The Wall Street Journal's Weekend section, two weeks ago, featured a section, in concert with MIT, concerning how corporations work in the modern era from many, remote locations.
In her article, "Working Together...When Apart," Lynda Gratton proposed 10 rules for making global, virtual teamwork successful. It's worth reading the entire piece, to get the full impact of the findings. She provides details about the origin of her information. In brief, it is the product of case studies at companies judged to have had successful virtual teams, followed by a London Business School survey of over 1,500 virtual team members at 15 US and multinational companies. From this information, the 10 rules common to successful virtual teams were distilled.
When I first read the list, my reaction was one of doubt that this sort of thing was going to be very replicable. I recall being at Accenture (then Andersen Consulting) in the 1990s, when we began using LotusNotes on project teams and in industry practices across the globe. Suffice to say, it wasn't pretty, and it wasn't all that effective, either.
However, as I returned to Ms. Gratton's piece to write about it, I am struck by another thought. Much of it is just common sense. For example,
2. Choose a few team members who already know each other.
5. Break the team's work up into modules so that progress in one location is not overly dependent on progress in another.
9. Ensure the task is meaningful to the team and the company.
Some of the other 'rules' make sense as well, but don't exactly seem like rocket science.
On one hand, one is tempted to give credit to the author(s) for distilling the 10 things that make the most difference. On the other hand, they aren't all that surprising.
As I wrote this, it occurred to me that there are some fairly older examples, before the internet age, which must have also produced rules lists like this, e.g., Boeing jet design, IBM mainframe computers, McDonnell Douglas jet and bomber design, intel chip design.
Surely some of these earlier projects learned similar lessons?
In the end, I found this article a bit disappointing. And reinforcing of something my proprietary research on equity performance discovered. Over time, surprisingly few companies can operate so effectively as to consistently outperform the S&P500. Getting things right, growing, and continuing to perform well, seems to remain a sort of 'catching lightning in a bottle' trick, even to this day.
Monday, June 25, 2007
Friday, June 22, 2007
Blackstone, Schwarzman, & The Tax Code
The current flap over: Blackstone's IPO; Steve Schwarzman's ostentatious lifestyle, and; Congress' intent to modify the tax code to "get" Schwarzman and his ilk, has many interesting aspects on which to comment.
Regarding the Blackstone IPO, my thoughts have not changed since I wrote a multi-part series, part three of which is found here, and this later piece. You can also simply click on the "Blackstone" topic under the Labels list, and read all of my pieces about this firm and its recent activities.
Basically, I suspect Schwarzman is selling at the top. More on this when I discuss Schwarzman's personal issues in the media of late.
Next, as I have frequently said to my partner recently, regarding the Blackstone IPO,
"Why in the world would you be buying, when one of the smartest private equity shops on Wall Street is selling?"
I also said this at the time of Goldman's IPO.
Then there is the little issue of 'fair value' for many of Blackstone's components, as discussed in one of my earlier, linked posts, above.
In summary, the Blackstone IPO essentially amounts to selling investors a limited interest in a blind investment pool. Once I put it that way, most intelligent investors realize that the Blackstone brand name is the only thing that gives this IPO any value whatsoever.
With that observation, let's turn to Steve Schwarzman's lifestyle. The Wall Street Journal and CNBC have run countless articles recently discussing Schwarzman's wealth, income from the IPO, his dietary habits (the expensive stone crabs), his birthday party, that he has a chauffeur and butler, and what tax rates those employees pay, relative to Schwarzman (allegedly higher than their boss).
Rather than comment on Schwarzman's lifestyle, let me try another tack.
Since an investor is buying a non-voting interest in a blind pool, s/he has to trust the judgment of the CEO and senior management of Blackstone. Does Schwarzman's recent behavior cause you to trust his judgment?
Here's a guy who is rapidly becoming the John D. Rockefeller of his era- obscenely wealthy, seemingly arrogant, aloof, and insensitive to the opulent and decadent life he is perceived to lead.
Hardly the poster-boy you want for your brand new equity asset.
Years ago, former Treasury Secretary, former Salomon partner, former WesRay partner Bill Simon was similarly featured in the media as being distant and obscenely wealthy for, come to think of it, being an early leveraged buyout king. Fairly rapidly, (I assume) his publicist set to work showcasing Bill and family's Christmas Day stint serving food at a local Morristown, New Jersey soup kitchen, as well as his many philanthropic activities. Rather than remaining demonized, Simon became more human and caring.
Not so, Steve Schwarzman. He seems to have this 'thumb in your eye' attitude. The comments about not having the slightest idea how expensive his and his wife's lunch of fresh stone crabs was. His frequently-quoted comments about wanting to 'win' at private equity, be the best, beat everyone else.
I think it's relevant that Schwarzman seems to have lost, assuming he had some to start with, any common sense regarding appearing as 'obscenely rich public enemy number one.' Personally, I would not want to own interest in a company led by someone whose judgment is now seeming so clouded.
Think Dennis Koslowski, Michael Millken, Ivan Boesky, et al. Things just seem to go badly when corporate titans wander into the public eye too prominently. None of those companies fared well as their leaders came under scrutiny.
Pete Peterson plans to retire as Chairman of Blackstone. Nobody really knows Larry Fink. Maybe they should gently nudge Schwarzman aside and let Fink become the lower-key, more kindly persona of the firm?
Finally, we come to the tax code aspect. This article describes the current tax situation for private equity partnerships, and proposed tax code changes.
My business partner and I discussed this yesterday over lunch. The reality of the tax code is that it is a collection of special-interest loopholes. Various industries get pilloried, or coddled, depending upon the year, the party in power in Congress, and economic conditions. Think about pharma, oil, 'high tech,' now private equity.
It's understandable that private equity partnerships should enjoy a capital gains treatment of their carried interest in risky buyout-and-turnarounds. However, if that includes paying lower rates on fairly quick payouts of 'special dividends' and operating profits of their owned operating units, then it's less clear that this is 'fair' to begin with.
It's unclear to me, as I write this post this morning, whether or not such special cashflows are shared by limited private equity 'partners,' i.e., investors, or only by the master partners. If it's the latter, then I would have less of a problem with the particular taxation of such income at shorter-term rates.
I don't condone Congress using Schwarzman's personal lifestyle and financial situation as a reason to "get" all private equity firm partners and their wealth. That's capricious, confiscatory, and symptomatic of class warfare. We don't need that. It is, in fact, antithetical to the whole basis of the American Dream- work hard, get rich.
For Congress to decide this month that some people who have succeeded must now be penalized, is extremely discomforting.
By the way, while I'm on the topic, does anyone else recall the last time Congress legislated its righteous indignation at another corporate excess? CEO compensation?
Remember when Congress became so critical of CEOs who earned large cash compensation that they imposed a special tax rate for salaries above $1MM?
The result was to pay CEOs with ....... stock options! Yes, the now-discredited compensation scheme that was spawned by Congressional ineptitude and jealousy.
Fact is, as Lloyd Blankfein, Goldman Sachs CEO, opined on CNBC this morning, tax code changes should be carefully considered by Congress before being enacted. Knee-jerk, envy-based changes will have serious consequences.
What Blankfein didn't explicitly say, but implied, was this. Who do you think is, on average, smarter- the average Wall Street/private equity partnership CEO, or a US Congressman or Senator?
Right. Nobody really smart stays in politics for long. So you have a bunch of basically mediocre, average-intelligence, at best, Congressmen and Senators enacting legislation, to be subsequently outwitted by some of America's most intelligent, best-educated and experienced minds.
The same thing happens every election cycle with campaign finance so-called "reform."
The ill-considered changes in the tax code for private (equity) partnerships will be no different.
Will such changes in the tax code trigger a private equity pullback, and, correspondingly, a public equity market value meltdown? The next market collapse, with attendant domino effect on asset values, buying behavior among average Americans, and, finally, economic recession?
Possibly. If it does, figure on a radical change in the political landscape in the runup to the 2008 Presidential and Congressional elections.
However, my guess is that it won't trigger such apocalyptic consequences. More likely, it will result in a higher hurdle rate for deals, a slowdown in their pace, and a gradual cooling off of the private equity deal frenzy.
However, nobody really knows. This particular focusing event, the Blackstone IPO, is fast becoming the transformational event in the longish journey of private equity firms as they emerge from their shadowy world of truly private activity, into the glaring light of publicly-traded interests.
One final observation. It's noteworthy that, despite the enormous financial and political stakes involved, pretty much everyone is fated to behave in their 'real' fashion, despite how it plays out in public.
Schwarzman is seen as a callous, ruthless financial titan, insensitive to how his actions affect public and political reactions to them. He is fast-becoming the lightning rod for legislative action to punish wealthy capitalists like him.
Henry Waxman appears as the power-hungry socialist he is, attempting to interject himself into the Blackstone IPO process, via an appeal to the SEC, with no basis for it. With any luck, his antics will attract sufficient attention to shift control of either or both Houses of Congress in two more years.
Investors are, even now, at 9:36am, feverishly bidding to own an uncontrollable, non-voting share of a pig in a poke. Sometime further down the road, when the nth private equity partnership sells public interest shares, there will be a fiasco of some sort, and perpetrators will be accused and convicted in the press and Congress long before anyone is indicted and brought to trial.
Some things never change, do they?
Regarding the Blackstone IPO, my thoughts have not changed since I wrote a multi-part series, part three of which is found here, and this later piece. You can also simply click on the "Blackstone" topic under the Labels list, and read all of my pieces about this firm and its recent activities.
Basically, I suspect Schwarzman is selling at the top. More on this when I discuss Schwarzman's personal issues in the media of late.
Next, as I have frequently said to my partner recently, regarding the Blackstone IPO,
"Why in the world would you be buying, when one of the smartest private equity shops on Wall Street is selling?"
I also said this at the time of Goldman's IPO.
Then there is the little issue of 'fair value' for many of Blackstone's components, as discussed in one of my earlier, linked posts, above.
In summary, the Blackstone IPO essentially amounts to selling investors a limited interest in a blind investment pool. Once I put it that way, most intelligent investors realize that the Blackstone brand name is the only thing that gives this IPO any value whatsoever.
With that observation, let's turn to Steve Schwarzman's lifestyle. The Wall Street Journal and CNBC have run countless articles recently discussing Schwarzman's wealth, income from the IPO, his dietary habits (the expensive stone crabs), his birthday party, that he has a chauffeur and butler, and what tax rates those employees pay, relative to Schwarzman (allegedly higher than their boss).
Rather than comment on Schwarzman's lifestyle, let me try another tack.
Since an investor is buying a non-voting interest in a blind pool, s/he has to trust the judgment of the CEO and senior management of Blackstone. Does Schwarzman's recent behavior cause you to trust his judgment?
Here's a guy who is rapidly becoming the John D. Rockefeller of his era- obscenely wealthy, seemingly arrogant, aloof, and insensitive to the opulent and decadent life he is perceived to lead.
Hardly the poster-boy you want for your brand new equity asset.
