Last week, I wrote this post regarding GE's status as a discounted, closed-ended fund.
Within it, I referred to CEO Jeff Immelt's remarks last week on the turnaround at NBC Universal. He assured the CNBC audience that he personally approved of the new slate of television programs and films. That everything was fixed, and good times were at hand for the media unit of the ailing conglomerate he oversees.
Then came an article in the Wall Street Journal this past Tuesday. It announced the firing of programming chief Kevin Reilly, "as ratings slide."
Wow! That was quick! And I thought Jeff had it all under control. Buttoned down. In the bag.
Guess not.
According to the article,
"NBC Universal's timing indicates it doesn't have much faith Mr. Reilly's new slate contains the type of hit that could lift the network out of the ratings basement.....Mr. Reilly's successor will need to move quickly to put his stamp on the shows for fall, build morale at the network and learn GE's corporate culture."
According to Nielsen ratings, NBC "ranks a distant fourth behind Fox, CBS and ABC."
Maybe Jeff should hope to get a call from Rupert Murdoch, offering to take the struggling GE media property off his hands while it still has some value.
In any case, it sure makes you wonder what kind of conglomerate Immelt is running. Last week, he assures investors that his network unit is in great shape, and the progamming lineup is fixed. This week, they fire the chief programmer, amid word that the slate is in trouble.
Is this why GE, and its shareholders, 'enjoy' continued mediocre performance?
Friday, June 01, 2007
Thursday, May 31, 2007
Apple, Microsoft & Schumpter- Steve and Bill Onstage Together
This morning's CNBC programming was heavy with clips of last night's Wall Street Journal-arranged hour and forty minute joint appearance by Steve Jobs and Bill Gates, hosted by two of the paper's columnists, Kara Swisher and Walt Mossberg.
Throughout this morning, I've seen the various clips of the two complimenting each other, discussing Apple's "PC Man" advertisements, and commenting about current technological trends.
As I listened to guests, on-air anchors, pundits, etc., all comment on the event, one thing was clear to me. These two people don't compete with each other anymore. One doesn't even really work now.
The fact that this event could even be staged tells you all you need to know. Active, competitive rivals don't typically sit around in plush leather chairs and exchange jokes and pleasantries about the "old days." Steve Jobs and Bill Gates, as software and/or hardware company CEOs, are now irrelevant. So was most of what they said last night.
Jobs has morphed Apple into a multi-pronged, digital entertainment and communications device manufacturer. Gates retired from his now-moribund software giant. Neither is changing the world with his company's work on PC-related efforts now.
Of course, CNBC's anchors stoked the fires, breathlessly asking,
'So, what does this mean for you as an investor?'
Fortunately, a few of their guests correctly replied, "nothing."
One CNBC anchor even opined on the two old rivals teaming their companies to "take on" Google.
As if.
Apple's taking advantage of the internet-oriented consumer base that Google has fostered. Microsoft is hopelessly behind. The two together have nothing that could possibly threaten Google now. They just compete in totally different product spaces.
This joint appearance by Jobs and Gates is a validation of Schumpeterian dynamics. In the 1983 clip of the two of them the last time they shared a venue, one can feel a bit of the old excitement of the nascent personal computer age. IBM's PC was just a few years old, and Jobs needed Gates & Co. to design software for the Macintosh.
That world is long, long gone. Apple PCs can run Windows operating systems, and the iTunes store was built to connect to a Windows world.
What this event demonstrated is that companies are a lot like athletes. They have a prime, then they age and die. CNBC commentators notwithstanding, neither Apple, nor Microsoft, is likely to be an investment in anyone's portfolio for their personal computer-related activities anymore.
The technological action has moved on, bypassing both companies' computer system-related efforts, as Schumpeter predicted.
Throughout this morning, I've seen the various clips of the two complimenting each other, discussing Apple's "PC Man" advertisements, and commenting about current technological trends.
As I listened to guests, on-air anchors, pundits, etc., all comment on the event, one thing was clear to me. These two people don't compete with each other anymore. One doesn't even really work now.
The fact that this event could even be staged tells you all you need to know. Active, competitive rivals don't typically sit around in plush leather chairs and exchange jokes and pleasantries about the "old days." Steve Jobs and Bill Gates, as software and/or hardware company CEOs, are now irrelevant. So was most of what they said last night.
