The Kraft-Cadbury Deal

Back in late September, I wrote this post concerning Kraft's pursuit of Cadbury. At the time, I thought little of the proposed merger, and highlighted Cadbury CEO Stitzer's insightful comments regarding institutional food buyers of the two companies' products.

This morning's news of Kraft's increased bid, for which it won Cadbury's board's approval of the deal, was probably unavoidable. But it's too bad for the assets of British confectioner.

Consider, first, the comparative equity prices of the two firms, and the S&P500 Index, over the past five years. Including the last four months during which Kraft has been stalking Cadbury.

If anything, Kraft has continued to fail to distinguish itself, probably also paying a price for what most investors evidently see as a mistaken acquisition play.

I find myself in agreement. Despite the Journal article's quote from Pershing Square hedge fund founder Bill Ackman endorsing the deal and predicting a wonderful performance outlook for the larger Kraft, I just don't buy it. There are too many potential pitfalls.

For one, there is the obvious bugaboo of trans-Atlantic culture clashes.

Next, you have a processed food purveyor with admittedly mediocre brand management skills, judging by past equity performances, hoping to excel by paying full price for a brand-sensitive business, confectionary.

Then you have the undeniable fact that Cadbury has done a better job earning total returns for its shareholders than has Kraft during the latter's CEO, Irene Rosenfeld's tenure.

Then there's the size issue. Kraft was only treading water with the S&P before this deal. What do you think will happen when it experiences the increased size and complexity of managing the merged firm, plus having to get to work improving Cadbury's performance to pay for the merger? It's really doubtful that things will get better at the merged Kraft. More likely is the larger American firm's mediocrity infecting and affecting Cadbury, pulling its performance down to that of its acquirer.

I still believe, as I did last September, that both parties would have benefited from Rosenfeld's selling Kraft's businesses which resemble Cadbury's, to the latter, taking equity in exchange.

Cadbury is simply a better management team than Kraft. If anything, I guess Cadbury shareholders should thank Stitzer and the board for getting top pound for the company, and walking away with cash after selling whatever Kraft paper they receive, while Kraft will be stuck trying to make this dubious tie-up pay off.

I wonder what Buffett will do with his Kraft shares now?

Geithner Played For a Sap By The French In 2008

This morning's Wall Street Journal contains perhaps the most damning evidence yet of how badly current Treasury Secretary Tim (tax scofflaw) Geithner bungled the AIG situation back in 2008.

We now learn, courtesy of the Journal piece, that the two french banks owed significant amounts of money on AIG swaps claimed that their executive would be imprisoned if they took less than the contractually-obligated full payment due.

Amazingly, Geithner, played by a sap by bankers not even domiciled in his own country, collapsed and acceded to their demands. Then, to complete the travesty, decided that, since all AIG creditors must be treated equally, everybody else would get full payment, too.

Guess who footed that bill? Yep, you and me, if you are an American reading this.

Of course, this whole mess is why we have bankruptcy law. It prevents ill-equipped, inexperienced officials from making bad policy decisions. In this case, atrociously bad monetary policy.

As I, and others, have argued for over a year, were AIG to simply have been put into bankruptcy, if not aided, like the other major US financial institutions, then none of this would have happened. Instead, a bankruptcy court would almost certainly have proportionally allocated assets available to the financial products group among its creditors. Period.

This sort of uncertainty is what erodes the confidence of business people. Geithner's actions, both as NY Fed president and Treasury Secretary, have been nothing, if not erratic and inexplicable.

I suspect that, with continued mis-leadership like this in the financial sector, it will be some time before a genuine, non-government-money-stoked recovery takes hold in the US.

About The New Bank Tax

The newly-proposed tax on banks, ostensibly to recoup TARP losses, is surely one of the worst ideas to come out of any administration and Congress.


There are so many flaws in the tax it's hard to know where to begin. But I'll try.


First, it seems the wrong way for Congress to now decide how not to have lost money on the bill they so hastily passed over a year ago. Why didn't they, or the Treasury which pushed the legislation, prescribe a method, ex ante, to recoup losses before banks and all other TARP recipients were allowed to operate normally?

To now, after some banks have met the bill's conditions and repaid forced borrowings, with interest, toss in an added tax just because the TARP was badly conceived and administered, is hardly fair.

By the way, is it even Constitutional to force a bank which did not want TARP money to take it, demand onerous repayment terms, and then also tax its profits because the TARP wasn't well-planned from the outset?

Why exempt GM and Chrsyler? They took TARP funds. And why exempt Fannie and Freddie, which were actually the prime movers in the recent financial sector meltdown?

None of it would have occurred had Democrat Representative Barney Frank, Conneticut Democrat Chris Dodd, and others in Congress, forced, and allowed, the two GSEs to underwrite ever-more marginal mortgage loans to risky borrowers. Once securitized by Fannie and Freddie, what investment and commercial banks did was tame by comparison.

If the new tax is supposed to be a "Financial Responsibility" tax, then Fannie and Freddie should be paying a disproportionately high share of it.

Finally, this tax won't fall, ultimately, on any institutions.

Apparently the current administration's economists were all absent the day their long-ago professors taught the economic theory of tax incidence.

Taxes are never paid by companies, only collected. Consumers will pay this tax through reduced access to financial services, or more expensive services, or added fees and penalties.

