Stephen Ross on Behavioral Finance: From the Ridiculous to the Sublime

Last night, my business partner and I attended a wonderful event hosted by the local alumni group of one of his alma maters, MIT. The occasion was a talk given by Stephen Ross, now the Franco Modigliani Professor of Finance and Economics at that august bastion of quantitative learning on the Charles River.

By the way, for what it's worth, the far better University in Boston than its better-known, non-empirical neighbor in Cambridge, which shall go unnamed. The only clue being, the seasons changed, and Summers' gone now.....

Anyway, back to last night's dinner and talk.

For the ridiculous, the evening began with polite talk over drinks on the breezy, brick patio of a pleasant catering facility. We engaged in conversation with another couple, the woman of which was the MIT graduate. Her partner is a recently-retired businessman who has just sold his enterprise. Upon learning of my equity portfolio work, he eagerly began to describe his latest interest- a web-based trading site/system known as WiseTrade. Suffice to say, WiseTrade is to equity investing what 'no money down' home buying is to real estate finance.

What was humorous about the episode is that, while the man excitedly discussed how easy it was to buy or sell green- or red- shaded stock tickers, based upon their appropriately colored-lines on a chart, his MIT-educated partner pointedly asked whether the use of such a program by perhaps thousands of people at the same time might not affect the ability of "the program" to mint money at unheard-of rates?

Now, to the sublime. My partner and I were fortunate in being seated at "the finance" table, with about eight other alumni, and Prof. Ross. We caught occasional wisps of his conversation, seated, as we were, across a rather large table.

If I had been a little more aware, I'd be posting a (admittedly posed) digital picture of Prof. Ross and myself, with me, no doubt, looking pensive as he appeared to be making a sage remark.

As we worked through a very serviceable catered-style dinner, Prof. Ross gave a talk of incredible lucidity, insight, sensibility, and humor. MIT is very fortunate indeed to have lured him to its classrooms and research facility.

As concerns my interests, and this blog, Ross' remarks provided the following insights and reinforcements.

First, he clearly stated his belief that there are many unresearched anomalies in finance. Thus, he noted, simply because we do not know why an anomaly exists, or how it works, does not mean that neo-classical finance does not, or, in time, will not explain why.

To simply throw up our hands and resort to behavioral finance explanations in the absence of any other research is mistaken.

Second, Ross chose the anomaly of closed-end funds well-known pricing at a discount to their net asset value, to illustrate this point. He provided an excellent survey of the phenomenon, prior research, and conclusions by other finance academics. He then described his own simple, sensible hypothesis, and subsequent research which confirmed his hypothesis.

It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.

Third, and perhaps most important, Ross remarked that, in his opinion, the best research into various anomalies typically is not overly-complicated, nor dependent upon 'fancy statistics,' but, rather, usually involves sensible ideas and relatively straightforward quantification of the phenomenon to resolve the apparent anomaly. Higher-level math or complicated statistical models are not necessarily indicative of reliable research, in his opinion.

Fourth, he consistently focused on the fundamental neo-classical contention that returns and risk are linked. Excess, or unexpectedly high returns, are invariably linked to added risk, whether that risk is explicitly known, measured, or described.

In that vein, during the post-talk Q&A period, he fielded my question regarding the newly-developed dividend "index" funds by Jeremy Siegel, now allied with Wisdom Tree funds. His thoughts are that one can construct many different weightings for funds, which he pointedly did not call "index" funds, which outperform classical indices such as the S&P500. However, when such constructed weightings lead to higher returns than those of indices, he attributes the excess to unrealized risks inherent in the constructed portfolios. As such, he effectively said, without engaging in any personal comment on Siegel, that the dividend-weighted index funds owe any above-average returns to risks which they seem not to have yet identified.

Finally, in a review of various other 'schools' of finance theory- behavioral, physics, and biological, he stressed two of the hallmarks of neo-classical finance that remain important. One is the field's clear-cut theory of efficient pricing of risk and information in markets. The other is its ability to quanitfy effects, which, specifically, he believes behavioral finance cannot. He likened behavioral finance, with its focus on overall behaviors of investors, to economics, rather than finance. That is, as a professor of both, he noted that economics is concerned with average behaviors of many market participants who effect prices, whereas finance is concerned with behaviors of a few 'sharks' who ferret out and capture price and risk inconsistencies, at the expense of the many who are not similarly motivated or informed.