Years ago, former Treasury Secretary, former Salomon partner, former WesRay partner Bill Simon was similarly featured in the media as being distant and obscenely wealthy for, come to think of it, being an early leveraged buyout king. Fairly rapidly, (I assume) his publicist set to work showcasing Bill and family's Christmas Day stint serving food at a local Morristown, New Jersey soup kitchen, as well as his many philanthropic activities. Rather than remaining demonized, Simon became more human and caring.
Not so, Steve Schwarzman. He seems to have this 'thumb in your eye' attitude. The comments about not having the slightest idea how expensive his and his wife's lunch of fresh stone crabs was. His frequently-quoted comments about wanting to 'win' at private equity, be the best, beat everyone else.
I think it's relevant that Schwarzman seems to have lost, assuming he had some to start with, any common sense regarding appearing as 'obscenely rich public enemy number one.' Personally, I would not want to own interest in a company led by someone whose judgment is now seeming so clouded.
Think Dennis Koslowski, Michael Millken, Ivan Boesky, et al. Things just seem to go badly when corporate titans wander into the public eye too prominently. None of those companies fared well as their leaders came under scrutiny.
Pete Peterson plans to retire as Chairman of Blackstone. Nobody really knows Larry Fink. Maybe they should gently nudge Schwarzman aside and let Fink become the lower-key, more kindly persona of the firm?
Finally, we come to the tax code aspect. This article describes the current tax situation for private equity partnerships, and proposed tax code changes.
My business partner and I discussed this yesterday over lunch. The reality of the tax code is that it is a collection of special-interest loopholes. Various industries get pilloried, or coddled, depending upon the year, the party in power in Congress, and economic conditions. Think about pharma, oil, 'high tech,' now private equity.
It's understandable that private equity partnerships should enjoy a capital gains treatment of their carried interest in risky buyout-and-turnarounds. However, if that includes paying lower rates on fairly quick payouts of 'special dividends' and operating profits of their owned operating units, then it's less clear that this is 'fair' to begin with.
It's unclear to me, as I write this post this morning, whether or not such special cashflows are shared by limited private equity 'partners,' i.e., investors, or only by the master partners. If it's the latter, then I would have less of a problem with the particular taxation of such income at shorter-term rates.
I don't condone Congress using Schwarzman's personal lifestyle and financial situation as a reason to "get" all private equity firm partners and their wealth. That's capricious, confiscatory, and symptomatic of class warfare. We don't need that. It is, in fact, antithetical to the whole basis of the American Dream- work hard, get rich.
For Congress to decide this month that some people who have succeeded must now be penalized, is extremely discomforting.
By the way, while I'm on the topic, does anyone else recall the last time Congress legislated its righteous indignation at another corporate excess? CEO compensation?
Remember when Congress became so critical of CEOs who earned large cash compensation that they imposed a special tax rate for salaries above $1MM?
The result was to pay CEOs with ....... stock options! Yes, the now-discredited compensation scheme that was spawned by Congressional ineptitude and jealousy.
Fact is, as Lloyd Blankfein, Goldman Sachs CEO, opined on CNBC this morning, tax code changes should be carefully considered by Congress before being enacted. Knee-jerk, envy-based changes will have serious consequences.
What Blankfein didn't explicitly say, but implied, was this. Who do you think is, on average, smarter- the average Wall Street/private equity partnership CEO, or a US Congressman or Senator?
Right. Nobody really smart stays in politics for long. So you have a bunch of basically mediocre, average-intelligence, at best, Congressmen and Senators enacting legislation, to be subsequently outwitted by some of America's most intelligent, best-educated and experienced minds.
The same thing happens every election cycle with campaign finance so-called "reform."
The ill-considered changes in the tax code for private (equity) partnerships will be no different.
Will such changes in the tax code trigger a private equity pullback, and, correspondingly, a public equity market value meltdown? The next market collapse, with attendant domino effect on asset values, buying behavior among average Americans, and, finally, economic recession?
Possibly. If it does, figure on a radical change in the political landscape in the runup to the 2008 Presidential and Congressional elections.
However, my guess is that it won't trigger such apocalyptic consequences. More likely, it will result in a higher hurdle rate for deals, a slowdown in their pace, and a gradual cooling off of the private equity deal frenzy.
However, nobody really knows. This particular focusing event, the Blackstone IPO, is fast becoming the transformational event in the longish journey of private equity firms as they emerge from their shadowy world of truly private activity, into the glaring light of publicly-traded interests.
One final observation. It's noteworthy that, despite the enormous financial and political stakes involved, pretty much everyone is fated to behave in their 'real' fashion, despite how it plays out in public.
Schwarzman is seen as a callous, ruthless financial titan, insensitive to how his actions affect public and political reactions to them. He is fast-becoming the lightning rod for legislative action to punish wealthy capitalists like him.
Henry Waxman appears as the power-hungry socialist he is, attempting to interject himself into the Blackstone IPO process, via an appeal to the SEC, with no basis for it. With any luck, his antics will attract sufficient attention to shift control of either or both Houses of Congress in two more years.
Investors are, even now, at 9:36am, feverishly bidding to own an uncontrollable, non-voting share of a pig in a poke. Sometime further down the road, when the nth private equity partnership sells public interest shares, there will be a fiasco of some sort, and perpetrators will be accused and convicted in the press and Congress long before anyone is indicted and brought to trial.
Some things never change, do they?
Thursday, June 21, 2007
Web Radio Tries To Go Mobile
Monday's Wall Street Journal carried a piece describing how web-based radio is now aiming to go mobile, rivaling XM and Sirius.
According to the article,
"Unlike satellite radio, Internet radio offers the potential for greater personalization without the cost of monthly subscriptions or satellite receivers."
Additionally, it notes that Internet radio uses stored program material which is 'pushed' down to the receivers. That makes it essentially a playlist of songs.
So, unlike XM and Sirius, or most 'radio,' Internet radio doesn't have a "live" component. It's just a unique mix of music, or other program material. Call me old-fashioned, but when I think of "radio," I think of news, live voices/commentary, and maybe some weather and traffic.
Internet "radio" is really just another digital music download method which can play through your radio.
How does this differ from my nearly-limitless capacity iPod?
From my limited experience with Internet radio through my PC, I know it can be soothing and enjoyable to listen to a stream of pre-programmed tunes while working. But I would not envision paying for that type of pablum on a hand-held receiver, or in my car.
Further, using those Internet radio stations prevents me from hearing other audio on my PC.
Unless I'm mistaken, XM and Sirius are, or were, trying to merge, because the market for their services hasn't been growing sufficiently quickly to give their business model a reasonable chance for profitability anytime soon.
Now we have an ostensibly cheaper, less value-added version, Internet radio, which is simply a glorified playlist.
I know there is at least one MP3 player, Sansa Connect, about which I wrote here, that allows 'rental' of music, pushed via WiFi. And I can always buy music for 99 cents per track from iTunes, and use my iPod. With the addition of a relatively inexpensive wireless accessory, or an older-technology cassette-based adapter, I can listen to my iPod in my car.
So, remind me why I want to buy another expensive electronic device, and probably pay a monthly fee, in order to have yet another collection of music, and process to learn. But I don't actually own the music.
As I opined in my Sansa Connect post, perhaps it's just that I'm not the target market for Internet radio. However, it really doesn't seem to add much more to my life than another method of downloading music to a portable digital player. Doesn't almost everyone now have access to a PC, high-speed access, and iTunes?
Who needs Internet "radio," when it's really just another means of playing digital music.
According to the article,
"Unlike satellite radio, Internet radio offers the potential for greater personalization without the cost of monthly subscriptions or satellite receivers."
Additionally, it notes that Internet radio uses stored program material which is 'pushed' down to the receivers. That makes it essentially a playlist of songs.
So, unlike XM and Sirius, or most 'radio,' Internet radio doesn't have a "live" component. It's just a unique mix of music, or other program material. Call me old-fashioned, but when I think of "radio," I think of news, live voices/commentary, and maybe some weather and traffic.
Internet "radio" is really just another digital music download method which can play through your radio.
How does this differ from my nearly-limitless capacity iPod?
From my limited experience with Internet radio through my PC, I know it can be soothing and enjoyable to listen to a stream of pre-programmed tunes while working. But I would not envision paying for that type of pablum on a hand-held receiver, or in my car.
Further, using those Internet radio stations prevents me from hearing other audio on my PC.
Unless I'm mistaken, XM and Sirius are, or were, trying to merge, because the market for their services hasn't been growing sufficiently quickly to give their business model a reasonable chance for profitability anytime soon.
Now we have an ostensibly cheaper, less value-added version, Internet radio, which is simply a glorified playlist.
I know there is at least one MP3 player, Sansa Connect, about which I wrote here, that allows 'rental' of music, pushed via WiFi. And I can always buy music for 99 cents per track from iTunes, and use my iPod. With the addition of a relatively inexpensive wireless accessory, or an older-technology cassette-based adapter, I can listen to my iPod in my car.
So, remind me why I want to buy another expensive electronic device, and probably pay a monthly fee, in order to have yet another collection of music, and process to learn. But I don't actually own the music.
As I opined in my Sansa Connect post, perhaps it's just that I'm not the target market for Internet radio. However, it really doesn't seem to add much more to my life than another method of downloading music to a portable digital player. Doesn't almost everyone now have access to a PC, high-speed access, and iTunes?
Who needs Internet "radio," when it's really just another means of playing digital music.
Wednesday, June 20, 2007
GE's & Pearson's Reported Bid for the Wall Street Journal
It's hard to know just where to begin this post. It has so many interesting angles.To begin with, let's take a look at this Yahoo-sourced price chart (click on the chart to view a larger version) for Pearson, LLC, GE, Dow Jones, and the S&P500 for the past five years. Ironically, of the three companies, Pearson has had the best five-year record of stock price performance (which I'm using here as a quick proxy for total returns), followed by GE and Dow Jones.
Even with Dow Jones' recent uptick in price, due exclusively to the acquisition offer by Rupert Murdoch (discussed here), it still badly trails the S&P. As does GE, despite its recent runup. The latter's price gains, by the way, are confined to about three weeks in the past five years, all of those weeks being in the past three months. If anything, it could well be some institutional investors pre-positioning for an eventual GE breakup.However, back to the subject of the Dow Jones offer. Last month, I wrote, in part, in that linked post,
"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."
Seen from this perspective, my own analysis of the recently-revealed GE-Pearson plans for a joint takeover of Dow Jones is as follows.
First, as the Wall Street Journal article published yesterday noted, most M&A deals are done from weakness, not strength. This one is no exception. Dow Jones isn't courting any suitors.
Rather, Murdoch wants the world's premier business print news brand to fuel his multimedia plans for the business news sector.
As such, it's difficult to see what Pearson adds, because it is a print publisher. In fact, according to various sources, its shareholders have rewarded it for reducing emphasis on its Financial Times unit. In fact, it's no accident that Pearson and Dow Jones both lag the S&P. Expensive, print-based business news organizations in the multimedia, YouTube and cable world, are just waiting to be cannibalized via Schumpeterian dynamics.