But be assured, no bank will actually pay the tax on its own.

And, thus, the entire notion of the tax, and its arrogant name, a “financial crisis responsibility fee,” is phony.

As always, its the consumers that will pay this tax and, thus, ultimately for losses from a poorly-designed and implemented TARP program.

An Old Idea Gets A Fresh Start with Technology

Thursday's Wall Street Journal had an article which really brought back some fond memories. It was on the back page of the Marketplace Section, concerning a pick-up grocery business in France.


A colleague and I also conceived this business back in 1987. Of course, 23 years ago, one was restricted to fax and phone. The problems still remain, but the nature of the business is otherwise better.

It's always struck me as the optimum mix of Peapod's delivery service and shopping in a store. I think many people have time to pick up a pre-selected and packaged order, but don't want to waste time with the mostly low-value-added task of the actual, physical stock-picking.

Now, with cheaper and more practical, effective communications, via cell and internet, ording grocercies is much easier than it was over 20 years ago. The business also features easier billing and fulfillment. For example, consider this passage,

"The warehouse model means Chronodrive doesn't need more than a dozen employees per location, so costs are low. But customers shop according to a list- there are no impulse buys at the checkout."

The drive-through model allows for less expensive site selections. The Journal article describes how French Chronodrive stores are located near highways and neighborhoods with lots of middle class families. They expect a terminal penetration of some 4-5% of the French market.

I've always believed that one could get people to buy the toughest non-sight items, produce and meat, by simply having a 'no questions asked' return policy for the first month. Once people felt comfortable with the product quality, and their ability to return bad 'fresh' food, I think they'd learn the habit of ordering those, as well.

Ironically, for me, at least, this harks back to my high school days. I worked at Matarelli's, a literal corner grocery store in my modest-sized downstate Illinois town. We were one of only two grocery stores that delivered. Our prices were SRP (suggested retail price) to cover the cost of our "free" delivery, and the store was known for its excellent meat quality.

However, many customers would telephone their orders to the two Italian sisters who ran the store, driving by a few hours later to pick up their boxed orders.

I hope this French business works out well, and makes an appearance on our shores soon.

Two Interesting WSJ Pieces On Financial Sector Regulation

Wednesday's Wall Street Journal editorial page featured the regular matched editorials by Holman Jenkins, Jr., and uber-liberal Frank Thomas.

While Jenkins wrote a thoughtful, insightful piece, as usual, what was surprising was Thomas' unexpectedly reasonable call for a return of Glass-Steagall.

I found Jenkins' editorial refreshingly candid on why it's Congress that "doesn't get it" about some bankers' compensation, and not the other way around.

He bluntly observed that taxpayers made money, via the Fed, on the assets whose depressed values got so many investment and commercial banks into trouble. That the Fed had record profits of $52B in 2009. A fact about which the administration and the Fed are being rather, well, quiet.

As Jenkins points out, like it or not, traders and investment bankers are highly mobile, so when they add value, they will either be paid commensurately, or leave for another outfit. And let's also be candid about who would do a better job devising admittedly imperfect compensation schemes- government or management? It's going to be management, because they have a vested interest in keeping their talent.

Meanwhile, the usually-ludicrous Thomas actually argued for something sensible. Something my friend B and I have been discussing for over a year. Call it a return of Glass-Steagall, or simply prohibiting any financial institution which enjoys the benefit any government support or insurance scheme, e.g., FDIC, Fed window access, etc., from engaging in: proprietary trading, securities underwriting or any other non-plain-vanilla lending.

Thomas is right to note that Bill Clinton's solemn intonation in 1999 about Glass-Steagall was completely wrong,

"worked pretty well for the industrial economy....But the world is very different."

Granted, as usual, Thomas wrongly blames a general rush to deregulation.

In this case, it was actually the concerted efforts of some stupid commercial banking CEOs who largely failed to understand, or deliberately ignored, that allowing more, and less-capable capacity into proprietary trading and general securities underwriting would cause disastrous systemic consequences for both businesses.

There are ways in which you could allow wholly-owned, separate subsidiaries of commercial banks to do these businesses, but the key would always be two-fold: no leverage, and no government backstops, insurance or aid of any kind, should the riskier units go down. Their failure would have to be fully absorbed by the units' equity, with no debt left unpaid.

It's simpler, of course, to simply forbid insured, government-assisted financial entities from those businesses. But it really is time to restore a functional equivalent of Glass-Steagall.

More than any current regulatory so-called reform afoot in Congress, this one act would do more to minimize the consequences of the inevitable future systemic financial disasters than any other suggestion in circulation today.

On Technology & The H-P Microsoft Closer Tie-Up

I skimmed through the Wall Street Journal piece this morning announcing H-P's closer ties with Microsoft. From what I gleaned, it's largely aimed at corporate cloud computing and similar product/markets.

Well, I'm here to tell you- after 4 hours wasted on a Microsoft-generated PC problem this morning- that the H-P-Microsoft relationship isn't the one to improve.

It's the Norton-Microsoft or McAfee-Microsoft interfaces.

If you are like me, your laptop periodically greets you in the morning with a sign-in screen and the notification that Microsoft's Windows operating system security updates thoughtfully invaded your machine during the night and rebooted it for you.