Jobs has morphed Apple into a multi-pronged, digital entertainment and communications device manufacturer. Gates retired from his now-moribund software giant. Neither is changing the world with his company's work on PC-related efforts now.
Of course, CNBC's anchors stoked the fires, breathlessly asking,
'So, what does this mean for you as an investor?'
Fortunately, a few of their guests correctly replied, "nothing."
One CNBC anchor even opined on the two old rivals teaming their companies to "take on" Google.
As if.
Apple's taking advantage of the internet-oriented consumer base that Google has fostered. Microsoft is hopelessly behind. The two together have nothing that could possibly threaten Google now. They just compete in totally different product spaces.
This joint appearance by Jobs and Gates is a validation of Schumpeterian dynamics. In the 1983 clip of the two of them the last time they shared a venue, one can feel a bit of the old excitement of the nascent personal computer age. IBM's PC was just a few years old, and Jobs needed Gates & Co. to design software for the Macintosh.
That world is long, long gone. Apple PCs can run Windows operating systems, and the iTunes store was built to connect to a Windows world.
What this event demonstrated is that companies are a lot like athletes. They have a prime, then they age and die. CNBC commentators notwithstanding, neither Apple, nor Microsoft, is likely to be an investment in anyone's portfolio for their personal computer-related activities anymore.
The technological action has moved on, bypassing both companies' computer system-related efforts, as Schumpeter predicted.
Wednesday, May 30, 2007
The Economy, Liquidity Sources, and The S&P's New High
Friday's Wall Street Journal featured a fascinating editorial by David Ranson and Penny Russell of H.C. Wainwright & Co. Economics.
Their contention summarizes thoughts I've had since my first year in graduate business school nearly twenty years ago. That is, private monetization has evolved, since the early 1960s, to the point where it's reasonable to question how much impact the Federal Reserve's decisions and actions now have on our economy.
As the S&P500 flirts with a new closing all-time high, it's prudent and natural to wonder if this is a spike, or simply a stop on the continued road upward, as the index mirrors a healthy, growing economy.
Back when the index hit its previous high, in March, 2000, just over seven years ago, its P/E was in the low 30s. I don't know the precise current P/E for the S&P500, but I've heard something in the neighborhood of 15-18 bandied about by various pundits on CNBC in the past few days. Thus, the value of the S&P has returned to its seven-year prior level, but on much healthier revenue and earnings, and growth thereon. As opposed to a quick runup in the index, based upon internet startup valuations, it's now a function of a broader, slower growth in real revenues and earnings.
What does this have to do with the Journal article? Plenty.
Some pundits believe that most of the reasons for this recent rise in the index, and equity markets in general, is merger and acquisition activity. Personally, I think it is more a case of gradual, grudging recognition by mediocre analysts and money managers that the US and global economies are, in fact, growing in a low-inflation, healthy manner, thank you very much. Now, as a result of the under-appreciation of this, some smart capitalists have been buying other companies. But I would say the M&A activity is a result of growth expectations on the part of the better investors, frequently at private equity firms. Not the cause of the market advances.
What is private equity, if not private monetization of value and liquidity?
Back to the article in the Journal. The authors contend that the effects on "real consumption" of a 100-basis point increase in short-term interest rates, driven by the Fed Fund rate, has decreased from 1.84% in the period 1945-59, to -0.01% in the period 1990-2004. They contend that, as recently as 1975-89, the effect was as high as 1.35%.
Back in my graduate business school days, we studied the Treasury's "Operation Twist," its attempt to manipulate the term structure of interest rates, in the face of the nascent Euro-dollar market. This began due to, as is so typical, unintended consequences of a tax policy. The Treasury levied a withholding tax on the purchase of debt securities, in an attempt to control monetization. The result was the development of an off-shore issuance market in dollar-denominated debt, free of the tax. Voila, the leaks in US monetary base control had begun.
Coupled with the gradual liberalization of the old (again, things we were still taught in graduate school in 1979) regulations (R and Q come to mind) governing installment credit and bank deposit creation, the US monetary base began to undergo a transformation from a tightly-controlled quantity to a more easily expanded one enhanced by private credit extension.