Now we turn to GE. Where to start? Here's a company that can't get out of its own way to reward investors with consistently superior returns for nearly six years under CEO Jeff Immelt. Now, it wants to form a closely-held joint venture with a European-based company, to merge print businesses.
What flavor of Kool-Aid are they drinking over at GE and NBC/Universal these days? You've got different social cultures, plus business cultures to merge, and a third-party entity to form, answering, one presumes to both parents.
Yeah. That's a surefire recipe for success. What Immelt's merry band can't manage with their own, wholly-owned assets, they will now fix by sharing a completely new business with a third party partner. Oh, and did I mention that the nascent bid is reported to allow for the Bancrofts to continue as minority shareowners?
Yes, that's going to make running or eventually disposing of the unit a lot simpler! Right!
Here's where the part about merging/acquiring from weakness comes in. The only reason GE is doing this is to try to keep The Wall Street Journal out of Murdoch's hands. Everyone knows that Murdoch wants that brand to fuel his imminent cable business news channel. What better brand name to use than "The Wall Street Journal News Channel," or somesuch moniker?
Ironically, whereas Murdoch pledges to invest in The Wall Street Journal, should he buy the parent company, most observers are fairly sanguine about the need for Pearson and GE to cut costs at Dow Jones in order to justify their bid. So not only are the two companies conglomerating an expensive new asset, but they plan to gut it while they attempt to manage it with some sort of trans-Atlantic management structure.
Will GE/Pearson get a credible bid together, and/or win Dow Jones? I have no idea. I will offer this insight, though. If they are successful in acquiring Dow Jones and, thus, The Wall Street Journal, look for it to be a financial non-event, at best, and failure, at worst, over the next decade.
Here's a funny little aspect of media businesses that seems to have escaped everyone. Everyone except, I am guessing, Rupert Murdoch. The key assets walk out of the door each night. Or email their work in from assignments each day.
If GE/Pearson buys Dow Jones, look for Murdoch to spend richly to buy a list of key Wall Street Journal talent, and distribute their well-regarded efforts via his multimedia empire.
Ironically, if GE were to spin NBC/Universal to shareholders, then it could cleanly pursue the Dow Jones acquisition as a media pure play, dispensing with the complexity of the Pearson angle. Perhaps even sell CNBC to Murdoch, and let him have Dow Jones, too, while reaping an enormous profit on the sale.
As with so much Jeff Immelt has touched since he became CEO of GE in late 2001, I think this business move will fail to lift the company's total returns to a consistently superior performance, relative to the S&P500. At best, it will prop up NBC/Universal, which may, when the unit is spun off under Immelt, or as part of a private equity de-conglomeration of GE, fetch a better price. But it's unlikely to be worth the price paid, especially if it leaves the Bancroft's with a say in management or editorial affairs.
Tuesday, June 19, 2007
Yahoo Finally Admits Failures
Yesterday's shuffling of senior officers at Yahoo, beginning with Terry Semel's departure, is long overdue. As long ago as last summer, in this post, I wrote of the company's lack of strategic direction, including Semel's ability to even correctly describe his firm's need for 'strategic planning.'
Since that time, I've written several other pieces about the firm's travails. You can locate the most recent ones by clicking on the label "Yahoo," among the listed topics on the side of the main page of this blog.
As this, ironically, Yahoo-sourced chart displays, the past two years have been abysmal ones for that firm. Especially compared to Google. What clearly meets the eye is how the S&P500 easily outperforms Yahoo, with Google far above it. With its long experience in online businesses, you have to wonder how Yahoo squandered its early brand awareness.I continue to contend, as I did in this post, from March of this year, that Yahoo has never successfully identified just what it offers that can command a sustainable price in the online marketplace.
Now, Semel has stepped down, and co-founder Jerry Yang has assumed the CEO title. As my partner said, when I mentioned it,
"yeah, that's going to work."
Doesn't it always? Chuck Schwab at his firm, or Ted Waite at Gateway Computer. Oh, right, and another computer maker, Dell, with Michael Dell returning to its helm.
Whether recent-hire, and newly-appointed President of Yahoo, CFO Susan Decker, will actually make a difference, is questionable. Some analysts believe she is only going to need to be open to a sale or merger, in order to effectively discharge her new responsibilities. Perhaps so.
I'm sure there will be lots of press about Microsoft/Yahoo or AOL/Yahoo mergers. And maybe one of them will even occur.
To me, however, the most likely epitaph for Yahoo is that it remained the used car of the online world for too long, wasting its early, premier position in so many nascent areas. Now, I believe Schumpeterian dynamics have overtaken it, rendering it a largely has-been collection of concepts, technologies and online information offerings. If they haven't managed to collect revenues for most of this by now, thus setting expectations of free services, what makes you think someone else can do better without losing visitors, resulting in continued problems achieving profitable growth and, with it, consistently superior total returns?
Hello Atlanta
The Sitemeter counter on the bottom of my main blog page provides me with some rather detailed information. While I never record them, individual IP numbers for each visitor are shown, along with the IP provider, web browser, computer operating system, time, date of visit, length, number of pages read, entry page, and a few other items.
That's how I know that someone from Home Depot's Atlanta HQ visits my blog every morning between 7 and 8AM.
I'm guessing that, due to the stream of posts I wrote about the ailing firm while it suffered under mediocre management by Bob Nardelli, someone in the public relations function is tasked with monitoring my blog, among others which have featured the firm.
It may even be an automated blog crawler, as my partner suggests, rather than a live human.
Either way, this post is for you, Home Depot.
As Nardelli's exit has partially removed the spotlight from your firm, it's quite possible that it may be months before I write about your firm again. Most of the interest was in comparing the egregious behavior of Nardelli with his inability to operate Home Depot in a manner which earned consistently superior total returns for shareholders. Something it actually had done for years prior to his arrival. In fact, in those days, I owned and profited from owning the company's stock. I wrote a post about it, here, last July.
However, if Frank Blake would like to know what I know about what level and patterns of operating performances will increase the probabilities that Home Depot's stock will consistently outperform the S&P500, I'd be happy to share my proprietary knowledge with him.
Although I now use my proprietary research for equity portfolio management, it was, in fact, originally developed as a knowledge transfer product. It has been applied to one large financial institution whose then-CEO is, even now, a well-known figure in US business circles. As I did with that firm's senior executives, I am quite sure I can help Blake and his colleagues understand what sort of fundamental operating performances are likely to lead to Home Depot's return to consistently superior total return performances.
Just post a comment here with contact directions, and we can discuss the matter privately.
That's how I know that someone from Home Depot's Atlanta HQ visits my blog every morning between 7 and 8AM.
I'm guessing that, due to the stream of posts I wrote about the ailing firm while it suffered under mediocre management by Bob Nardelli, someone in the public relations function is tasked with monitoring my blog, among others which have featured the firm.
It may even be an automated blog crawler, as my partner suggests, rather than a live human.
Either way, this post is for you, Home Depot.
As Nardelli's exit has partially removed the spotlight from your firm, it's quite possible that it may be months before I write about your firm again. Most of the interest was in comparing the egregious behavior of Nardelli with his inability to operate Home Depot in a manner which earned consistently superior total returns for shareholders. Something it actually had done for years prior to his arrival. In fact, in those days, I owned and profited from owning the company's stock. I wrote a post about it, here, last July.
However, if Frank Blake would like to know what I know about what level and patterns of operating performances will increase the probabilities that Home Depot's stock will consistently outperform the S&P500, I'd be happy to share my proprietary knowledge with him.
Although I now use my proprietary research for equity portfolio management, it was, in fact, originally developed as a knowledge transfer product. It has been applied to one large financial institution whose then-CEO is, even now, a well-known figure in US business circles. As I did with that firm's senior executives, I am quite sure I can help Blake and his colleagues understand what sort of fundamental operating performances are likely to lead to Home Depot's return to consistently superior total return performances.
Just post a comment here with contact directions, and we can discuss the matter privately.
Monday, June 18, 2007
GM's Union Negotiations
According to Thursday's Wall Street Journal, GM is once again in negotiations with the UAW to try to solve its profitability problems on the backs of its blue-collar labor force.
I know, it sounds like I'm some sort of Debsian liberal. But I'm not. I actually happen to believe that the responsibility for Detroit's auto makers' mess is management's, not union's.
As I wrote in one of my first posts on this blog, here,
"Why did unions ever begin taking future pension contributions from the companies for which their members worked, instead of cash compensation?
When you think about it, some of those company CEOs of yesteryear were deceptively brilliant. They managed to get unsecured loans, in the form of future pension “obligations,” from the unions representing their workers. No bank would have lent the same sums on the same terms for the same prices. That’s because, ultimately, companies have much more latitude with which to discharge or change their pension obligations in bankruptcy than they have to escape a group of angry, unified, legally-empowered financial creditors in the same situation
In hindsight, “defined benefit” plans of any type or name, public or private, are a clever way for a public corporation or a government to fund operations with implicit loans. For big steel, autos and airlines, as well as other labor-intensive sectors in the ‘50s, ‘60s and later, this amounted to labor union members lending, via unsecured future compensation and fringe benefit promises from their employers, sums of money for which they had no collateral. Financial engineering which puts modern investment bankers to shame.
Where is the expose on the union leaders who foolishly negotiated, on behalf of their members, to accept unsecured IOUs from companies on terms that the companies’ banks would never have lent them the money?"
As I read the Journal article, what I see is further futility in the actions of all parties. Management attempting to close its cost gap with competitors mainly through cutting its employees' compensations. Union leaders breaking their organization into tiers, so that older members get higher compensation, while sacrificing newer workers, to preserve union membership and jobs. A very French-style, Faustian bargain.
Don't get me wrong. I think the union wage scale has remained stuck at an unsustainably high lever, with respect to the value now added in the manufacture of Detroit products. It's just a little sad to watch even the union leaders sacrifice their own members for the leaders' political aspirations of remaining head of a large union, when the number of members should be declining, with the value of output, and the number of employees necessary to create that output.
Looks like business as usual in Detroit this summer, all the way 'round.
I know, it sounds like I'm some sort of Debsian liberal. But I'm not. I actually happen to believe that the responsibility for Detroit's auto makers' mess is management's, not union's.
As I wrote in one of my first posts on this blog, here,
"Why did unions ever begin taking future pension contributions from the companies for which their members worked, instead of cash compensation?
When you think about it, some of those company CEOs of yesteryear were deceptively brilliant. They managed to get unsecured loans, in the form of future pension “obligations,” from the unions representing their workers. No bank would have lent the same sums on the same terms for the same prices. That’s because, ultimately, companies have much more latitude with which to discharge or change their pension obligations in bankruptcy than they have to escape a group of angry, unified, legally-empowered financial creditors in the same situation
In hindsight, “defined benefit” plans of any type or name, public or private, are a clever way for a public corporation or a government to fund operations with implicit loans. For big steel, autos and airlines, as well as other labor-intensive sectors in the ‘50s, ‘60s and later, this amounted to labor union members lending, via unsecured future compensation and fringe benefit promises from their employers, sums of money for which they had no collateral. Financial engineering which puts modern investment bankers to shame.