Hopefully, you think, the damn thing will still work.

Not this morning.

I won't go into exhaustive detail. Suffice to say, I spent a full hour on the phone with Comcast, rewired two laptops directly to the cable modem, and opened countless system management windows for the Comcast technicians in their quest to get my connection operating.

Only late in the process did I realize, as a backup laptop connected directly to the modem and the internet, but this machine did not, that there was a reason Norton Anti-Virus no longer appeared in the icon tray. Nor responded when I clicked on the icon.

The Windows security update had obviously corrupted the Norton program, causing it to simply die in place. But not become uninstalled.

Thus, every other internet access program was still waiting for the crippled Norton security program to allow it to connect. Which it couldn't do. Only when another machine was hardwired directly to the modem was it able to bypass the crippled security program's iron grip on my internet access.

Once I uninstalled Norton, everything worked.

Silly me. Why didn't it occur to me right away that Microsoft would so carelessly reach into my machine, disable my anti-virus and firewall while leaving it in place, then silently leave me to figure out the damage. And how to overcome it.

Instead, I wasted an hour with Comcast, 10 minutes with my computer technician, subsequent troubleshooting of my wireless router and time spent re-installing Norton.

I'm sure I'm not alone. The Comcast technician, who was both pleasant and very skilled, remarked that they have waves of this type of malfunction during periodic Windows security updates. And that Zone Alarm was notorious for causing these sorts of issues, too.

You would think, by now, that Microsoft would have figured this out. That, at least, its updates would alert you to the fact that it had corrupted your firewall and anti-viral software. Or, heaven forbid, actually detect that program first, then download updates designed not to corrupt your resident security program.

But that would require some actual sensitivity to customer needs and concerns. Something of which Microsoft has never shown itself capable.

Kyle Bass In Washington Today

I saw an interview on CNBC this morning with Kyle Bass.

Bass achieved fame by appearing in the networks special program on the 2007-08 financial crisis, House of Cards. He's a Texas-based fund manager who had approached Bear Stearns with his concerns before their two risky mutual funds blew up in the summer of 2007.

From Bass' remarks on camera, the special Congressional commission allegedly investigating the sources for the crisis- as if it was so hard to do- is going to get quite the earful about Fannie's and Freddie's responsibility for the mess.

And that, of course, will hopefully lead to identifying publicly and for more Americans to see, Congressional members Barney Frank, Chris Dodd and Kent Conrad as chief among their government representatives directly responsible for directing the two GSEs to engage in the behavior that triggered the crisis.

Yet More Ideas For Corporate Board Reform

There's not much new under the sun.


Earlier this week, the Wall Street Journal published a review of a book purporting to offer solutions for what is ailing today's American corporations' boards of directors. The review mentioned several ideas, but there was only one which gained any positive attention. It involved making directors take a substantial stake in a firm on the board of which they sit.


It's not a bad idea. It's also an old idea. I wrote, in this post nearly three years ago,

"Here's another insight. If, as I wrote last summer as a solution to America's corporate governance problems, board members were required to "run" for the post, and invest significant assets of their own in the company, thus clearly aligning their financial interests with those of shareholders, it might improve corporate board oversight and involvement in the operation of companies.



Suppose private equity firm partners offered their services to a publicly-held company. Would they not, in effect, take board positions, in exchange for options to own much of the firm, or be paid a percentage of the value they created over, say, a function of the firm's prior total returns, relative to the S&P500? In effect, like my idea, they'd commit their financial fortunes to, and align them with those of the firm's. But what mechanism exists for shareholders to do this? None.


It would, in fact, be a sort of return to the days of the original form of shareholder capitalism. A few wealthy, skilled owners running the boards of large companies. Since, instead, many boards are infested with lesser lights, faded failures of other boards (look at Microsoft for a great example of this tendency), or "politically correct" members with absolutely no business skills, corporate performances are often appallingly bad, while CEOs and board members are still handsomely compensated."

I do honestly mean it when I write that I can't recall any other idea these two authors had.

For me, they join a long list of politicians, union leaders and so-called shareholders' rights champions who fail, in my opinion, to understand the fundamental structure and bargain struck by those selling common equity shares in an enterprise to the public.

Those owners want the public's money, nothing more. Buying a share entitles the public owner to a vote on the board and a share of dividends, plus the ability to sell a share whose value has risen.

That's it.

In an ideal world, board members would, in fact, be so because they had the opportunity to help a company make much more money, and, thus, would invest their own capital. A board like this would not be pawns of the CEO. They'd be actively involved and, if necessary, firing the CEO much sooner than is now the custom.

It's not an entirely new idea. But it actually would require moving backward in time to when public corporations were more often run by genuinely gifted businessmen and their competent colleagues, rather than boards stuffed with politically correct members, often with no business acumen whatsoever.

Jim Chanos' Bearish Bets On China

A friend sent me a recent NY Times article, the topic of which was short-selling hedge fund manager Jim Chanos' current focus on China.

It seems there is a clear difference of opinion building between some respected financial veterans.

Chanos suspects that the Chinese have been misrepresenting their economics statistics, among other things. He also, according to the NYT piece, believes that China will soon be stuck with warehouses full of goods they manufactured or assembled, but can't sell to the West, notably America.