With the arrival of more general-purpose credit cards, ATMs, cash-management sweep accounts at brokerages, and more expansion of public-company debt, monetization went wild.
I've always thought that most people gave far too little credit, if you'll pardon the pun, to the ability in our society for the private, which is to say, non-government, sector, to issue large amounts of debt in ever-easier to use packaging.
If you recall your old classical theory of money, M=Q*V, the V, or velocity, has been revved up by devices such as credit and debit cards. Additionally, the Q, or quantity, has been changed in character, as, now, immense pools of private equity capital invest small equity stakes in acquisitions, and simply issue debt through the public markets to complete the financing.
Ranson and Russell believe that this marginalization of the Fed is a good thing, as its "medicine" typically consisted of either starving the economy of funding, or flooding it with the same. Feast or famine, unemployment or inflation.
Now, we have the entire financial sector engaged in the role of money creation. Think about that.
Which would you prefer, if you had to choose just one method of money creation? A somewhat closeted group of unelected, but very intelligent and educated people who divine the market via their analyses, and set an interest rate? Or dozens of private entrepreneurs, large and small, who issue debt and monetize value, hoping to guess correctly on the profitable uses of the value they have monetized with their own currencies- resold mortgages, corporate debt, LBO debt, credit card receivables, etc.
It's a testament to our economic system that, slowly, without much notice, the private sources of monetization have come to limit, if not eliminate, much of the long-term effects of Fed policy, while shouldering the risks associated with the management of the quantity of "money" in our economy.
To quote from the economists' editorial,
"Ready access to both equity and debt capital from a proliferating number of sources means that businesses are no longer forced to curtail their activities when the Fed impeded the banking system's ability to provide credit. And since businesses thus no longer needed to lay off employees, employees no longer needed to cut back on their spending."
The passage which I have bolded is crucial. Essentially, after a 46-year management of US value monetization by the Fed (1914-1960), private sources began to flourish as means to fine-tune and adaptively finance business liquidity needs.
Right now, we see a situation in which the old quote, "this time, it's different," is actually true. Instead of the Fed's blunderbuss firing at a sector such as subprime real estate lending, and taking out the entire economy, we have private credit creation selectively expanding and contracting, according to the risks and losses experienced in each sector.
Congress, with its witch hunt for culprits in the subprime meltdown, is years away from comprehending this. Ben Bernanke is not. I think he actually realizes the truth, as synopsized in Ranson's and Russell's insightful editorial.
The benefit of risk-bearing, private-capital-providing credit creation is now, a la Adam Smith, a sort of invisible hand, evolving without design, which is allowing our economy to weather various sectoral peaks and valleys with the risks spread, and no need for the entire economy to tank over one sector's collapse.
Thus, with this broader, risk-aware monetization of the US economy by private, as well as governmental sources, economic growth seems to be steadier, and the sources of the S&P500's recent gains more enduring.
Their contention summarizes thoughts I've had since my first year in graduate business school nearly twenty years ago. That is, private monetization has evolved, since the early 1960s, to the point where it's reasonable to question how much impact the Federal Reserve's decisions and actions now have on our economy.
As the S&P500 flirts with a new closing all-time high, it's prudent and natural to wonder if this is a spike, or simply a stop on the continued road upward, as the index mirrors a healthy, growing economy.
Back when the index hit its previous high, in March, 2000, just over seven years ago, its P/E was in the low 30s. I don't know the precise current P/E for the S&P500, but I've heard something in the neighborhood of 15-18 bandied about by various pundits on CNBC in the past few days. Thus, the value of the S&P has returned to its seven-year prior level, but on much healthier revenue and earnings, and growth thereon. As opposed to a quick runup in the index, based upon internet startup valuations, it's now a function of a broader, slower growth in real revenues and earnings.
What does this have to do with the Journal article? Plenty.
Some pundits believe that most of the reasons for this recent rise in the index, and equity markets in general, is merger and acquisition activity. Personally, I think it is more a case of gradual, grudging recognition by mediocre analysts and money managers that the US and global economies are, in fact, growing in a low-inflation, healthy manner, thank you very much. Now, as a result of the under-appreciation of this, some smart capitalists have been buying other companies. But I would say the M&A activity is a result of growth expectations on the part of the better investors, frequently at private equity firms. Not the cause of the market advances.