Where is the expose on the union leaders who foolishly negotiated, on behalf of their members, to accept unsecured IOUs from companies on terms that the companies’ banks would never have lent them the money?"
As I read the Journal article, what I see is further futility in the actions of all parties. Management attempting to close its cost gap with competitors mainly through cutting its employees' compensations. Union leaders breaking their organization into tiers, so that older members get higher compensation, while sacrificing newer workers, to preserve union membership and jobs. A very French-style, Faustian bargain.
Don't get me wrong. I think the union wage scale has remained stuck at an unsustainably high lever, with respect to the value now added in the manufacture of Detroit products. It's just a little sad to watch even the union leaders sacrifice their own members for the leaders' political aspirations of remaining head of a large union, when the number of members should be declining, with the value of output, and the number of employees necessary to create that output.
Looks like business as usual in Detroit this summer, all the way 'round.
Friday, June 15, 2007
GE To Become A Public/Private Equity Shop
In an attempt to justify GE's existence as a conglomerate, its CEO, Jeff Immelt, announced today that, henceforth, he would transform GE into a public/private equity enterprise.
"If Steve Schwarzman (Blackstone CEO) can go public with its portfolio of operating businesses, then I can take GE into the private equity game," Immelt was quoted as saying.
Tiring of getting "no respect," and feeling like "the Rodney Dangerfield of CEOs," Immelt has decided to spin off his entire business portfolio, while buying ailing units of other firms.
"We're going to show the world, and our investors, that GE's vaunted management system is the best in the world. We can take a corporate sow's ear and make it into the proverbial business silk purse, then spin it back to the public, just like Blackstone, KKR, and TPG," Immelt declared.
Regarded for decades as one of the two most influential incubators of US corporate management talent, along with Proctor & Gamble, GE has been known for training generations of financially-oriented managers who have gone on to lead other American corporations. Not, mind you, always to consistently superior total returns. But lead, nonetheless, complete with comfortable compensation packages.
As such, Immelt intends to convert GE into a sort of managerial competence "pure play." According to pundits and analysts, Immelt intends to put every manager in GE's new acquisitions through its storied Crotonville 're-education' center, in order to remake them as fully-trained, GE-style managers.
Immelt, tired of the heckling of numerous analysts and bloggers, declared,
"We're going to prove to investors, analysts, bloggers, and the public, that GE managers can manage anything well. If private equity shops can buy on the cheap and fix businesses, so can we. And to prove it, I'm starting with a clean slate of operating businesses."
To be sure, it's a novel approach. But, then, nothing else Immelt has done has delivered consistently superior returns for his shareholders. They would have been far better off selling their GE stock upon Immelt's elevation to CEO, and simply buying and holding the S&P500.
In a related story, GE's board was reportedly raising Immelt's compensation for 2008 to approximately $800MM. A spokesperson for the board noted that Blackstone's Schwarzman had received some $700MM from his company's IPO, and, thus, the CEO of a public 'private equity' shop, as GE's Immelt has reclassified his company, ought to be worth the same, if not a little more.
CNBC said it would not be interviewing Immelt on this latest compensation-related development. Not, at least, until NBC/Universal has been spun off to shareholders.
(The preceding piece is intended as humor. None of the quotes are factual. However, given Immelt's insistence on running a conglomerate, it may well be that the only way he can avoid penalizing GE shareholders with a discount to net asset values is to transform GE into the only type of successful conglomerates on the American business scene today- private equity firms.)
"If Steve Schwarzman (Blackstone CEO) can go public with its portfolio of operating businesses, then I can take GE into the private equity game," Immelt was quoted as saying.
Tiring of getting "no respect," and feeling like "the Rodney Dangerfield of CEOs," Immelt has decided to spin off his entire business portfolio, while buying ailing units of other firms.
"We're going to show the world, and our investors, that GE's vaunted management system is the best in the world. We can take a corporate sow's ear and make it into the proverbial business silk purse, then spin it back to the public, just like Blackstone, KKR, and TPG," Immelt declared.
Regarded for decades as one of the two most influential incubators of US corporate management talent, along with Proctor & Gamble, GE has been known for training generations of financially-oriented managers who have gone on to lead other American corporations. Not, mind you, always to consistently superior total returns. But lead, nonetheless, complete with comfortable compensation packages.
As such, Immelt intends to convert GE into a sort of managerial competence "pure play." According to pundits and analysts, Immelt intends to put every manager in GE's new acquisitions through its storied Crotonville 're-education' center, in order to remake them as fully-trained, GE-style managers.
Immelt, tired of the heckling of numerous analysts and bloggers, declared,
"We're going to prove to investors, analysts, bloggers, and the public, that GE managers can manage anything well. If private equity shops can buy on the cheap and fix businesses, so can we. And to prove it, I'm starting with a clean slate of operating businesses."
To be sure, it's a novel approach. But, then, nothing else Immelt has done has delivered consistently superior returns for his shareholders. They would have been far better off selling their GE stock upon Immelt's elevation to CEO, and simply buying and holding the S&P500.
In a related story, GE's board was reportedly raising Immelt's compensation for 2008 to approximately $800MM. A spokesperson for the board noted that Blackstone's Schwarzman had received some $700MM from his company's IPO, and, thus, the CEO of a public 'private equity' shop, as GE's Immelt has reclassified his company, ought to be worth the same, if not a little more.
CNBC said it would not be interviewing Immelt on this latest compensation-related development. Not, at least, until NBC/Universal has been spun off to shareholders.
(The preceding piece is intended as humor. None of the quotes are factual. However, given Immelt's insistence on running a conglomerate, it may well be that the only way he can avoid penalizing GE shareholders with a discount to net asset values is to transform GE into the only type of successful conglomerates on the American business scene today- private equity firms.)
Thursday, June 14, 2007
Blackstone's IPO Underwriting Strategy: Silence The Street
"Bribe" is an ugly word. So I'm not going to use it again in this post.
I read yesterday that Blackstone has employed 17 Wall Street investment banking houses in its IPO process. Even, according to the Wall Street Journal article by 'breakingviews.com,' Goldman Sachs. The latter was originally snubbed for having worked on another private equity shop's IPO.
Additionally, it is alleged that Chase was allowed in, despite its having backed a competing bidder for Equity Office Properties, a recent Blackstone purchase.
To quote the Journal article,
"But perhaps Blackstone has another motive. By bringing everyone on board, it may keep criticism of its trumpeted $33 billion-plus valuation at a minimum. This is particularly important for, say, Goldman, whose own stock trades at a whopping price-to-earnings discount to Blackstone's implied valuation.
Yet, behind closed doors, it's widely believed that those who publicly criticize Blackstone's value won't be invited to sell its IPO. Looks like Wall Street opted to keep its collective mouth shut."
You think?
This is unquestionably the motive for Blackstone's hoovering up any party whose credible scepticism about its IPO valuation might cause investors to balk. The effect is to mute all sell-side criticism. Then you have the unstated silence of anybody else with a trading desk, who hopes to broker any of Blackstone's order volume in this lifetime.
You can search my blog for posts on Blackstone's IPO. For starters, however, read this one, from April.
In this post, I wrote,
"What I find amazing, however, is that investors are lining up to buy shares of an entity in which they can't even measure risk levels. Essentially, they are buying income 'participation shares,' much like I advocated last year in this post regarding corporate governance and takeovers. But, rather than retaining interest in a previously-public firm, they are buying the equivalent of a blind pool.
In a very real sense, Schwarzman has created the best of both worlds- retaining total control and privacy of operations, while establishing a value for the firm, and cashing out while doing it.
Honestly, I have even more respect for him now than I did before. Not that I would be on the other end of an equity transaction from him. And, correspondingly, I have less respect for the investors who buy the Blackstone IPO shares."
I can only reiterate my earlier sentiments. As I said to my partner over lunch yesterday,
"Who would be foolish enough to be on the other side of an equity deal from Goldman or Blackstone?"
I own Goldman in my equity portfolio now. But I only bought it in January, not as an IPO. As such, it is market-valued now, not seller-valued.
With all the hoopla on Capitol Hill this week regarding new taxes for carried interest income in private equity deals, and Schwarzman's $700+MM payday, and $7B interest in Blackstone, the real danger is overlooked.
I contend it is this pervasive, collaborative silence on Wall Street, as it collectively abets Blackstone in valuing its IPO.
Alas, no amount of legislation will ever remedy this. No, for this, we have to trust people to use their common sense. To think.
And that brings me to an old story about the former Governor and Senator from my home state of Illinois, Adlai Stevenson.
When running in one of his campaigns for President against Eisenhower, it is said that Stevenson was approached by a woman who gushed,
"Governor, you have the vote of every thinking American."
Stevenson, perhaps apocryphally, is said to have replied,
"Oh, Madam, I'll need many more votes that that to win the election."
Caveat Emptor, indeed!
I read yesterday that Blackstone has employed 17 Wall Street investment banking houses in its IPO process. Even, according to the Wall Street Journal article by 'breakingviews.com,' Goldman Sachs. The latter was originally snubbed for having worked on another private equity shop's IPO.
Additionally, it is alleged that Chase was allowed in, despite its having backed a competing bidder for Equity Office Properties, a recent Blackstone purchase.
To quote the Journal article,
"But perhaps Blackstone has another motive. By bringing everyone on board, it may keep criticism of its trumpeted $33 billion-plus valuation at a minimum. This is particularly important for, say, Goldman, whose own stock trades at a whopping price-to-earnings discount to Blackstone's implied valuation.
Yet, behind closed doors, it's widely believed that those who publicly criticize Blackstone's value won't be invited to sell its IPO. Looks like Wall Street opted to keep its collective mouth shut."
You think?
This is unquestionably the motive for Blackstone's hoovering up any party whose credible scepticism about its IPO valuation might cause investors to balk. The effect is to mute all sell-side criticism. Then you have the unstated silence of anybody else with a trading desk, who hopes to broker any of Blackstone's order volume in this lifetime.
You can search my blog for posts on Blackstone's IPO. For starters, however, read this one, from April.
In this post, I wrote,
"What I find amazing, however, is that investors are lining up to buy shares of an entity in which they can't even measure risk levels. Essentially, they are buying income 'participation shares,' much like I advocated last year in this post regarding corporate governance and takeovers. But, rather than retaining interest in a previously-public firm, they are buying the equivalent of a blind pool.
In a very real sense, Schwarzman has created the best of both worlds- retaining total control and privacy of operations, while establishing a value for the firm, and cashing out while doing it.
Honestly, I have even more respect for him now than I did before. Not that I would be on the other end of an equity transaction from him. And, correspondingly, I have less respect for the investors who buy the Blackstone IPO shares."
I can only reiterate my earlier sentiments. As I said to my partner over lunch yesterday,
"Who would be foolish enough to be on the other side of an equity deal from Goldman or Blackstone?"
I own Goldman in my equity portfolio now. But I only bought it in January, not as an IPO. As such, it is market-valued now, not seller-valued.
With all the hoopla on Capitol Hill this week regarding new taxes for carried interest income in private equity deals, and Schwarzman's $700+MM payday, and $7B interest in Blackstone, the real danger is overlooked.