I came away from Prof. Ross' talk feeling that my own proprietary equity research, and the conclusions resulting from it, on which my equity portfolio strategy is based, are on very solid ground. According to Ross' views, I have identified a heretofore unrealized anomaly which may well continue to exist for decades. Due to some of the specific ways in which I classify and measure various attributes of stock performance, there may never be many, if any, other finance researches who identify precisely the type of return opportunities which I have found. Further, the research I designed and performed is remarkably simple. I used some fairly straightforward concepts from my quantitative market research background, off-the-shelf point-and-click statistical software, and basic analytical tools to discover the phenomena which I use in my portfolio strategy.

When a finance academic of Stephen Ross' caliber provides me with information and insights which dovetail with my own work and methods, I feel reassured and confident in the strength and longevity of the underpinnings of my equity portfolio management approach. While it is theoretically possible for all anomalies to eventually be reduced to understanding and, perhaps, eliminated, in practice, it's not possible. Further, as Prof. Ross pointed out with several examples, often times, explaining the anomaly does not eliminate it. It simply provides the reason why the particular investment approach works as it does.

As I told my business partner, it was a dinner well worth whatever he paid for it.

CBS Tries Another Online Strategy

Monday's Wall Street Journal carried an article discussing CBS's abandonment of its proprietary website for video content. I last wrote about this topic here, in February. That post referenced my earlier piece, here, in October of last year, wherein I discussed Comcast's attempt to become the megaportal of the web for video.

While a worthwhile article to read in its entirety, here are some salient passages from the Journal piece,

A year ago, CBS Corp. announced the creation of Innertube, an entertainment channel on CBS.com designed to make the company a player in online video. It streams video of sporting events, news reports and reruns of shows such as the hit comedy "How I Met Your Mother."
CBS's new chief Internet strategist now jokes that the Web address for Innertube should be "CBS.com/nobodycomeshere."

CBS, after a year of experimenting with various Web initiatives, says that forcing consumers to come to one site -- its own -- to view video hasn't worked. Instead, the company plans to pursue a drastically revised strategy that involves syndicating its entertainment, news and sports video to as much of the Web as possible. It represents a stark departure for the TV industry. Most of CBS's major competitors, including Walt Disney Co.'s ABC, General Electric Co.'s NBC Universal and News Corp.'s Fox, are to some degree all betting that they can build their own Internet video portals.

"We can't expect consumers to come to us," says Quincy Smith, the president of CBS Interactive. "It's arrogant for any media company to assume that."

Joanne Bradford, chief media officer of MSN, says advertisers would be served better by buying online ads directly from Web sites rather than buying Internet packages offered alongside their upfront TV deals with the networks. "I'm a little irritated that the networks have put together a digital package that lets a marketer check a box and isn't as robust or deep," she said at a conference last week for advertisers in Seattle.

Advertisers will ultimately decide if CBS's new strategy is the right one. So far, media buyers are positive about the move, although they note that CBS has had troubles implementing some heavily promoted digital efforts in the past. CBS has already signed up major advertisers for its digital network such as Procter & Gamble Co., General Motors Co. and AT&T Corp.'s Cingular Wireless.

I take two messages away from the CBS experience. The first is a reinforcement of my original prediction that it will be unwise for anyone to plan to create and run the single, most-important media site on the web. YouTube happened more or less by accident. It is similar to EBay in that it hosts the work of others, but does not, per se, create content.

This is why I think Comcast is going to fail in its expensive quest to create a web media hub that is the ne plus ultra of the 'net.

The second message I note is how much what is old is new again. New technology, new empowerment of consumers with respect to what to watch, when, and how. Yet, advertising is still going to pay for all of that convenience.

Funny how that ad model keeps recurring for 80 years now, isn't it? It's followed media advancement from radio in the 1920s all the way to multi-media web video in a new century.