One-time hedge fund manager Jim Rogers emphatically disagrees. Rogers became such a proponent of Asian growth that he moved his family to Singapore a few years ago. From this perspective, Rogers has criticized Chanos, derisively observing,

“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China,” said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. “China is not in a bubble.”

We both inherently distrust Rogers' objectivity. Additionally, Rogers seems to believe that Chanos is bearish on China forever. But that's not what Chanos is actually saying.

Rather, according to the Times article, I've seen Rogers hold forth enthusiastically on commodities and Asia for the past few years in various interviews on CNBC. That may well be true in the long term.

But I believe Chanos is, instead, contending that there is a short term valuation disconnect in China. Speaking from personal experience watching equity market downdrafts for over twenty years, the sudden awareness of overvaluation brings about a quick, severe drop in values. But it doesn't necessarily derail long term growth prospects, nor reverse advantageous terms of economic competition.


It's a reasonable bet, though, that any Chinese economic slowdown and valuation collapse would have ripple effects on the US equity markets, if only as a sentiment reflecting more serious, sustained global economic weakness than had been hoped.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.



“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point.

I asked the colleague who sent me the article what he thought, and he, as do I, leaned toward Chanos' view.

Business Week's "New" Work Force

A colleague described the recent BusinessWeek cover to me over coffee this weekend.

The details portray the average employee as a contract worker with no health care, pension nor vacation.

You know what? This is what 75 years of government intervention has wrought.

Think about it.

Unionism fought for recognition in the '20s and '30s, culminating in FDR's liberal Democrat administration and the then-Democrat controlled Congress passing legislation to enshrine unions in our nation's workforce.

Neither the corporate behavior toward employees at the time, nor permanent legislation favoring unions, were effective solutions.

But since the 1930s, government and the unions it has, thanks to a long run of Democrat-controlled Congresses, supported, have cemented into the US economy the notion that employees are entitled to health care, pensions, and vacations, all provided by the companies for whom the employees work.

Within the cocoon of that system, it all seems to make sense, doesn't it? Fair, compassionate minimum standards and lifestyle provisions which, otherwise, workers would never receive?

Here's an alternative view.

For every non-cash benefit, workers receive less cash compensation. Mandatory vacation days means that companies implicitly adjust cash wages and their increase to the number of actual hours worked by employees. More vacation days means less in terms of wage increases.

It's the same thing with employer-paid insurance and pensions.

As my colleague put it so well, they are all simply another variant of the old-style 'defined benefit' compensation system. And every non-cash mandate or demand by unions or government decreases cash compensation to workers.

One of my very first blog posts concerned the culpability of union chiefs in recommending to their workers to take promises of future pension and health care benefits, rather than cash upfront.

That has turned out to be a huge mistake.

Companies don't live forever. Business dynamics change. Promises made 40 years ago may become unaffordable, and simply unpayable.

Imagine if unions had stopped at demanding safe working conditions and a maximum number of hours in a 'regular' workweek?

Then better workers would make more money. In cash. Those who wanted a pension would save for it. Those who desired health care could buy it. Those who did not, would enjoy greater disposable incomes.

Those who wished to work longer hours for more money could negotiate that, too.

Typifying the modern worker as BusinessWeek does actually tells us something very important.

Seventy-five or so years after New Deal-backed initiatives to force companies to obey a truckload of mandates regarding employees, company managements have finally come full circle to simply defining workers as not belonging to their companies.

If they don't have permanent employees, then they don't have to comply with an overgrown thicket of employee regulations.

In truth, the business world is always in flux. There are no free lunches. There is no static business world in which a promise today has a guarantee of fulfillment 30 years from now.

That would be fantasyland.

The trend to portable IRAs is a good one. So, too, would a simple tax-treatment change to allow everyone to purchase health insurance on the same tax-preferenced basis, but as individuals.

In the long run, it's actually better for workers to control the way they spend, or save, higher cash wages, than to have mediocre managements and union leaders promise to look after their medical insurance and pensions, while paying employees less in cash today.

I'm sure that's not what the BusinessWeek cover and article intends to contend. But that's the perspective I have on it.

It may have taken three generations of business management and radical transformation of the US economy, but it ought to be clear to everyone now that relying on promises of future payments by any company, or the government, is foolish.

Better to function like a private contractor of your own talents, demand more cash with no strings attach, and make your own lifestyle choices for health care and future income from invested savings.

The Fed's Behavior Re: AIG Disclosures

The Wall Street Journal published two very damning articles concerning the federal government's handling of AIG in 2008.

The first, on Friday, concerned emails from Fed personnel addressing the filing of detailed information regarding AIG's payments to counterparties. The Fed directed AIG to conceal details which AIG personnel indicated the SEC would prefer reported.

Aside from the obvious issue of one hand not knowing what the other is doing, or there being conflicts between federal entities on what they demand/require of companies, there's the issue of transparency.

The Fed's position smacks of concern that the actions it directed AIG to take were ones it would be unable, or unwilling, to explain and defend in public.

This sort of clandestine action by government, with a major once-private, then questionably "taken" by government, ought to be very worrisome to the business community.

A day later, in the weekend edition, the Journal published, as its customary single, long interview with a prominent business person, a piece by Holman Jenkins regarding his recent conversation with former AIG CEO Hank Greenberg.