I contend it is this pervasive, collaborative silence on Wall Street, as it collectively abets Blackstone in valuing its IPO.
Alas, no amount of legislation will ever remedy this. No, for this, we have to trust people to use their common sense. To think.
And that brings me to an old story about the former Governor and Senator from my home state of Illinois, Adlai Stevenson.
When running in one of his campaigns for President against Eisenhower, it is said that Stevenson was approached by a woman who gushed,
"Governor, you have the vote of every thinking American."
Stevenson, perhaps apocryphally, is said to have replied,
"Oh, Madam, I'll need many more votes that that to win the election."
Caveat Emptor, indeed!
Wednesday, June 13, 2007
Private Equity Meets The MBA
Yesterday's Wall Street Journal carried a piece about private equity and MBA schools in its Career Journal section.
Where to begin? Perhaps with the question,
"Have these already questionable educational programs absolutely no shame?"
As I have written recently, here, and less recently, here, here, and here, the once-vaunted MBA is already, in my opinion, a shadow of its former self. Between more mediocre talent pools, teaching ranks stretched more thinly as more schools offer the degree, and a shift in focus to 'soft skills,' it's become a mere trade school certificate.
However, today's Journal article shocked even me. The gist of the piece is that MBA schools are angling to get more of their new grads into the lucrative private equity firms. They are trying to set up co-taught courses, using retired private equity partners. Trying to make contacts for mainlining their grads into the firms.
At this point, let's have a brief reality check. Private equity firms are, by and large, composed of very experienced, once-senior executives in publicly-held companies, who realized they could do better managing and fixing some businesses without the glare of shareholders and required SEC filings. They hire, for the most part, similarly-seasoned managers to actually work on and improve the businesses they buy. Then they spin them back out for the profit.
Where, in the model, besides ordering take-out for delivery late at night, or perhaps scheduling car services for the late-night workers on the various acquisitions, is there room for newly-minted, inexperienced young MBAs?
Didn't we all learn from the consulting sector that, ultimately, customers wise up to being read rehashed B-school platitudes from fresh-faced young things with MBAs? Last I looked, McKinsey, Booz Allen, and most of their ilk had much reduced circumstances and reputations, as their customers began to catch on.
So, now, the MBA mills are training their sights on private equity firms?
This is either about to be comical, or tragic. Comical, because PE firms are the real McCoys of smart, no-nonsense capitalists. Tragic, if some of those firms actually buy this line, and begin hiring novices to ply their ultra-profitable trade.
Not to mention, again, as in this post, that so much of what private equity does is simply better, faster implementation of the classic lessons of old-style, non-soft skill MBA and BS in BA programs. It's not so much the insights, as it is the experience of knowing just what to do, when, in which situations.
At some point, there actually are jobs that require experience, not simply a newly-minted degree from the right school.
It should be interesting to see if this story has legs, and we learn, in a year or so, that there is, indeed, an influx of newly-graduated MBAs into the sector. And what effect they are having on their employers.
On that note, one last word of warning. Back in the day, when I was a young MBA myself, a little outfit called Atari ruled the newly-digitizing world. I don't recall the exact number, but one year, something like 25% of the Harvard Business School's graduates went to work there. The next year, 1984, Atari, then a unit of Warner Brothers, and a victim of overheated expansion and loss of control over the company's strategic direction, was, in large part, sold to Jack Trarmiel. Upon this ignominious event, one wag commented that it should be a signal to the market that anytime a company begins hiring that large a portion of HBS's graduating class, it's time to dump the company's shares.
Last year, 11% of the HBS class went to work in private equity companies.
Where to begin? Perhaps with the question,
"Have these already questionable educational programs absolutely no shame?"
As I have written recently, here, and less recently, here, here, and here, the once-vaunted MBA is already, in my opinion, a shadow of its former self. Between more mediocre talent pools, teaching ranks stretched more thinly as more schools offer the degree, and a shift in focus to 'soft skills,' it's become a mere trade school certificate.
However, today's Journal article shocked even me. The gist of the piece is that MBA schools are angling to get more of their new grads into the lucrative private equity firms. They are trying to set up co-taught courses, using retired private equity partners. Trying to make contacts for mainlining their grads into the firms.
At this point, let's have a brief reality check. Private equity firms are, by and large, composed of very experienced, once-senior executives in publicly-held companies, who realized they could do better managing and fixing some businesses without the glare of shareholders and required SEC filings. They hire, for the most part, similarly-seasoned managers to actually work on and improve the businesses they buy. Then they spin them back out for the profit.
Where, in the model, besides ordering take-out for delivery late at night, or perhaps scheduling car services for the late-night workers on the various acquisitions, is there room for newly-minted, inexperienced young MBAs?
Didn't we all learn from the consulting sector that, ultimately, customers wise up to being read rehashed B-school platitudes from fresh-faced young things with MBAs? Last I looked, McKinsey, Booz Allen, and most of their ilk had much reduced circumstances and reputations, as their customers began to catch on.
So, now, the MBA mills are training their sights on private equity firms?
This is either about to be comical, or tragic. Comical, because PE firms are the real McCoys of smart, no-nonsense capitalists. Tragic, if some of those firms actually buy this line, and begin hiring novices to ply their ultra-profitable trade.
Not to mention, again, as in this post, that so much of what private equity does is simply better, faster implementation of the classic lessons of old-style, non-soft skill MBA and BS in BA programs. It's not so much the insights, as it is the experience of knowing just what to do, when, in which situations.
At some point, there actually are jobs that require experience, not simply a newly-minted degree from the right school.
It should be interesting to see if this story has legs, and we learn, in a year or so, that there is, indeed, an influx of newly-graduated MBAs into the sector. And what effect they are having on their employers.
On that note, one last word of warning. Back in the day, when I was a young MBA myself, a little outfit called Atari ruled the newly-digitizing world. I don't recall the exact number, but one year, something like 25% of the Harvard Business School's graduates went to work there. The next year, 1984, Atari, then a unit of Warner Brothers, and a victim of overheated expansion and loss of control over the company's strategic direction, was, in large part, sold to Jack Trarmiel. Upon this ignominious event, one wag commented that it should be a signal to the market that anytime a company begins hiring that large a portion of HBS's graduating class, it's time to dump the company's shares.
Last year, 11% of the HBS class went to work in private equity companies.
Tuesday, June 12, 2007
The Market, She Be Confused
Roughly a year ago, in one of the earlier pieces on this blog, , "The Market, She Be Angry...," I commented on how analysts so often, mistakenly, anthropomorphize capital markets.
In part, I wrote,
"Despite the signs of investors waffling on the economy's health, Brian Wesbury commented that average mortgage interest rates are still a full point lower than they were during the last expansion. And the Fed is moving to ensure low, long-term inflation. Thus, there's no reason to expect the economy to suddenly sieze up and slide into a recession."
And that paragraph roughly fits today's market, too. This time, the S&P500 Index is down recently due to investor worries about inflation.
In the past week and a half, inflation worries have trimmed roughly 3 percentage points from the Index's year-to-date return, driving down to about 5.3%.
But, wait. Weren't investors worried only two months ago about global economic growth and weak earnings? Wasn't the last earnings announcement season a big surprise, accounting for the Index's more than 8 percentage points of gain in April and May?
So, in the space of something like 60 days, we apparently have investors moving from worries about too little growth, to worries about too much growth, too little liquidity, and rising inflation.
Which is it? Or is it even either one? Is it simply the usual case of many inept pundits and analysts misleading equally-naive investors?
That would be my bet. More heat than light, again. In fact, in each of the past three years, pundits have called a near-recession for later in the year, only to see investors push the index up by November, as low-inflation growth was confirmed by the fourth quarter.
What is disconcerting is how much of this misinterpretation of economic signals is repetitive, and, yet, goes unreported as such. The much heralded recessions have not materialized. Now, the much heralded inverted yield curve is normal, rather than inverted.
So, where's the celebration, now that the non-inverted yield curve should be signaling no recession? Instead, the pundits frown, note the possibility of a Fed rate hike, or less global liquidity with higher rates, and, thus, slowing growth.....and a recession.
I think we're seeing more confusion on the part of most market watchers, pundits, analysts, talking heads, etc. And even retired Fed Chairmen, albeit one who has a spotty record on forecasting equity prices.
When I see this amount of baseless, rapid change of thinking in the equity investor base, I pay it little heed for long term equity market trends.
In part, I wrote,
"Despite the signs of investors waffling on the economy's health, Brian Wesbury commented that average mortgage interest rates are still a full point lower than they were during the last expansion. And the Fed is moving to ensure low, long-term inflation. Thus, there's no reason to expect the economy to suddenly sieze up and slide into a recession."
And that paragraph roughly fits today's market, too. This time, the S&P500 Index is down recently due to investor worries about inflation.
In the past week and a half, inflation worries have trimmed roughly 3 percentage points from the Index's year-to-date return, driving down to about 5.3%.
But, wait. Weren't investors worried only two months ago about global economic growth and weak earnings? Wasn't the last earnings announcement season a big surprise, accounting for the Index's more than 8 percentage points of gain in April and May?
So, in the space of something like 60 days, we apparently have investors moving from worries about too little growth, to worries about too much growth, too little liquidity, and rising inflation.
Which is it? Or is it even either one? Is it simply the usual case of many inept pundits and analysts misleading equally-naive investors?
That would be my bet. More heat than light, again. In fact, in each of the past three years, pundits have called a near-recession for later in the year, only to see investors push the index up by November, as low-inflation growth was confirmed by the fourth quarter.
What is disconcerting is how much of this misinterpretation of economic signals is repetitive, and, yet, goes unreported as such. The much heralded recessions have not materialized. Now, the much heralded inverted yield curve is normal, rather than inverted.
So, where's the celebration, now that the non-inverted yield curve should be signaling no recession? Instead, the pundits frown, note the possibility of a Fed rate hike, or less global liquidity with higher rates, and, thus, slowing growth.....and a recession.
I think we're seeing more confusion on the part of most market watchers, pundits, analysts, talking heads, etc. And even retired Fed Chairmen, albeit one who has a spotty record on forecasting equity prices.
When I see this amount of baseless, rapid change of thinking in the equity investor base, I pay it little heed for long term equity market trends.
Monday, June 11, 2007
The New York Times Gives Jeff Immelt A Pass
New York Times writer Joe Nocera penned a long, fawning piece about Jeff Immelt, GE's CEO, in the paper's Saturday edition. My partner had mentioned it to me on Sunday morning, and sent me the article, knowing of my prior posts on GE and Immelt (search on either term, and/or click on the two labels on the side of the main page).
I wrote most recently on this topic here, and here. For the record, let me state my unequivocal belief that Immelt has failed in his richly-compensated role as GE's CEO for nearly six years. I believe that Immelt should go, as the company is spun into its constituent parts as standalone businesses. The firm no longer has an economic reason for being.
That said, let me quote some of the more outrageous passages from Mr. Nocera's Times piece,
“When you put your foot on the gas in this company,” Jeffrey R. Immelt said a few weeks ago, with just the slightest trace of a satisfied smile, “the car goes forward.”