Cheating At Colleges and Grad Schools

This Friday's Wall Street Journal featured an article discussing cheating at Duke University's Fuqua School of Business. It went on to mention the percentage of cheating reported in some other graduate disciplines, and undergraduate programs.

According to the Journal article, undergraduate cheating hovers around 50%. Using a slightly looser definition, Donald McCabe, of Rutgers, found, in research for the Center for Academic Integrity, that undergraduate cheating approached 67%. The B-school average for students who cheat is reported to be 56%. That of other graduate programs is said to be around 50%.

Rather than tackle the moral dimension of this sad situation, a simpler notion comes to my mind.

Does this prominent example of B-school cheating have anything to do with the increasing mediocrity we seem to see emanating from US businesses? Could we simply be seeing businesses increasingly hire graduates who have cheated so often that they simply don't have the skills which are expected to accompany the degrees they have allegedly earned?

Perhaps it's not so much the day-to-day, low-level skills and knowledge, but higher-level applications of that knowledge.

There will always be a few brilliant, driven young men and women who become tomorrow's innovators. Engineering, physics or chemistry students at universities like MIT, CalTech, Carnegie, Stanford, etc.

But what of the mass of middling graduates from so many other four-year programs? And graduate degree programs? I'm beginning to think that many students are so fixated on receiving (already inflated) grades, that they are simply skipping true learning, in order to secure an initial billet upon finishing their degree programs.

Of course, once you're in the work force, as a very wise grad school professor and mentor told me, it's rare people recall the school from which you graduated six months later. If they do, he intoned, you have a problem. Performance is what predominates in the workforce, although, of course, not in every case. Connections, relatives, alumni, can sometimes grease the skids for the somewhat-above, or just truly, mediocre. However, if so many students simply cheat to finish college, is it any wonder that they might not really have the knowledge that forms a foundation on which they, and their employers, can progress and improve?

Chrysler's Latest Rescue

As I wrote in this post in the fall of 2005, I expected at least one of America's Big Three auto makers to have some sort of change of control by 2010. My exact wording was,

"Judging from where GM and Ford appear to be putting much of their energies these days, I’d say we’re going to be shy at least one major US-based car manufacturer before the decade is out. It may involve a merger among onshore rivals, if Congress is afraid to let so many UAW workers lose their jobs at once through a total financial failure of GM or Ford. But I'm willing to bet there will be one less automotive CEO in Detroit when 2010 dawns."

My verbiage was, I suppose, focused on the still-independent companies. My intent was to predict a change of ownership in one of the three, if not bankruptcy.

Today's sale by Daimler, to Cerberus, the private equity group, of its Chrysler unit, in my opinion, qualifies as meeting my prediction.

What puzzles me, though, is how Cerebrus plans to actually operate the weak man of Detroit at a continuing profit, amidst the general consensus about excess capacity in the sector. Sure, they own some suppliers, and maybe even have a few old auto company hands. Does that mean John Snow & Company can turn back the tide of industrial economics in the sector, and restructure and rehabilitate Chrysler's product line, financial situation, and marketing so thoroughly, successfully and quickly as to create value where nobody else could?

We all know that the UAW can break any deal for Chrysler. Or the other two- GM and Ford- for that matter. Whether they can actually make the deal....that's another question.

I have my doubts. So many analysts, including many of today's commentators on CNBC, focus on the labor costs when they discuss these auto makers. But it was the white-collar managers who led GM, Ford and Chrysler to where they are now. I don't think the machinists and assemblers down on the factory floors can remedy those ills.

Of course, once Cerberus gets its hands on Chrysler and drags it behind the impenetrable curtain of its private balance sheet, there's no telling what will come back out, and with what profitability dynamics. I'm eager to see this one come out the other end.

On Statistical Distributions: A Review of "The Black Swan"

A few weeks ago, the Wall Street Journal published a review of the book, "The Black Swan," written by Nassim Taleb, and reviewed by David Shaywitz.