I won't reprint major portions of Jenkins' piece. Suffice to say, Greenberg made his major theme that the business press needs to ferret out why Goldman Sachs, Morgan Stanley, Citigroup, et. al., were saved by federal cash, while AIG was, instead, marked for takeover and eradication.

Greenberg mentions something about which I was unaware, and I'm sure I'm not alone. He explained a 2005 change in the operation of credit default swaps by ISDA, the International Swaps and Derivatives Association. The change essentially changed such swaps from having value changes settled once, at maturity, to being ongoing 'mark to market' payments. He doesn't allege, but asks, whether or not Goldman Sachs, which bought large amounts of such swaps from AIG, was behind this change?

He also bluntly challenges the press to discover why AIG was treated so differently by Paulson and Bernanke than were the commercial and investment banks?

One passage really does deserve to be quoted,

"Most of all, he cannot fathom why Treasury and the Federal Reserve let billions of dollars fly out the backdoor to Goldman and other firms. Washington could have simply ordained that AIG's debts were the government's debts and so no collateral was due given Uncle Sam's bulletproof credit rating."

It's a more than fair point. And Greenberg, never a fool, is clever to call for objective press investigations into this mess.

If you see unholy alliances between Goldman and the Treasury and/or Fed, made in the shadows, then you find yourself agreeing with Greenberg's demand that somebody force explanations.

Even if you don't see such alliances, it still makes sense that, over a year later, the major players explain exactly why such differential treatment was demanded for AIG, than the commercial and investment banks which the government elected to save.

Google's Misunderstood Android Phone

Since the launch of Google's Android cell phone recently, much discussion has focused on Google vs. Apple. On how big a lead the iPhone has, how many units sold, users, applications downloaded, etc.

This all misses the point.

In fact, the Android provides an example of what my old boss at Chase Manhattan, Gerry Weiss, and his team at GE, in the 1960s, identified as 'arena competition.'

Portraying GE's businesses in arenas, they noticed way back in that era how cable and other entertainment forms could and would have impacts on GE's television and related businesses. The most damaging sorts of competition, they found, were when one company inadvertently entered another arena other than its own, typical product/market, in order to support business strategies in its core areas.

These new entrants often undercut the profitability of the business models of the existing competitors because their main focus was on another sector.

Google is following online eyeballs from PCs to cell phones. In order to control the environment, they want to control the operating system. To do that, they simply added the commodity platform, too. A new cell phone.

Because they don't want to earn all, or even most of their profits from the cell phones, they represent a danger to other cell phone makers. And, as one pundit noted, to Microsoft, by reducing that company's market for mobile operating system sales.

Apple? Google probably doesn't really care that much about the iPhone, per se. Rather, they care about extending their advertising business to the cell phone market.

If they can support healthy growth in ad revenues on cell phones with minimal outlays for Android, or break even, they have probably met their objectives.

In the process, they are reducing the carriers to "operators," teaching people to buy a phone, then choose the network, and disrupting a product/market they don't really even see as central to their profitability, except as it supports and facilitates continued ad revenue growth.

Rather like IBM cannibalizing all manner of products, services and labor as mainframe computing applications marched out of the first areas, into more accounting, inventory and other business processes. How many purveyors of supplies and services to old-fashioned offices of the early 1960s were put out of business by IBM, while IBM only saw rising mainframe and applications software revenues?

It's the same for Google and its Android.

More Reflections On AOL, TimeWarner, & Steve Case's Understated Brilliance

On Monday, I wrote this post regarding the appearance of both Steve Case and Gerald Levin, the co-architects of arguably the absolute worst merger in the past 10 years.

As I discussed the post, and the event, with my business partner over lunch yesterday, more nuances came out which I honestly don't think I've ever seen mentioned about the ill-fated deal.

What I wrote earlier this week,

"Let's be really frank here. In 1999, nobody wrote blogs, and I didn't write this one. But at the time, I verbally declared to all who would listen that the TimeWarner-AOL merger was simply a case of the latter cashing in on its temporary valuation surge, at the expense of the former. Nothing more, nothing less.


There was zero business reason for the merger. I immediately sold the shares I held by virtue of my AOL position when the merger closed.

Levin isn't some accomplished graybeard former CEO. He is a failed wannabe-CEO. Steve Case induced Levin to snooker his own board and rob his own shareholders' wealth to give it to investors in AOL."

My partner asked whether I thought AOL, now spun off, had actually declined in value by more than, say, Yahoo, from its 1999 highs.

As the nearby price chart shows, Yahoo is down significantly from its 2000 high. For purposes of this post, a rough estimate is sufficient. It looks like Yahoo peaked in 2000 at around 100. Today, it's trading at 16-17. That's about a 84% decline on the $50 base.

By 2002, one news article of the day noted that the combined AOL-TW had already plunged by some 70% in value.

Looking at the TW price chart, we see the company's equity price fell from the $300 range to around $29 now, ex-spin off of the remaining stump of AOL. The per-share numbers for the old and new AOL wouldn't be meaningful, until adjusted for number of shares, so a straight market value comparison would be appropriate.

However, here's where the real genius of Steve Case becomes apparent. When we got to this point, I suggested to my business partner that there wasn't really much point in comparing the two values, because cable internet access had, would have, destroyed the core value of AOL anyway.