What is private equity, if not private monetization of value and liquidity?
Back to the article in the Journal. The authors contend that the effects on "real consumption" of a 100-basis point increase in short-term interest rates, driven by the Fed Fund rate, has decreased from 1.84% in the period 1945-59, to -0.01% in the period 1990-2004. They contend that, as recently as 1975-89, the effect was as high as 1.35%.
Back in my graduate business school days, we studied the Treasury's "Operation Twist," its attempt to manipulate the term structure of interest rates, in the face of the nascent Euro-dollar market. This began due to, as is so typical, unintended consequences of a tax policy. The Treasury levied a withholding tax on the purchase of debt securities, in an attempt to control monetization. The result was the development of an off-shore issuance market in dollar-denominated debt, free of the tax. Voila, the leaks in US monetary base control had begun.
Coupled with the gradual liberalization of the old (again, things we were still taught in graduate school in 1979) regulations (R and Q come to mind) governing installment credit and bank deposit creation, the US monetary base began to undergo a transformation from a tightly-controlled quantity to a more easily expanded one enhanced by private credit extension.
With the arrival of more general-purpose credit cards, ATMs, cash-management sweep accounts at brokerages, and more expansion of public-company debt, monetization went wild.
I've always thought that most people gave far too little credit, if you'll pardon the pun, to the ability in our society for the private, which is to say, non-government, sector, to issue large amounts of debt in ever-easier to use packaging.
If you recall your old classical theory of money, M=Q*V, the V, or velocity, has been revved up by devices such as credit and debit cards. Additionally, the Q, or quantity, has been changed in character, as, now, immense pools of private equity capital invest small equity stakes in acquisitions, and simply issue debt through the public markets to complete the financing.
Ranson and Russell believe that this marginalization of the Fed is a good thing, as its "medicine" typically consisted of either starving the economy of funding, or flooding it with the same. Feast or famine, unemployment or inflation.
Now, we have the entire financial sector engaged in the role of money creation. Think about that.
Which would you prefer, if you had to choose just one method of money creation? A somewhat closeted group of unelected, but very intelligent and educated people who divine the market via their analyses, and set an interest rate? Or dozens of private entrepreneurs, large and small, who issue debt and monetize value, hoping to guess correctly on the profitable uses of the value they have monetized with their own currencies- resold mortgages, corporate debt, LBO debt, credit card receivables, etc.
It's a testament to our economic system that, slowly, without much notice, the private sources of monetization have come to limit, if not eliminate, much of the long-term effects of Fed policy, while shouldering the risks associated with the management of the quantity of "money" in our economy.
To quote from the economists' editorial,
"Ready access to both equity and debt capital from a proliferating number of sources means that businesses are no longer forced to curtail their activities when the Fed impeded the banking system's ability to provide credit. And since businesses thus no longer needed to lay off employees, employees no longer needed to cut back on their spending."
The passage which I have bolded is crucial. Essentially, after a 46-year management of US value monetization by the Fed (1914-1960), private sources began to flourish as means to fine-tune and adaptively finance business liquidity needs.
Right now, we see a situation in which the old quote, "this time, it's different," is actually true. Instead of the Fed's blunderbuss firing at a sector such as subprime real estate lending, and taking out the entire economy, we have private credit creation selectively expanding and contracting, according to the risks and losses experienced in each sector.
Congress, with its witch hunt for culprits in the subprime meltdown, is years away from comprehending this. Ben Bernanke is not. I think he actually realizes the truth, as synopsized in Ranson's and Russell's insightful editorial.
The benefit of risk-bearing, private-capital-providing credit creation is now, a la Adam Smith, a sort of invisible hand, evolving without design, which is allowing our economy to weather various sectoral peaks and valleys with the risks spread, and no need for the entire economy to tank over one sector's collapse.
Thus, with this broader, risk-aware monetization of the US economy by private, as well as governmental sources, economic growth seems to be steadier, and the sources of the S&P500's recent gains more enduring.
Tuesday, May 29, 2007
Amazon's Music Store vs. iTunes
The Wall Street Journal reported recently on Amazon's entry into online music purchasing for digital players. Apparently, their major innovation is selling DRM-free tunes.