Taleb is currently a hedge fund manager, and, as such, takes particular notice of the distributions of various types of events. Distributions are important....they can undermine models when inappropriately chosen. Parenthetically, this Friday's Journal carried a piece on the recent cheating scandal at Duke University's Fuqua Business school, and I could not help wondering how much such cheating results in even more mediocre, mis-educated people wind up in positions where they can do real damage to others.

From other reading about Taleb, I know that he is keenly sensitive to a specific sort of anomaly- that of sudden and unpredicted market swings of the type experienced on the heels of Long Term Capital Management's difficulties in 1998. The following passage is from a 2002 New Yorker article about Taleb,

"Physical events, whether death rates or poker games, are the predictable function of a limited and stable set of factors, and tend to follow what statisticians call a "normal distribution," a bell curve. But do the ups and downs of the market follow a bell curve? The economist Eugene Fama once studied stock prices and pointed out that if they followed a normal distribution you'd expect a really big jump, what he specified as a movement five standard deviations from the mean, once every seven thousand years. In fact, jumps of that magnitude happen in the stock market every three or four years, because investors don't behave with any kind of statistical orderliness. They change their mind. They do stupid things. They copy each other. They panic. Fama concluded that if you charted the ups and downs of the stock market the graph would have a "fat tail,"meaning that at the upper and lower ends of the distribution there would be many more outlying events than statisticians used to modelling the physical world would have imagined."

In effect, the behaviors of people which follow power-law distributions can screw up financial theories and their implementations. e.g., LTCM, when those theories and their implementations are based upon the wrong distributional assumptions.

The larger lesson from Taleb, beginning with Fama's observation, is that purposeful, goal-directed human behavior is probably not random. Thus, it should not be assumed to approximate a normal distribution of possible occurrences.

Personally, I am not at all surprised by this phenomenon of mistaking one distributional assumption for another. It's been my experience, and belief, since 1985, that the inclusion of powerful statistical tools in spreadsheet programs began the inexorable slide in the quality of statistical analytical applications in business. In that year, a University of Chicago-educated MBA colleague of mine at the Chase Manhattan Bank managed to mangle a rather straightforward piece of stock price movement attribution analysis, thanks to his access to a regression analysis tool in Lotus 123, and an ignorance of how to build valid models.

This example of how a little knowledge can be a dangerous thing has, I suspect, been multiplied many times since in portfolio management and trading operations the world over.

Taleb's key insight is that what are often seen as 'once in a lifetime' events which are unrelated, per se, are, in fact, neither 'once in a lifetime, nor, strictly speaking, unrelated. To quote Gilda Radner's SNL character, Roseanne Roseannadanna,

"....it's always something......"

It certainly is.

1987: a major market drop of proportions not seen in one day since 1929.

1989: Chase Manhattan Bank's failure lend to UAL's ESOP for a buyout triggers this 'little crash.'

1995: Barings Bank fails due to Nick Leeson's trading losses and fraud in concealing them.

1997: Asian financial markets crash.

1998: LTCM's incorrect assumptions regarding various hedged financial instruments' behaviors under stress results in the firm's demise, and a brief but severe market downturn.

2001: 9/11 attack on World Trade Center towers causes a market slide already in progress for a year to deepen and lengthen.

2006: Amaranth hedge fund fails from overly-risky, wrong bet by one trader on natural gas prices.

Thus, courtesy of Fama and Taleb, we see that there is considerable risk in assuming that severe market disturbances of the sort which occurred in 1929 do not recur very frequently. And a market composed of investors and traders who predominantly model strategies with risk metrics that employ the wrong, normally-distributed assumptions about the frequency of occurrences of various outcomes, is inevitably going to react badly to the actually more-frequent occurrences of extreme outcomes which affect financial markets.

Perhaps my own approach, using consistency of membership in a class, rather than forecasting the value of each member of the class, is less susceptible to this type of risk.

However, it goes even further. Thanks to reading this review of Taleb's book, and the 2002 New Yorker article, my partner and I have developed a powerful new variant of my equity strategy which explicitly takes into account Taleb's preoccupation with extreme market occurrences.

I'll write more about this in an upcoming post.