And this is where you have to give Steve Case credit far, far beyond what anyone has even hinted at so far.

As my colleague and I discussed why we were members of AOL back in the 1990s, we agreed it was the simplicity of access. The site's content was never very important to either of us. In fact, as we remembered those days, I pointed out that the content was added mostly as a freebie to give subscribers something more than bare-bones dial-up access. It differentiated AOL from the other ISPs of the day which only provided simple web access and an email address.

But by 1999, any really smart industry player or observer could see that AOL's very success was already about to undermine its business model. To wit, the huge subscriber base it had created was rapidly learning to stay logged in all day.

Remember when modem speed was an important feature on your desktop PC? When your local phone company had to create new area codes just to generate new telephone numbers for second phone lines dedicated to online access? I cancelled mine only about seven years ago, when I elected to use my main landline as a dial-up backup access mode, should my high-speed cable connection fail.

Who even bothers with that anymore? How many are already just closing their landline accounts?

So, back to AOL and Steve Case.

By 1999, I think Steve Case already saw the flattening of growth in AOL's subscriber base, as people began to migrate to their local cable television's high-speed internet service. Even if AOL's membership and revenue hadn't actually declined, the slowing of its growth would have immediately poppled the company's equity price bubble.

Remember, we're talking about the final days of the famed 'tech bubble' in equity markets.

I think Steve Case, by early 1999, or perhaps even mid-1998, knew he had about 24 months to find someone willing to monetize the incredible bubble of temporary, excess franchise value inherent in AOL's equity price. Left on its own, AOL would have become another Yahoo.

But Steve Case managed a masterful sleight-of-hand trick. By convincing TimeWarner's Gerald Levin that AOL's content and distribution, married with TW's content, would make for the first great internet content-plus-access giant, he successfully off-loaded his shareholders' price risk to TW's hapless owners.

Case exited the combined company rather quickly. It was fairly easy, as a former AOL shareholder, to immediately sell TW shares at a decent price.

To see how big a con game Case managed to pull on Levin and his board, note how tepid the market's response has been to Comcast's purchase of NBC from GE. Yesterday's Wall Street Journal editorial by Holman Jenkins castigates Comcast for being late and myopic in understanding what is at stake. How fast the movement of viewing platforms has moved, so that the real game is already beyond television, and onto laptop and cell phone screens.

Steve Case managed to convince Gerald Levin ten years earlier that there was value in combining distribution and content. A concept about which I've written in prior posts over the past years, as have others in other media. It's never worked. It's always been a flawed strategy.

In the case of AOL-TW, as I mentioned to my colleague, when he asked, neither Case nor Levin addressed the price issue on CNBC Monday morning. Neither did any of the co-anchors. Amazingly, everyone simply bought the story of implementation failure, electing to ignore the obvious overpayment by TW for fleeting value temporarily resident in AOL's equity price at the time of the merger.

Case solemnly spoke to issues of implementation with a straight face!

What an actor! What a magician! He duped Levin into overpaying for a dial-up based internet access firm about to be crushed by high-speed cable. He adroitly invited Levin on air to confess to his errors, leaving Case to avoid the spotlight.

The truth is, Case delivered for his shareholders, then moved on to new ventures. By inviting Levin to appear with him and take all the blame, as well as conveniently ignore his own culpability in even doing the merger, Case publicly shut the door on ever being viewed as a charlatan.

Credit Steve Case with continuing brilliance. He saw the end of AOL's dominance long before anyone else, and, unusual for a CEO, actually accepted reality and moved to get ahead of it. He found a dupe to pay full price in advance of the decline of value in AOL's business model. He rewarded his own shareholders, then smartly left the scene, moving on and away from the developing disaster at TW-AOL.

The best part of the story Monday morning, and probably forever, about the AOL-TW merger, will never emerge from Case's lips. He's much too smart and clever for that.

didn't go far enough. Or give Steve Case due credit.

The Nature of Risk In 2010 & Beyond

As a new year begins, people are prone to attempting forecast coming events which may be major opportunities or threats to expected 'business as usual' flow.

However, the day-in, day-out business of risk management, such as it is, at financial services firms, revolves around various mathematical models involving variance and various derivations thereof.

As I mentioned to a colleague recently, even after financial markets in 2007-2008 exhibited quite exceptionally above-average volatility and experienced some generational failures of institutions, what most people mean by 'risk management' at a bank, trading or investment firm continues to be dominated by these intricately-modeled approaches.

To me, however, the big lesson of the past two and a half years, beginning with the failure of two mutual funds at Bear Stearns in the summer of 2007, is that of large-scale, unmodelable events which overwhelm those intricately-calibrated, position-by-position, trader-by-trader or instrument-by-instrument, quantitative risk management systems throughout various financial institutions.

In early September of 2008, just days before the equity market took a dramatic, once-every-twenty-year plunge in value, my business partner and I, having blithely begun to invest in long-dated equity options about a year earlier, apprised the risk of buying calls as minimal.

Talk about risk.

That event set off a continuing, evolutionary process of development of risk monitoring tools for our options investments. We learned that the speed and nature of market impacts on options is distinctly different than it is on equities.