As the article noted, however,
"...it is unclear whether typical consumers even think about the kind of problems the Amazon service is trying to address. That's because Apple's tightly integrated iTunes Store and iPod so thoroughly dominate their respective markets that most people may not even be aware that there are restrictions on what they can do with their downloads."
If I recall correctly, Steve Jobs' recent memo arguing for the cessation of DRM systems cited a surprisingly low percentage of iPod capacity being filled by iTunes Store purchases. Most of the capacity, he contends, is ripped by users from their own collections of CDs, and stored onto an iPod.
If so, this suggests that Amazon is targeting an extremely small 'problem,' indeed. And, by being so late to the game, it's essentially paying up to enter a commoditizing market. There are several other MP3-compatible online music selling or renting services, so premium pricing would not seem to be possible.
This new initiative by Amazon causes me to wonder if this is the best they can do for growth now. Looking at the nearby Yahoo-sourced price chart, it's clear that Amazon has been essentially in neutral for nearly four years. It has outperformed the S&P500 for the period, but largely all in 2003. Since then, it's drifted lower, then slowly picked up again in the last year.However, it doesn't seem to demonstrate the sort of investor confidence, by driving its price steadily higher, that one associates with a profitably growing, technology- or retail-oriented company. I'm guessing that this new digital music sales effort won't do much to change this picture.
Friday, May 25, 2007
Business Media & Schumpeterian Dynamics
Today's "Financial Insight" column on the back page of the Wall Street Journal's Money & Investing section discussed Dell's recent foray back into retail, via Wal-Mart.
Essentially, the computer maker has deigned to sell some desktop units through the giant discount chain. Notably absent, however, are its notebook products. I wrote this post last fall, discussing how mistaken I believe Dell's strategy is in this respect.
At the end of the short piece, the authors wrote,
Dell has tried this strategy before, and it failed. In 1993, it began selling PCs at Sam's Clubs, a division of Wal-Mart. One year later, it pulled out. The reason: "This is a no- or low-return business," said Michael Dell. "We like to be in businesses where we can make money, and we know how to do that in the direct business. He must be hoping history doesn't repeat itself"
Guys, it never does.
What puzzles me is why much ink is even spent on this sort of Dell action anymore. History assuredly won't 'repeat' itself, in the larger sense, in that Dell is history. Its phenomenal total return and sales growth run is history. It has become just another datapoint sustaining Joseph Schumpeter's keen observations, early in the last century, on the nature of the rise and fall of businesses in a technologically-based, fast-moving capitalistic economy.
Home Depot is essentially the same. It, too, is now a market-saturating, mature company. The salad days of rapid, profitable growth and consistently-superior total returns are over.
Why can't the people in the business media see this? Companies are born, some develop strongly, they mature, then they age and go gently into that good night.
From an industrial structure point of view, aging sectors tend to consolidate, in order to preserve some vestiges of profit margin, amidst slowing or declining sales volumes and revenues. Very rarely, if ever, do leaders in a non-cyclical sector rise again, without drastically changing their business focus.
Dell and Home Depot are now, hopefully, just interesting, Schumpeterian footnotes in business history. I wish I could write that we won't hear a lot about them anymore, but that's probably not true. Because business writers and reporters don't seem to know all that much about business theory and reality over time. At bottom, business "news" and reporting seems to be more about entertainment than providing useful insights and information.
Essentially, the computer maker has deigned to sell some desktop units through the giant discount chain. Notably absent, however, are its notebook products. I wrote this post last fall, discussing how mistaken I believe Dell's strategy is in this respect.
At the end of the short piece, the authors wrote,
Dell has tried this strategy before, and it failed. In 1993, it began selling PCs at Sam's Clubs, a division of Wal-Mart. One year later, it pulled out. The reason: "This is a no- or low-return business," said Michael Dell. "We like to be in businesses where we can make money, and we know how to do that in the direct business. He must be hoping history doesn't repeat itself"
Guys, it never does.
What puzzles me is why much ink is even spent on this sort of Dell action anymore. History assuredly won't 'repeat' itself, in the larger sense, in that Dell is history. Its phenomenal total return and sales growth run is history. It has become just another datapoint sustaining Joseph Schumpeter's keen observations, early in the last century, on the nature of the rise and fall of businesses in a technologically-based, fast-moving capitalistic economy.