Oh, and one other thing: the entire time he’s been chief executive, the stock hasn’t budged. (It closed yesterday at $37.32.) In April, Jeffrey T. Sprague, the Citigroup analyst, called for “a partial breakup” of G.E., arguing that the company’s “size and complexity is working against investor interest in the stock.” During Mr. Welch’s 20 years at the helm, G.E.’s stock had a staggering 7,000 percent total return, including dividends. If the company’s share price doesn’t start to rise soon, Wall Street is going to be agitating for more than a breakup.
Mr. Immelt seems pretty much at ease about that, too.
Mr. Immelt also felt that G.E. needed to do a better job at what is called “organic growth,” that is, growth that is not a result of acquisitions. So he had G.E. study companies that excelled at internal growth, like Apple and Toyota, quantified the qualities that those companies had in common, and began teaching them at General Electric. Now, Mr. Immelt has told Wall Street that he wants the company’s organic growth rate to be 8 percent a year, twice what it used to be.
Most C.E.O.s whose stock hasn’t moved in five years would be in a world of trouble, of course. And Mr. Immelt is not going to get his 20-year run if he can’t get the stock to move. But he’s still got plenty of time to show that his repositioning is working; Wall Street may be antsy, but no investor is crazy enough to call for his ouster. And he’s adamant that the solution is to wait for the market to catch up with the company’s changing nature, rather than to execute a partial breakup just to please the Street.
“Investors go through cycles where they don’t like conglomerates,” Mr. Immelt said. “But if you want to be a lasting company, you have to know how to be a multibusiness structure. If Google is going to be a 100-year-old company someday, it is going to have to learn to do more than search.”
Let me make a few points, by way of rebuttal.
First, my proprietary research has concluded that, in order to have a significantly above-average probability of earning consistently superior total returns, companies need to post real rates of revenue growth in excess of Immelt's goal of 8% per annum. Less than the rate I discovered, and the company will not be considered a consistently high-revenue growth firm. Earnings growth, by the way, is statistically unrelated to consistently superior total return performance.
So much for Jeff's foot on the accelerator helping shareholders enjoy consistently superior returns by holding GE stock.
Second, as I wrote in one of the linked posts recently,
"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."
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."
Thus, Immelt has actually broken the pattern of GE leadership through the ages by essentially changing virtually nothing. The firm has adapted to past eras, that is true. And this era is one of the continued de-conglomeration of American business. His sarcastic shots about Google to the contrary, Immelt's firm is too diversified to provide consistently superior returns to shareholders, because it's taxing them to feed an overgrown bureaucracy presided over by....none other than Chairman Jeff the First.
What Immelt fails to understand, in suggesting Google can't continue growing in its natural niches, is that every business undergoes a Schumpeterian life- and death- cycle. My guess is, Immelt is going to preside over GE's death.
Third, regarding Immelt's observation about investors "going through cycled where they don't like conglomerates" is a bit disingenuous. As I wrote in one of the linked posts above,
"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."
The era of growing, permanent corporate conglomerates is over, thanks to very efficient, large and deeply liquid capital markets. Markets so liquid that private equity firms can borrow to buy ailing business units of conglomerates, fix them, and spin them back out to the public. The only apparently consistently profitable "conglomerates" these days appear to be the large, multi-operating-unit private equity shops. But they don't seem to want to hold their businesses- just increase their value and flip them back to the public.
I question Nocera's trust that Immelt has 20 years to eventually re-ignite GE's total return performance. In Welch's day, the large private equity pools now common did not exist, and investors were far more patient.
Typically, it's been my experience that corporations, and their CEOs, cite 'soft' values and concepts when they simply can't earn consistently superior total returns for their shareholders. Even today, as Yahoo's Terry Semel came under assault for that company's abysmal performance under his tenure, Yahoo's corporate spokesperson recited a long list of non-quantitative 'accomplishments' under Semel's reign, carefully avoiding the clear record of financial failure.
Immelt is no different, nor are his supporters, such as Mr. Nocera.
I wrote most recently on this topic here, and here. For the record, let me state my unequivocal belief that Immelt has failed in his richly-compensated role as GE's CEO for nearly six years. I believe that Immelt should go, as the company is spun into its constituent parts as standalone businesses. The firm no longer has an economic reason for being.
That said, let me quote some of the more outrageous passages from Mr. Nocera's Times piece,
“When you put your foot on the gas in this company,” Jeffrey R. Immelt said a few weeks ago, with just the slightest trace of a satisfied smile, “the car goes forward.”
Oh, and one other thing: the entire time he’s been chief executive, the stock hasn’t budged. (It closed yesterday at $37.32.) In April, Jeffrey T. Sprague, the Citigroup analyst, called for “a partial breakup” of G.E., arguing that the company’s “size and complexity is working against investor interest in the stock.” During Mr. Welch’s 20 years at the helm, G.E.’s stock had a staggering 7,000 percent total return, including dividends. If the company’s share price doesn’t start to rise soon, Wall Street is going to be agitating for more than a breakup.
Mr. Immelt seems pretty much at ease about that, too.
Mr. Immelt also felt that G.E. needed to do a better job at what is called “organic growth,” that is, growth that is not a result of acquisitions. So he had G.E. study companies that excelled at internal growth, like Apple and Toyota, quantified the qualities that those companies had in common, and began teaching them at General Electric. Now, Mr. Immelt has told Wall Street that he wants the company’s organic growth rate to be 8 percent a year, twice what it used to be.
Most C.E.O.s whose stock hasn’t moved in five years would be in a world of trouble, of course. And Mr. Immelt is not going to get his 20-year run if he can’t get the stock to move. But he’s still got plenty of time to show that his repositioning is working; Wall Street may be antsy, but no investor is crazy enough to call for his ouster. And he’s adamant that the solution is to wait for the market to catch up with the company’s changing nature, rather than to execute a partial breakup just to please the Street.
“Investors go through cycles where they don’t like conglomerates,” Mr. Immelt said. “But if you want to be a lasting company, you have to know how to be a multibusiness structure. If Google is going to be a 100-year-old company someday, it is going to have to learn to do more than search.”
Let me make a few points, by way of rebuttal.
First, my proprietary research has concluded that, in order to have a significantly above-average probability of earning consistently superior total returns, companies need to post real rates of revenue growth in excess of Immelt's goal of 8% per annum. Less than the rate I discovered, and the company will not be considered a consistently high-revenue growth firm. Earnings growth, by the way, is statistically unrelated to consistently superior total return performance.
So much for Jeff's foot on the accelerator helping shareholders enjoy consistently superior returns by holding GE stock.
Second, as I wrote in one of the linked posts recently,
"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."
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."
Thus, Immelt has actually broken the pattern of GE leadership through the ages by essentially changing virtually nothing. The firm has adapted to past eras, that is true. And this era is one of the continued de-conglomeration of American business. His sarcastic shots about Google to the contrary, Immelt's firm is too diversified to provide consistently superior returns to shareholders, because it's taxing them to feed an overgrown bureaucracy presided over by....none other than Chairman Jeff the First.
What Immelt fails to understand, in suggesting Google can't continue growing in its natural niches, is that every business undergoes a Schumpeterian life- and death- cycle. My guess is, Immelt is going to preside over GE's death.
Third, regarding Immelt's observation about investors "going through cycled where they don't like conglomerates" is a bit disingenuous. As I wrote in one of the linked posts above,
"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."
The era of growing, permanent corporate conglomerates is over, thanks to very efficient, large and deeply liquid capital markets. Markets so liquid that private equity firms can borrow to buy ailing business units of conglomerates, fix them, and spin them back out to the public. The only apparently consistently profitable "conglomerates" these days appear to be the large, multi-operating-unit private equity shops. But they don't seem to want to hold their businesses- just increase their value and flip them back to the public.
I question Nocera's trust that Immelt has 20 years to eventually re-ignite GE's total return performance. In Welch's day, the large private equity pools now common did not exist, and investors were far more patient.
Typically, it's been my experience that corporations, and their CEOs, cite 'soft' values and concepts when they simply can't earn consistently superior total returns for their shareholders. Even today, as Yahoo's Terry Semel came under assault for that company's abysmal performance under his tenure, Yahoo's corporate spokesperson recited a long list of non-quantitative 'accomplishments' under Semel's reign, carefully avoiding the clear record of financial failure.
Immelt is no different, nor are his supporters, such as Mr. Nocera.
Friday, June 08, 2007
Distorted Market Signals On Insurance In The Hurricane Belt
Yesterday's Wall Street Journal featured an excellent piece on the shifting burden of homeowner's insurance for those who build and live in the known or highly-probable path of hurricanes.
As I explained to my 11-year old daughter over breakfast, while we looked at the headline, when governments attempt to control the price of risk for insuring things like building vacation, or even primary, homes in the likely path of destructive weather, the tendency is for private capital to flee, and government, meaning, all of us who don't enjoy that ocean view, to subsidize those who have so built.
As the article clearly describes, the recent trend has been for states to attempt to cap insurance rates, companies to leave states, then the same states organize their own 'insurance funds,' which are, logically, inadequate to the task at hand. The ultimate guarantor, since the people in these states see fit to guarantee coverage to their coastal-dwelling denizens, is going to be Uncle Sam.
Let's review the history. The year after I was born, there was a decade-long hiatus in killer hurricanes along the Gulf and Atlantic coasts. The resulting rush to build in these hurricane alleys resulted in today's dilemma. People have been allowed to expect that they will always be given coverage, at affordable rates, for their dubious choice of location for a vacation home. Or, in some cases, primary residence.
Now that nature has returned, as it were, to the field, there's been millions of tons of toothpicks created since Hugo set down in North Carolina those many years ago. Most recently, Katrina and Rita wrecked the New Orleans and parts of the Texas, Mississippi and Louisiana coasts.
Someone must pay!
But why? Back when I began this blog, in September of 2005, I quickly wrote about who really bore the cost of location decisions in the Gulf Coast areas. Leaving aside industry, it is pretty clear that, through distorted market signals on the price of risk for homeowner insurance, too many people have built too much housing which they cannot personally afford to insure at market rates, or rebuild from their personal fortunes, in the likely path of hurricanes.
A reasonable person will see in a hot minute that the most effective solution is to reduce insurance regulation, not involve more state and Federal price signal distortion.
On a related matter, what do you think is really happening every time some Gulf Coast location is declared a "Federal disaster area?" The local residents get to rely on every other US citizen to bail them out of their choice of living in an area which may be too risky for their own wallets.
The net effect of today's mess of homeowners insurance in hurricane areas is to make all Americans ultimately pay the tab for the difference between what local politicians feel they can ask their ocean-front-dwelling homeowners to pay for insurance, and what private insurers would actually demand for those risks. So you and I, if you don't have a beachfront home somewhere between North Carolina and Texas, pay a form of rent to those who do, but we never get to enjoy their view.
Common sense says that if it's too expensive for a person to afford privately-offered insurance to replace the value of a home built so near the ocean in hurricane territory, then the home shouldn't be built. Not that 'someone else' should step in and pay to make it affordable. How long can we, as a nation, afford this sort of economic idiocy?
