken French, have created, are also omitted.
If anything, finance professors may be more likely to be hidebound, since they must teach what has already been vetted. Or, if it's cutting-edge, what they teach becomes the market behavior. You'd expect to find the more successful asset management strategists out of the limelight, and certainly not prostyletizing their concepts to the masses in MBA and PhD programs.
As an example of this, several years ago, I worked with a wealthy private investor who desired to develop his own hedge fund complex. He told me that he and his colleague, Burton Malkiel, managed the money of some associates.
Did they employ some abstruse black-box econometrically-based model? No. Did they engage in esoteric hedging strategies across currencies, durations, and asset classes? They did not.
Their approach was almost comically simple. It used the yield on Treasuries, and a simply-derived proxy of yield for the S&P500 from its forecasted earnings and PE multiple. They then simply moved client funds between two publicly-available, pure index funds based upon the relative values of the two forward-looking yields.
Hardly rocket science.
However, my comments are hypotheses. Anecdotal, if you will.
What we really need to know, in order to determine whether ex- or current finance professors are uniquely talented asset managers, is whether, as a group, finance professors have outperformed their non-academic peers in the marketplace with their hedge, mutual fund, and/or private account strategies. Did they also outperform the average comparable fund or account? How about the S&P500 index, for equities, or other relevant indices for other asset classes?
This would be fascinating work for some financial media company, such as the Wall Street Journal, Barrons, Forbes, or CNBC to undertake or commission. Just using a few high-profile names and some anecdotes isn't sufficient to demonstrate or conclude anything.
For example, as noted above, Long Term Capital Management blew up, losing billions of investor dollars, with the help of two ex-academic, Nobel Laureates. Siegel's strategies, somewhat disingenuously called 'index funds,' have been off to a rocky start at Wisdom Tree, according to a recent Journal article.
There's no clear sense in the literature as to whether academics have done a better job consistently outperforming their respective market indices, or non-academic asset management peers. From that perspective, the Wall Street Journal article is an intriguing start on this topic, but by no means the final word.
Monday, April 23, 2007
Wall Street on Wal-Mart
Friday's Wall Street Journal ran a piece in their Money & Inveseting section on what ails wal-mart, and how to fix it. Trouble is, they mostly asked a group of money managers. Why they think those guys would have a lock on such knowledge is beyond me.
In my opinion, most of them are barking up the wrong tree. Wal-Mart isn't 'coming back' as they knew it. It's big, sluggish, and hard to manage with its saturated markets.
In my opinion, most of them are barking up the wrong tree. Wal-Mart isn't 'coming back' as they knew it. It's big, sluggish, and hard to manage with its saturated markets.
A look at the Yahoo-sourced chart above ( please click on it to view a larger version) displays the firm's stock price over the past five years. To call it 'stalled' would be kind. It's in deep trouble.
Among the suggestions from the analysts and portfolio managers were: improve customer service; focus on same-store sales, not new growth; exit Japan; enter another foreign market like Mexico, and; sell the Sam's Club operation.
It's quite a mix of advice, but I doubt most of it will result in consistently superior returns for Wal-Mart, like its heyday in the 1980s and '90s.
From what I've read of the firm's travails of the past few years, customer service, per se, is not the problem. Certainly not of the sort that matters to McDonalds. It's a totally different customer satisfaction model.
Rather, Wal-Mart is likely at a crossroads. If it desires to regain consistently superior total return performance via growth, then it needs to do a better job identifying those markets which will sustain its traditional, logistics-dependent strategy for dominating the low end of retail merchandising. Whether this means staying or leaving Japan, I don't know. But Wal-Mart's management should.
Similarly, selling or keeping Sam's Club is strictly a matter of whether it contributes to high-margin, high-revenue growth, or not.
However, what all of these observers miss is that real companies become senescent. Eventually, investor expectations become adjusted to their performance, their competitive environment brings the firm to parity, and, like Wal-Mart, it may even draw the focus and ire of public interest and governmental groups, further burdening the firm's efforts to outperform the market.
My own view is that it's unlikely that Wal-Mart will regain its former consistently superior outperformance record. Its size, need to be in multiple countries and exposed to radically varying cultures and logistics environments probably presents the firm's management with too many challenges to overcome simultaneously.
But, since I'm neither a broker, nor a current investor in Wal-Mart, I don't have a stake in convincing others to either buy, or sell the firm's stock based upon expectations. I'm just writing what I have observed, from both my proprietary research, track record of portfolio selections, and the recent media coverage of Wal-Mart's performance.
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