Home Depot is essentially the same. It, too, is now a market-saturating, mature company. The salad days of rapid, profitable growth and consistently-superior total returns are over.
Why can't the people in the business media see this? Companies are born, some develop strongly, they mature, then they age and go gently into that good night.
From an industrial structure point of view, aging sectors tend to consolidate, in order to preserve some vestiges of profit margin, amidst slowing or declining sales volumes and revenues. Very rarely, if ever, do leaders in a non-cyclical sector rise again, without drastically changing their business focus.
Dell and Home Depot are now, hopefully, just interesting, Schumpeterian footnotes in business history. I wish I could write that we won't hear a lot about them anymore, but that's probably not true. Because business writers and reporters don't seem to know all that much about business theory and reality over time. At bottom, business "news" and reporting seems to be more about entertainment than providing useful insights and information.
Thursday, May 24, 2007
Burberry's New CEO and New Focus
Today's Wall Street Journal featured an article on Burberry's new CEO, Angela Ahrendts, and her retrenchment strategy at the famous brand's company.
I think Ms. Ahrendts is a very bright and decisive CEO. Her corporate pedigree suggests she's ideal for the job.
What really puzzles me, however, is that her predecessor was unable to effect the same strategy, even though it is more than 50 years old.
According to the article, when
"Walking through the Burberry showroom here after becoming chief executive last July, Angela Ahrendts looked at the wealth of apparel and accessories and thought, she recalls, "Way too much stuff."
....On her third day as CEO at Burberry Group PLC, Ms. Ahrendts asked Burberry Chief Financial Officer Stacey Cartwright for a report on what each product contributed to the business. Its findings: 80% of Burberry's sales came from 20% of its wares."
This simple, yet magnificently effective analytical approach was pioneered by Russell Ackoff in the 1950s among America's steel mills.
My manager and mentor at Chase Manhattan Bank, Gerry Weiss, used to say,
"There are hundreds of business aphorisms which we all know. The question is, which three or four apply in this particular instance?"
Few CEOs, it appears, know enough of the business strategy playbook to be able to shift gears and handle different situations, well, differently. So many seem, in effect to be one-trick ponies. Perhaps growth, or cost-cutting, or simply 'steady as she goes.'
Thus, Ms. Ahrendt's predecessor, Rose Marie Bravo, pursued rapid growth at Burberry's, although it eventually plateaued after almost a decade.
What I think this suggests is that boards of directors need to be more sensitive to how a CEO continues to perform over time. Initial successes are fine, and should be compensated. But that does not guarantee an endless honeymoon.
The reality of business seems to be that most CEOs cannot easily transition between environments, such as turnarounds, cost-cutting, or growth.
So at Burberry's, as Ms. Ahrendt reins in the product line, improving profitability, it will probably be worth watching in a few years to see how she does re-igniting profitable growth, when the pruning is finished.
I think Ms. Ahrendts is a very bright and decisive CEO. Her corporate pedigree suggests she's ideal for the job.
What really puzzles me, however, is that her predecessor was unable to effect the same strategy, even though it is more than 50 years old.
According to the article, when
"Walking through the Burberry showroom here after becoming chief executive last July, Angela Ahrendts looked at the wealth of apparel and accessories and thought, she recalls, "Way too much stuff."
....On her third day as CEO at Burberry Group PLC, Ms. Ahrendts asked Burberry Chief Financial Officer Stacey Cartwright for a report on what each product contributed to the business. Its findings: 80% of Burberry's sales came from 20% of its wares."
This simple, yet magnificently effective analytical approach was pioneered by Russell Ackoff in the 1950s among America's steel mills.
My manager and mentor at Chase Manhattan Bank, Gerry Weiss, used to say,
"There are hundreds of business aphorisms which we all know. The question is, which three or four apply in this particular instance?"
Few CEOs, it appears, know enough of the business strategy playbook to be able to shift gears and handle different situations, well, differently. So many seem, in effect to be one-trick ponies. Perhaps growth, or cost-cutting, or simply 'steady as she goes.'
Thus, Ms. Ahrendt's predecessor, Rose Marie Bravo, pursued rapid growth at Burberry's, although it eventually plateaued after almost a decade.