As with our equity risk tools, we explored and designed options risk monitoring tools to signal directional changes, rather than point-estimates of value or forecasts of indices.

Personally, I would venture to guess that such global risk indicators actually provide more value than the minutae generated by the complex mathematical risk management systems at major institutions.

It appears, in retrospect, that John Paulson's hedge fund, and Goldman Sachs, used such rudimentary approaches to place their investments on the more profitable side of the steep equity sell-off of 2008.

To me, that sort of correct macro move is, although simpler, more important than the very complex and higher-order risk management systems which hold so much sway at financial institutions.

I commented to my business partner this weekend that our conversations about risk are much richer, better-informed and useful now than they were on that fateful day in September of 2008.

For example, in the fall of 2008, I noted, we could have easily observed the mounting problems in CDO valuations, as well as the looming basic economic woes of the US economy.

Of course, we didn't have the options risk monitoring tools we now possess. Had we had them at our disposal that September, we'd have already been positions in puts, ready for the ensuing roller-coaster ride down with the S&P500.

The point is, now we have useful, effective monitoring tools which draw our attention to the things which might account for the indicators which we observe.

The risk monitoring tools don't explain why they are indicating the actions, or inactions, they do, but they give us a context in which to assess the information, usually qualitative, which we have at hand.

To me, that's what risk identification and management is really about. It's not the detailed minor decisions, so much as the sweeping, large-scale market inflections that so often surprise investors.

When Jobs Go Away, Do They Come Back Again?

So much focus over the past twelve months has been put on job losses and hopes for their return that it has apparently become the be-all and end-all of US economic policy.

On that note, a colleague and I discussed the recent equity market reactions, never mind the cheerleading pundits, over the recent slowing of job losses and new jobless claims.

Let's take a moment to view job losses over the past few years.

We've known for about a year that the NBER declared the US economy to enter recession in late 2007. Here's a pdf file from the US Dept. of Labor containing a very clear, easy-to-read chart of monthly payroll changes from November 2007. Job losses peaked a year ago at a rate of over 600,000/month. By last August, the rate was back under 200,000/month.

The US experienced a recession brought on, in large part, by a long term explosion of bad real estate lending, brought forth by Congressional mandates and suasion of two GSEs, Fannie Mae and Freddie Mac, to buy, package and distribute marginally-creditworthy mortgage loans. The plummeting value of bonds containing those loans, and their subsequent repackagings, caused financial service firms to lose equity, slash lending and, by extension, create downward economic pressure. Coincidentally, the marginal mortgage loans began experiencing high losses, which caused loan defaults, foreclosures, and subsequent losses of value in various US locales which had recently experienced such heated residential property value growth.

After this two-pronged blow to the US economy began in late 2007, consumer spending and net worths plummeted, as job losses mounted. To be sure, 2008 was a year of maximal effects of these trends.

Thus, nobody would have expected 2009 to necessarily be as bad as 2008. And the deep job losses of late 2008 did, indeed, attenuate and slow to a trickle last month.

But as we stand at a point of seeming inflection, ask yourself,

"Where will new jobs appear?"

Do you really think what happens now is that companies that cut workers start calling them up to return to offices, production lines, etc.?

Do you think that companies which spent the last 24 months re-engineering operations, boosting productivity with fewer employees, and enjoying higher margins amidst low revenue growth, are simply going to issue calls for more people?

Or do you think those components of the US economy, in a Schumpeterian manner, have evolved and improved to a degree that what was normal for them no longer is?

It would be a set of incredibly inept managements to have stood still for two years amidst a slumping economy and made no changes whatsoever to business models, staffing, operations, etc., so that current production levels would require the same numbers of employees as before 2007.

And the most recent quarterly productivity data did indeed show some incredible growth. If memory serves, more than +5%. Or some other, totally unexpected number.

So, where will new jobs appear in the US economy?

My colleague and I quickly ascertained, having been in business for a combined total of more than 50 years, that they will appear in new businesses.

Don't expect great job growth from a propped-up, failed, government- and UAW-owned GM. Or Chrysler. Don't expect the recent Congressional health care bill to spur hiring in pharmaceutical firms. Or health insurers.

No, it's much more likely that new hiring after recessions, since 1982, come from new businesses in the economy.

Given the improvements since the mid-1980s in usable technology, it's clear that startups don't engage in as much physical goods creation, metal-bashing, and high employment levels to create market value. For example, Google has a market capitalization of nearly $200B, but employs only about 20,000 people full-time.

That equates to roughly $10MM of market value and $1.1MM of revenue per employee. On only $250K of PPE/employee.

Hardly a steel or auto company, is it?

Yet that's where non-commodity, high value-added, defensible competitive-advanted jobs are created in our economy now.

Think about that again and reread it.

If you created another GOOGLE, you'd only add 20,000 workers to the US economy! And that's a well-run, long-lived, successful knowledge-oriented US business.

So, don't hold your breath on employment growth in the US economy anytime soon. With so much government-induced uncertainty and consumer spending declines, there's just no longer a linkage between a recession's technical end and the robust growth of jobs.

That seems to have ended with the last pre-Reagan recession-recovery cycle.

Misunderstanding Inflation

Tyler Matheson, CNBC's program director, was filling in for an anchor this afternoon.