When I read in the Journal article that,
"lawmakers in some states are also facing deep public anger about the rising cost of insurance on the coast,"
I was dumbfounded. Who's fault is this? The 'rising cost' reflects reality peeking in on an otherwise state of denial.
Something's very wrong. The incentives for rational decision-making with respect to economic development is distorted. Back in the post-Katrina era, I wrote a post quoting a Holman Jenkins WSJ editorial in which he revealed that southern Senators demanded the removal of a provision in Federal flood insurance laws that put a limit on the number of times a homeowner could file claims under the insurance. They explicitly admitted that the insurance guaranteed 'economic development' by way of assuring the rebuilding of the initially dubiously-sited homes.
This sort of market price signal distortion, on such a grand scale, is bound to come a cropper at some point. It's a good argument for simplifying the insurance market to become a national one, rather than 50 local ones, each hostage to local political appointees who try to beggar their neighbors by capping risk prices in their own states, and attempting to force the insurers to recover the true risk premiums 'somewhere else.'
The way things are looking, this would seem to cast doubt on the wisdom of investing in property and casualty firms anytime soon, if one expects consistently superior total returns.
As I explained to my 11-year old daughter over breakfast, while we looked at the headline, when governments attempt to control the price of risk for insuring things like building vacation, or even primary, homes in the likely path of destructive weather, the tendency is for private capital to flee, and government, meaning, all of us who don't enjoy that ocean view, to subsidize those who have so built.
As the article clearly describes, the recent trend has been for states to attempt to cap insurance rates, companies to leave states, then the same states organize their own 'insurance funds,' which are, logically, inadequate to the task at hand. The ultimate guarantor, since the people in these states see fit to guarantee coverage to their coastal-dwelling denizens, is going to be Uncle Sam.
Let's review the history. The year after I was born, there was a decade-long hiatus in killer hurricanes along the Gulf and Atlantic coasts. The resulting rush to build in these hurricane alleys resulted in today's dilemma. People have been allowed to expect that they will always be given coverage, at affordable rates, for their dubious choice of location for a vacation home. Or, in some cases, primary residence.
Now that nature has returned, as it were, to the field, there's been millions of tons of toothpicks created since Hugo set down in North Carolina those many years ago. Most recently, Katrina and Rita wrecked the New Orleans and parts of the Texas, Mississippi and Louisiana coasts.
Someone must pay!
But why? Back when I began this blog, in September of 2005, I quickly wrote about who really bore the cost of location decisions in the Gulf Coast areas. Leaving aside industry, it is pretty clear that, through distorted market signals on the price of risk for homeowner insurance, too many people have built too much housing which they cannot personally afford to insure at market rates, or rebuild from their personal fortunes, in the likely path of hurricanes.
A reasonable person will see in a hot minute that the most effective solution is to reduce insurance regulation, not involve more state and Federal price signal distortion.
On a related matter, what do you think is really happening every time some Gulf Coast location is declared a "Federal disaster area?" The local residents get to rely on every other US citizen to bail them out of their choice of living in an area which may be too risky for their own wallets.
The net effect of today's mess of homeowners insurance in hurricane areas is to make all Americans ultimately pay the tab for the difference between what local politicians feel they can ask their ocean-front-dwelling homeowners to pay for insurance, and what private insurers would actually demand for those risks. So you and I, if you don't have a beachfront home somewhere between North Carolina and Texas, pay a form of rent to those who do, but we never get to enjoy their view.
Common sense says that if it's too expensive for a person to afford privately-offered insurance to replace the value of a home built so near the ocean in hurricane territory, then the home shouldn't be built. Not that 'someone else' should step in and pay to make it affordable. How long can we, as a nation, afford this sort of economic idiocy?
When I read in the Journal article that,
"lawmakers in some states are also facing deep public anger about the rising cost of insurance on the coast,"
I was dumbfounded. Who's fault is this? The 'rising cost' reflects reality peeking in on an otherwise state of denial.
Something's very wrong. The incentives for rational decision-making with respect to economic development is distorted. Back in the post-Katrina era, I wrote a post quoting a Holman Jenkins WSJ editorial in which he revealed that southern Senators demanded the removal of a provision in Federal flood insurance laws that put a limit on the number of times a homeowner could file claims under the insurance. They explicitly admitted that the insurance guaranteed 'economic development' by way of assuring the rebuilding of the initially dubiously-sited homes.
This sort of market price signal distortion, on such a grand scale, is bound to come a cropper at some point. It's a good argument for simplifying the insurance market to become a national one, rather than 50 local ones, each hostage to local political appointees who try to beggar their neighbors by capping risk prices in their own states, and attempting to force the insurers to recover the true risk premiums 'somewhere else.'
The way things are looking, this would seem to cast doubt on the wisdom of investing in property and casualty firms anytime soon, if one expects consistently superior total returns.
Thursday, June 07, 2007
Hedge Fund Leverage Risks
Today's Wall Street Journal carried a piece on the back page of the Money & Investing Section, describing the state of credit derivative hedge fund investments.
According to the article, over $300B is currently invested in these funds, on a leveraged basis, 6-1, for roughly $1.8T of controlled assets. One of the eye-opening pieces of arithmetic the authors did was to point out that a credit derivative fund with only 4x leverage, experiencing a decline of just 5% in the value of its portfolio, would be required to liquidate as much as 25% of its total assets to meet a 20% margin requirement. Multiply this by many hedge funds engaged in similar investing, with similar exposures, and you understand a fundamental underpinning of my partner's and my own options strategy.
We have a static options strategy in place which works automatically, without any recourse to a change in positions, in the event of severe market declines.
During a lunch meeting today with some associates in the financial sector, to explain in more detail our recent options-based implementation of our equity portfolio strategy, we discussed precisely this aspect of risk management. Ranging in ages from the 60s through 40s, we had enough cumulative and historical experience in the markets to all agree on one thing- the time at which you need to deploy a dynamic risk management strategy is precisely when it will be unable to be deployed, due to unforeseen market conditions involving illiquidity. This illiquidity could take the form of a failure for markets to be made in the instruments in question, or their quotes and prices to be impractical to take, due to an overall shortage of liquidity at affordable prices.
Thus, reading this recent piece on the implicit current risk of rapid and dysfunctional declines in prices and liquidity in the credit derivative markets, I am pleased that we are putting in place a 'no moving parts' risk management approach which relies on the simple attribute of a call or put option to allow for, but not necessitate, a trade, in order to limit downside risk to value.
According to the article, over $300B is currently invested in these funds, on a leveraged basis, 6-1, for roughly $1.8T of controlled assets. One of the eye-opening pieces of arithmetic the authors did was to point out that a credit derivative fund with only 4x leverage, experiencing a decline of just 5% in the value of its portfolio, would be required to liquidate as much as 25% of its total assets to meet a 20% margin requirement. Multiply this by many hedge funds engaged in similar investing, with similar exposures, and you understand a fundamental underpinning of my partner's and my own options strategy.
We have a static options strategy in place which works automatically, without any recourse to a change in positions, in the event of severe market declines.
During a lunch meeting today with some associates in the financial sector, to explain in more detail our recent options-based implementation of our equity portfolio strategy, we discussed precisely this aspect of risk management. Ranging in ages from the 60s through 40s, we had enough cumulative and historical experience in the markets to all agree on one thing- the time at which you need to deploy a dynamic risk management strategy is precisely when it will be unable to be deployed, due to unforeseen market conditions involving illiquidity. This illiquidity could take the form of a failure for markets to be made in the instruments in question, or their quotes and prices to be impractical to take, due to an overall shortage of liquidity at affordable prices.
Thus, reading this recent piece on the implicit current risk of rapid and dysfunctional declines in prices and liquidity in the credit derivative markets, I am pleased that we are putting in place a 'no moving parts' risk management approach which relies on the simple attribute of a call or put option to allow for, but not necessitate, a trade, in order to limit downside risk to value.
Wednesday, June 06, 2007
Prudential's Withdrawal From Equity Research
Today's early morning program on CNBC provided breaking coverage of the announcement of Prudential's dissolution of its equity group. According to the story, some 400 people are being dismissed, including institutional equity trading, analysis, and, one supposes, underwriting.
As Becky Quick and Joe Kernen discussed the new development, nobody seemed to acknowledge the elephant in the room on this issue. Rather, they were musing about whether this means most research shops are not able to pay their way. One would think this was a foregone conclusion after the heavy use of 'research' to market underwriting and trading during the technology bubble of the late 1990s and early 2000s.
Conventional institutional equity trading of highly liquid, large- or mid-cap issues is simply unprofitable. Prudential is an also-ran player, behind the major investment and commercial banks. What hope could a second-rate securities unit, at an insurance firm, have to add unique value for institutional investors in the area of vanilla equities?
Personally, I'm happy to read of this development. It is yet another good example of Schumpeterian dynamics at work, weeding out the mediocre players in mature product/markets.
It's unlikely that anyone will notice, six months from now, that Pru's equity operation is even missing. The next two or three smallest shops could also shut down, with similar lack of impact on the markets. With so much free information available online now, why is anyone surprised at the shrinking market for providing conventional research and related equity services to institutional investors?
Of more value in today's market is the shifting volumes of transactions in specific issues, and sources of upward or downward pressure on demand for them among fund managers. That is a far cry from the old-style, conventional paper-based equity research provided by firms like Pru.
As Becky Quick and Joe Kernen discussed the new development, nobody seemed to acknowledge the elephant in the room on this issue. Rather, they were musing about whether this means most research shops are not able to pay their way. One would think this was a foregone conclusion after the heavy use of 'research' to market underwriting and trading during the technology bubble of the late 1990s and early 2000s.
Conventional institutional equity trading of highly liquid, large- or mid-cap issues is simply unprofitable. Prudential is an also-ran player, behind the major investment and commercial banks. What hope could a second-rate securities unit, at an insurance firm, have to add unique value for institutional investors in the area of vanilla equities?
Personally, I'm happy to read of this development. It is yet another good example of Schumpeterian dynamics at work, weeding out the mediocre players in mature product/markets.
It's unlikely that anyone will notice, six months from now, that Pru's equity operation is even missing. The next two or three smallest shops could also shut down, with similar lack of impact on the markets. With so much free information available online now, why is anyone surprised at the shrinking market for providing conventional research and related equity services to institutional investors?
Of more value in today's market is the shifting volumes of transactions in specific issues, and sources of upward or downward pressure on demand for them among fund managers. That is a far cry from the old-style, conventional paper-based equity research provided by firms like Pru.
Tuesday, June 05, 2007
Implementing an Equity Strategy Through Options: More On Nassim Taleb
My recent post on the review of Nassim Taleb's book, "The Black Swan," has led to some insights which have radically transformed the alternatives for implementing our equity portfolio strategy.
In that prior post, I discussed Taleb's concerns regarding the inappropriate use of statistical distributions for various financial event forecasting and/or simulation.
Following on that book review, in a circuitous fashion, my partner and I were given a fairly lengthy article about Taleb, which appeared in the New Yorker magazine several years ago.