On Murdoch's Bid for Dow Jones

There was a very interesting piece in Monday morning's Wall Street Journal. It detailed the Ottaway's and retired Wall Street Journal executive Peter Kahn's opposition to Rupert Murdoch's offer of $60/share to buy Dow Jones.

On the surface, it appears to be a rather complex situation.

On one hand, Kahn, Ottoway et. al. sound antiquatedly quaint in defending journalistic integrity and independence. That's the sort of thing we used to hear from broadcast newsrooms, before cable television put them under.

In this case, blogging and cable TV have pressured print journalism. Why else the tie-up between CNBC and the WSJ?

Further, as a letter to the editor in today's Journal noted, the Bancrofts and The Wall Street Journal are all for capitalism, until it comes home to roost at their poorly-performing, partially publicly-held company. In that case, however, they argue for morals, standards, and eschew the same free market winds that they claim must blow throughout the economy.

For the record, the closing price of Dow Jones Inc. rose from $36.33 on April 30th, to $56.20 on May 1st. That's a 55% increase in the market price, nevermind Murdoch's promise of $60, which would be a 65% increase in the value of the stock. On an economic basis, it's clear that the time has come for someone else to create value with the Dow Jones stable of assets.

The nearby Yahoo-sourced chart of the Dow Jones stock price, versus the S&P500 Index for more than thirty years, tells a sorry tale indeed. The media firm has barely managed one-third the return of the market over this time, and has been flat for the last five years and declining over the last seven years.

On the other hand, there is the argument of journalistic independence. Critics say Murdoch will sell out the vaunted Journal staff that has won Pulitzer's for covering investigative stories in China. Kahn was reported to be concerned that, under Murdoch, the WSJ would not have earned those two Pulitzers for covering stories critical of China and its government.

Now, that sounds like something to consider. Kahn pointed to Murdoch's many actions calculated to placate the Chinese, so that his BSkyB service could beam into the country. He is reputed to have eliminated BBC from the satellite service, cancelled Chris Patten's last book deal, and sold the South China Morning Post, all to remove material offensive to the Chinese government.

Such accommodation worries Kahn.

At first, it worried me, as well. Do you force private equity to afford such ethics? Can Dow Jones afford this, on behalf of its shareholders, independently? Or is this something capitalism will simply cost out and, if necessary, eliminate as too expensive? Trusting someone else to do the investigative reporting and write the needed criticisms of China.


Then, while discussing this issue with my consultant friend, S, I stumbled upon the real answer. Murdoch's answer, actually.


The reality is that print is a dead, bygone medium. The CBS franchise program, 60 Minutes, breaks tons of stories. How? By using television, not print. Do you think for a moment that the same program, as a print medium, could ever have lasted? Not a chance.


What Murdoch understands is that by marrying the Dow Jones assets and brands, particularly The Wall Street Journal, to his existing multimedia empire, he will enable those brands to actually create more value while doing even more investigative journalism.


The Dow Jones board's recent Chair has been trying to goose the company's performance, to little avail. My guess is that most investors understand that the old media pond within which Dow Jones lives is going to overwhelm the effects of any one firm's individual efforts. It's time for a more modern media vehicle to properly invest in and use the Journal's brand franchise.


No, the narrow version of the journalistic independence argument won't work for a publicly held company. Maybe if Ottoway and the Bancrofts wanted to take the firm private. But that's not what they want. They want top dollar and journalistic immunity from any economic realities.

The likely best outcome for the Journal and the rest of Dow Jones' media assets is to join a modern, global multimedia entity which can leverage their values further than is possible currently, while affording investment in them to retain their current competitive attributes. More than anyone else in media, Murdoch fits this description.


The crocodile tears over a potential loss of editorial independence and a standalone media presence are misplaced. This is about a too-small, old media company which has failed to properly take advantage of its best brands to create shareholder value. It's time for the Bancrofts to put up or sell. Either commit to investing in Dow Jones to enable it to consistently earn superior returns and realize its brand values, or sell it to someone who can.

More On GE's Breakup: The Right Idea

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.

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."

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.