As such, he showed remarkable ignorance of a debate on his own network when he pontificated that,

'in order to have inflation, wages or spending have to go up!'

For the millionth time, let's get it straight.

Friedman. Inflation. Monetary phenomenon.

"Inflation is always and everywhere a monetary phenomenon."

Sheesh. Can't these guys get anything right?

Only a committed Keynesian would still believe that inflation must always and only be demand-push in nature.

First giving that nitwit Levin a platform to show how inept he was and is this morning.

Now this.

How much worse can CNBC get?

Gerald Levin & Steve Case on CNBC This Morning: TimeWarner-AOL Merger Failure

CNBC had former AOL CEO Steve Case as guest host this morning for several hours. As his guest, Case invited his former co-CEO, TimeWarner's Gerald Levin, to appear and discuss the merger which is now generally regarded as the worst of that decade, or the past ten years, if it's not a formally-demarcated decade.

The exchanges among Case, Levin, and the CNBC co-anchors, as well as Levin's own soliloquy, were amazing. And not in a good way.

First, let me remark on Levin's performance.

If memory serves, Levin's son was murdered in a highway robbery-and-murder case sometime during the aftermath of the TimeWarner-AOL merger. Even back then, I believe Levin gave the event some weight in his decision to leave the company. It's fair to say that it had a profound effect on him.

That said, Levin's new persona is, to be blunt, stomach-churning. He now sports a goatee/beard and moustache, jacket and open-collared dress shirt, and a whole new, evidently therapist-supplied vocabulary of kindness and gentility.

Levin took total responsibility for the merger's failure, absolving Case, who sat only a few feet away, as well as the TimeWarner board.

This is ridiculous. As I said to colleagues at the hedge fund with which I worked at the time, the TimeWarner board should have engaged an investment bank, economist and valuation consultant to build a case that TW's shareholders would be harmed in the long term by being forced to buy a temporarily overvalued AOL with TW equity. It wouldn't have taken too much to construct a reasonable defense that would have allowed Levin and his board to contest the merger bid from Case's AOL.

In any event, Levin's statements merely add to the view that corporate boards are meaningless. Not to mention that he implied that he would have, or did, simply ignore whatever his board, as shareholder trustees, wanted, and forged ahead regardless.

Thus, I think Levin marked himself this morning as simply a poor, inept CEO.

However, Levin then took questions and pontificated on large mergers, TimeWarner-AOL's subsequent inept merger implementation, and various other managerial topics.

His comments were peppered with soft, touchy-feely phrases which really do suggest he's spent a lot of time and money on therapy. The phrases, which I can't recall exactly, truly sounded like a well-rehearsed mantra which emanated from his therapist's mouth.

Essentially, Levin alleged that the post-merger challenges were all about people, expectations, fears, etc., and that he and Case were required to satisfy "Wall Street" expectations. Thus, Wall Street was the villain, and poor Levin and Case were just babes in the woods as they tried to merge and then manage the two companies.

Case chimed in similarly, which isn't surprising. He has taken his winnings and moved on to another web-based business. It's easy for him to now declare that it was really always about people, not technology.

That's not what he said at the time of the merger.

Further, Levin now confesses that the performance that he and Case promised in the first merged year was, in reality, unrealistic.

Sounds like fraud and incredibly naive management, doesn't it? I mean, Levin didn't stop the deal because he couldn't commit to the performance he believed was required by shareholders or analysts. Neither did Case. Neither resigned or said they really wouldn't be up to the task.

No, they both took lavish compensation and then, much later, declare that it was never really possible to meet investors' expectations anyway.

Pardon me, but who exactly set those expectations in the first place? Wasn't it Case and Levin, to justify a merger that few thought was really worthwhile?

Let's be really frank here. In 1999, nobody wrote blogs, and I didn't write this one. But at the time, I verbally declared to all who would listen that the TimeWarner-AOL merger was simply a case of the latter cashing in on its temporary valuation surge, at the expense of the former. Nothing more, nothing less.

There was zero business reason for the merger. I immediately sold the shares I held by virtue of my AOL position when the merger closed.

To see Levin now denounce GE, Citigroup, and a host of other companies as lacking in focus and managerial sensitivity, or whatever it was he babbled about, was almost embarrassing.

Equally embarrassing was that nobody on CNBC even pretended to question, challenge or otherwise call Levin, and, for that matter, Case to account for the mess they created.

It was shameful. Instead of grilling the two in front of business viewers, they just lobbed softball comments and occasional helpful, nearly adulatory questions.

From what I saw, Levin is just one of at least two lawyers who inherited large, unwieldy companies and mismanaged them into disaster. The other, of course, is Citi's Chuck Prince.

To suggest that Levin has anything worthwhile to tell anyone else, or any other CEO, except,

'Don't be a lawyer and try to pretend to be CEO at a large, complex, already-undperforming company,'

is just plain silly.

Levin isn't some accomplished graybeard former CEO. He is a failed wannabe-CEO. Steve Case induced Levin to snooker his own board and rob his own shareholders' wealth to give it to investors in AOL.

CNBC does a great disservice to business and investors everywhere by giving Levin and Case this platform, sans critical questioning. Levin and Case then proceeded to compound the mistake by behaving like they were somehow victims, themselves.

All in all, a disgusting, nauseating performance this morning on CNBC.