What I think this suggests is that boards of directors need to be more sensitive to how a CEO continues to perform over time. Initial successes are fine, and should be compensated. But that does not guarantee an endless honeymoon.
The reality of business seems to be that most CEOs cannot easily transition between environments, such as turnarounds, cost-cutting, or growth.
So at Burberry's, as Ms. Ahrendt reins in the product line, improving profitability, it will probably be worth watching in a few years to see how she does re-igniting profitable growth, when the pruning is finished.
Wednesday, May 23, 2007
On Derivative For Risk Management: Richard Bookstaber's Views
Last Friday's Wall Street Journal featured a long article which constituted, more or less, a review of Richard Bookstaber's new book, "A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation."
The review sketches out Bookstaber's informed opinion that the dynamic use of various financial innovations, specifically derivatives, has contributed greatly to market meltdowns- the 1987 crash and 1998 LTCM, to name two.
Later that day, I saw a corresponding interview with Bookstaber, by the hapless Maria Bartiromo, on CNBC. Bookstaber reiterated most of the points covered in the Journal article. His response to her question concerning why Ben Bernanke would express confidence in derivatives as helping to spread risk more manageably throughout financial institutions, as evidenced by reduced market volatility, while Bookstaber is sounding a warning regarding the potential for increased, dysfunctional volatility, was quite interesting.
Bookstaber said, in effect,
"Yes, it's quiet right now, and things are working. But once they don't, watch out! That's when all hell will break loose."
Without a doubt, he's right, as is Bernanke. I discussed this with my current, and a former business partner at lunch that day. I hadn't yet heard Bookstaber's interview, but the same point was implied in the Journal piece.
The key to understanding the situation is to examine whether derivatives are used statically to guard against an unexpected, sudden market meltdown, or are planned to be used to offset a sudden and unexpected market meltdown. If you are using derivatives for the latter purposes, then, per Bernanke's view, they are beneficial. If, however, you are expecting to use derivatives dynamically amidst a market crisis, then Bookstaber's warning is correct, and, if anything, and understatement.
My partners and I all agreed, from twenty years of observing modern financial market meltdowns and crises, that the one thing of which you can absolutely be sure during a market crisis is that you cannot be certain of being able to trade any position.
Thus, there is a major difference between, say, using derivatives, such as options, as outlined in this prior post about Nassim Taleb's book, The Black Swan, and employing them in mind-numbingly complex combinations which are only underpinned by probabilistic distributional expectations, rather than straightforward, certain relationships. The use of call options to gain exposure to equity price appreciation, while removing the corresponding full exposure of price depreciation, is an example of the former. LTCM's complicated straddles and linked, cross-instrument and -market bets is an example of the latter.
When multiple derivative positions involving different instruments and markets are employed, many more assumptions regarding underlying distributions of occurrences of various price movements, and the probabilistic bets taken thereon, are often made than are realized.
Personally, I think this relates in some sense to the quality of talent going into financial engineering disciplines. Too often, less attention than necessary is paid to assumed underlying price distributions and various probabilistic assumptions on which, ultimately, so much of the value of presumed portfolio 'insurance' rests.
So, in this respect, I believe Bookstaber is right. Getting overly complicated in the use of derivatives invites failure of an investment strategy in the midst of a market meltdown that precludes any certain ability to dynamically reposition a portfolio.
Thus, as we consider options implementation of my basic equity portfolio strategy, I am mindful that it would be a static one, rather than an options approach that assumed any ability to trade in the midst of the type of rapidly-moving, unexpected market conditions. The key to successfully using derivatives is to allow them to function just by being in place, rather than hoping that a string of them move as predicted, according to 'typical' market conditions, or, if not, that they can be traded during such a market maelstrom to try to repair the damage of any incorrect assumptions.
The review sketches out Bookstaber's informed opinion that the dynamic use of various financial innovations, specifically derivatives, has contributed greatly to market meltdowns- the 1987 crash and 1998 LTCM, to name two.
Later that day, I saw a corresponding interview with Bookstaber, by the hapless Maria Bartiromo, on CNBC. Bookstaber reiterated most of the points covered in the Journal article. His response to her question concerning why Ben Bernanke would express confidence in derivatives as helping to spread risk more manageably throughout financial institutions, as evidenced by reduced market volatility, while Bookstaber is sounding a warning regarding the potential for increased, dysfunctional volatility, was quite interesting.