In that piece, buried toward the end, amidst considerable qualitative reasoning by Taleb on the subject of 'once in a lifetime' events, were a few jewels of investment insight. One was, a la Taleb's book, to eschew the use of normal distributions when assessing the likelihood of extreme market events, such as outsized negative or positive returns. The other was his avoidance of any equities, in favor of only purchasing puts or calls.
After considerable reflection, and the integration of the very timely comments of Professor Stephen Ross, discussed in this post, I realized that, strictly from a catastrophic event perspective, there is no scenario in which holding equities would be preferable to holding out-of-the-money call options on the same portfolio.
The only limiting factor to implementing an equity strategy in this fashion is one familiar to those who frequent casinos. Can we be fairly certain that our portfolios of call options will rise in value, above the cost of the premium, which is lost (unlike the investment in the underlying equity) each period, sufficiently frequently to avoid going bankrupt from a run of mediocre or negative portfolio performances?
After more reflection and some fairly involved quantitative Monte Carlo simulations, my partner and I have found the answer to be, "yes."
Further, once we determined that the risk of this bankruptcy is acceptable, we turned to a fairly simple, but incredibly effective strategy familiar to any casino player- banking your winnings. That is, we developed a simple approach to sweeping the positive returns back into the investment base, and making the size of each investment portfolio dependent upon various multiples of the original investment having been 'banked.' Thus, within a few periods of investing in the equity strategy via call options, we are playing with house, or the market's, money. This rapidly builds over time. The greatest risk for the strategy, as expressed through options, is a losing streak during the first 18 months. After that, the probabilities are that virtually any dry period can be weathered without losing the entire investment.
Along with the safety of implementing our equity strategy via call and put options, we realized two other transforming aspects of the new approach. By using options, rather than equities, we are able to reduce the investment required for holding a given dollar-value portfolio by roughly a factor of 20. And by more frequently investing in the strategy, using each month's selections, rather than simply running two, six-month duration equity portfolios each year, we were able to increase the expected returns by a roughly a factor of 6.
Together, the effect of using less-capital-intensive options, more frequently, have allowed us to increase the expected returns of the original equity portfolio strategy by something in the neighborhood of more than 100-fold, on a gross basis. And this assumes delta neutrality for long-dated, out-of-the-money options. In reality, our assumptions are very conservative with respect to the expected returns of such options, vis a vis those of their underlying equities. Since the original equity strategy had an expected annual return of roughly 20%, this yields a much more potent, yet safer, approach to exploiting the consistency of our large-cap equity selection process.
As a result of these recent new, and transformational, developments in our equity portfolio strategy, through the use of call and put options instead of underlying equities, we believe we will be able to forego the search for a large, institutional investor for the near term, and turn, instead, to our own capital, and that of selected high net worth individuals.
In that prior post, I discussed Taleb's concerns regarding the inappropriate use of statistical distributions for various financial event forecasting and/or simulation.
Following on that book review, in a circuitous fashion, my partner and I were given a fairly lengthy article about Taleb, which appeared in the New Yorker magazine several years ago.
In that piece, buried toward the end, amidst considerable qualitative reasoning by Taleb on the subject of 'once in a lifetime' events, were a few jewels of investment insight. One was, a la Taleb's book, to eschew the use of normal distributions when assessing the likelihood of extreme market events, such as outsized negative or positive returns. The other was his avoidance of any equities, in favor of only purchasing puts or calls.
After considerable reflection, and the integration of the very timely comments of Professor Stephen Ross, discussed in this post, I realized that, strictly from a catastrophic event perspective, there is no scenario in which holding equities would be preferable to holding out-of-the-money call options on the same portfolio.
The only limiting factor to implementing an equity strategy in this fashion is one familiar to those who frequent casinos. Can we be fairly certain that our portfolios of call options will rise in value, above the cost of the premium, which is lost (unlike the investment in the underlying equity) each period, sufficiently frequently to avoid going bankrupt from a run of mediocre or negative portfolio performances?
After more reflection and some fairly involved quantitative Monte Carlo simulations, my partner and I have found the answer to be, "yes."
Further, once we determined that the risk of this bankruptcy is acceptable, we turned to a fairly simple, but incredibly effective strategy familiar to any casino player- banking your winnings. That is, we developed a simple approach to sweeping the positive returns back into the investment base, and making the size of each investment portfolio dependent upon various multiples of the original investment having been 'banked.' Thus, within a few periods of investing in the equity strategy via call options, we are playing with house, or the market's, money. This rapidly builds over time. The greatest risk for the strategy, as expressed through options, is a losing streak during the first 18 months. After that, the probabilities are that virtually any dry period can be weathered without losing the entire investment.
Along with the safety of implementing our equity strategy via call and put options, we realized two other transforming aspects of the new approach. By using options, rather than equities, we are able to reduce the investment required for holding a given dollar-value portfolio by roughly a factor of 20. And by more frequently investing in the strategy, using each month's selections, rather than simply running two, six-month duration equity portfolios each year, we were able to increase the expected returns by a roughly a factor of 6.
Together, the effect of using less-capital-intensive options, more frequently, have allowed us to increase the expected returns of the original equity portfolio strategy by something in the neighborhood of more than 100-fold, on a gross basis. And this assumes delta neutrality for long-dated, out-of-the-money options. In reality, our assumptions are very conservative with respect to the expected returns of such options, vis a vis those of their underlying equities. Since the original equity strategy had an expected annual return of roughly 20%, this yields a much more potent, yet safer, approach to exploiting the consistency of our large-cap equity selection process.
As a result of these recent new, and transformational, developments in our equity portfolio strategy, through the use of call and put options instead of underlying equities, we believe we will be able to forego the search for a large, institutional investor for the near term, and turn, instead, to our own capital, and that of selected high net worth individuals.
Monday, June 04, 2007
HP's Resurgence: The Details
Today's Wall Street Journal features an article purporting to describe, in detail, the reasons for H-P's resurgence under Mark Hurd. According to the piece, it all comes down to Hurd's first new hire, Todd Bradley, late of Palm.
What Mr. Bradley did, upon arriving at H-P, was essentially three basic things:
-reviewed consumer purchase behavior research
-concommitantly focused H-P's PC marketing on retailers
-identified, tackled and solved various operational issues involving distribution to said retailers>
What ought to concern any reader, and does me, is that none of what Mr. Bradley did was all that unusual. As I wrote about Burberry's recent CEO change here, so often, the solutions are not all that novel.
Why is it so hard to find people who can do the mundane and obvious? Where was H-P's board all the while when Carly Fiorina bumbled this one, via her 'management team,' such as it was? Why wasn't that board grilling Carly & Co. as to the reasons for whatever PC strategy they had, and why it wasn't working?
As I look at Mr. Bradley's actions, they are classically excellent. Clearly, this guy is worth whatever they pay him, as is Hurd, for finding him. But why did it take just Bradley? Why wasn't there some underling in the marketing or product management ranks at H-P who has or had sufficient talent to do this?
Let's review Mr. Bradley's program for rescuing the PC business.
First, he went to the data. He learned that Dell was weak in retail.... duh! That most consumers were now moving to buy laptops and notebooks and, consequently, wanted to see, touch and feel them, then walk out of the store with them. As I wrote here last fall, one benefit of selling notebook computers is that there isn't a whole lot to customize, so a vendor can realistically cover several price points at retail, without the time and expense of custom building the products for each order.
Next, Mr. Bradley focused on channel management issues. He improved communications and service to his downstream partners, listened to their problems and ideas, forged stronger relationships with them. Now he was in a leadership position in the channel of choice for notebooks and laptops.
Finally, he went about hunting down and fixing the various logistical stumbling blocks inside H-P that threatened the successful execution of the retail strategy. Through painstaking homework to identify bottlenecks, hold frequent meetings and establish performance metrics, he brought the logistical performance up to grade, and completed the overhaul of the unit's product and marketing strategy.
What about any of this was magic? Bradley did not apparently bring a team with him, or, if he did, the article omitted this. He simply used basic, traditional marketing strategy and tactics, common sense, and good management skills.
Are these so lacking in most American businesses, and H-P, as to require an infusion of this type of skill from another company?
Honestly, I think this speaks very poorly for the continuing state of American management education, the MBA as a useful degree, and middle-to-upper management in the average large US corporation.
H-P prior to Hurd seems to have simply been allowed to become mediocre. Even the board seemed to take a long time to show Fiorina the door and usher in a more competent CEO, Mark Hurd.
How many more US corporations underperform, consistently underperform the S&P500 total return, due simply to inept management of decent products in attractive markets?
What Mr. Bradley did, upon arriving at H-P, was essentially three basic things:
-reviewed consumer purchase behavior research
-concommitantly focused H-P's PC marketing on retailers
-identified, tackled and solved various operational issues involving distribution to said retailers>
What ought to concern any reader, and does me, is that none of what Mr. Bradley did was all that unusual. As I wrote about Burberry's recent CEO change here, so often, the solutions are not all that novel.
Why is it so hard to find people who can do the mundane and obvious? Where was H-P's board all the while when Carly Fiorina bumbled this one, via her 'management team,' such as it was? Why wasn't that board grilling Carly & Co. as to the reasons for whatever PC strategy they had, and why it wasn't working?
As I look at Mr. Bradley's actions, they are classically excellent. Clearly, this guy is worth whatever they pay him, as is Hurd, for finding him. But why did it take just Bradley? Why wasn't there some underling in the marketing or product management ranks at H-P who has or had sufficient talent to do this?
Let's review Mr. Bradley's program for rescuing the PC business.
First, he went to the data. He learned that Dell was weak in retail.... duh! That most consumers were now moving to buy laptops and notebooks and, consequently, wanted to see, touch and feel them, then walk out of the store with them. As I wrote here last fall, one benefit of selling notebook computers is that there isn't a whole lot to customize, so a vendor can realistically cover several price points at retail, without the time and expense of custom building the products for each order.
Next, Mr. Bradley focused on channel management issues. He improved communications and service to his downstream partners, listened to their problems and ideas, forged stronger relationships with them. Now he was in a leadership position in the channel of choice for notebooks and laptops.
Finally, he went about hunting down and fixing the various logistical stumbling blocks inside H-P that threatened the successful execution of the retail strategy. Through painstaking homework to identify bottlenecks, hold frequent meetings and establish performance metrics, he brought the logistical performance up to grade, and completed the overhaul of the unit's product and marketing strategy.
What about any of this was magic? Bradley did not apparently bring a team with him, or, if he did, the article omitted this. He simply used basic, traditional marketing strategy and tactics, common sense, and good management skills.
Are these so lacking in most American businesses, and H-P, as to require an infusion of this type of skill from another company?
Honestly, I think this speaks very poorly for the continuing state of American management education, the MBA as a useful degree, and middle-to-upper management in the average large US corporation.
H-P prior to Hurd seems to have simply been allowed to become mediocre. Even the board seemed to take a long time to show Fiorina the door and usher in a more competent CEO, Mark Hurd.
How many more US corporations underperform, consistently underperform the S&P500 total return, due simply to inept management of decent products in attractive markets?
Subscribe to:
Posts (Atom)