Bookstaber said, in effect,
"Yes, it's quiet right now, and things are working. But once they don't, watch out! That's when all hell will break loose."
Without a doubt, he's right, as is Bernanke. I discussed this with my current, and a former business partner at lunch that day. I hadn't yet heard Bookstaber's interview, but the same point was implied in the Journal piece.
The key to understanding the situation is to examine whether derivatives are used statically to guard against an unexpected, sudden market meltdown, or are planned to be used to offset a sudden and unexpected market meltdown. If you are using derivatives for the latter purposes, then, per Bernanke's view, they are beneficial. If, however, you are expecting to use derivatives dynamically amidst a market crisis, then Bookstaber's warning is correct, and, if anything, and understatement.
My partners and I all agreed, from twenty years of observing modern financial market meltdowns and crises, that the one thing of which you can absolutely be sure during a market crisis is that you cannot be certain of being able to trade any position.
Thus, there is a major difference between, say, using derivatives, such as options, as outlined in this prior post about Nassim Taleb's book, The Black Swan, and employing them in mind-numbingly complex combinations which are only underpinned by probabilistic distributional expectations, rather than straightforward, certain relationships. The use of call options to gain exposure to equity price appreciation, while removing the corresponding full exposure of price depreciation, is an example of the former. LTCM's complicated straddles and linked, cross-instrument and -market bets is an example of the latter.
When multiple derivative positions involving different instruments and markets are employed, many more assumptions regarding underlying distributions of occurrences of various price movements, and the probabilistic bets taken thereon, are often made than are realized.
Personally, I think this relates in some sense to the quality of talent going into financial engineering disciplines. Too often, less attention than necessary is paid to assumed underlying price distributions and various probabilistic assumptions on which, ultimately, so much of the value of presumed portfolio 'insurance' rests.
So, in this respect, I believe Bookstaber is right. Getting overly complicated in the use of derivatives invites failure of an investment strategy in the midst of a market meltdown that precludes any certain ability to dynamically reposition a portfolio.
Thus, as we consider options implementation of my basic equity portfolio strategy, I am mindful that it would be a static one, rather than an options approach that assumed any ability to trade in the midst of the type of rapidly-moving, unexpected market conditions. The key to successfully using derivatives is to allow them to function just by being in place, rather than hoping that a string of them move as predicted, according to 'typical' market conditions, or, if not, that they can be traded during such a market maelstrom to try to repair the damage of any incorrect assumptions.
Tuesday, May 22, 2007
Jeff's GE: Discounted Closed End Fund
Exactly one week ago, my partner and I attended a talk given by MIT Franco Modigliani Professor of Finance and Economics, Stephen Ross. I wrote about it here.
One of Professor Ross' topics was the anomaly of closed-ended funds selling at discounts to their net asset value. Specifically, approximately 7.5% for financial funds. I wrote that Ross discovered,
It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.
What, you may ask, does this have to do with Jeff Immelt's GE? Plenty.
Today's Wall Street Journal carries a short article on page C14, by the paper's guest columnist, the online website breakingviews.com. Usually, these pieces are pithy, regurgitating what's already been in current discussion in the business media.
This morning, however, it raises the question of what GE's plastics division sale says about the rest of the conglomerate's valuation. To quote from the article,
"GE's vaunted premium to the sum of its parts, as estimated by analysts, has pretty much disappeared. Moreover, the plastics sale suggests many of GE's assets may have more value than investors and analysts are giving the company credit for in their models.....Companies that trade at a discount to their parts are prime targets for activist investors. Mr. Immelt should consider spinning off businesses such as GE Money and NBC Universal, before uppity investors dictate a more-Draconian corporate strategy for him."
I couldn't have said it much better, although I wrote it first. Here. Last August. Only it's not about spinning units off, but simply breaking the whole company into its constituent, standalone, unrelated businesses.
You see, Jeff Immelt is, in reality, simply an overpaid closed-ended fund manager. GE's shares are, well, shares of a closed-ended fund. The fund has invested in, actually acquired, a collection of unrelated businesses- finance, power systems, plastics (now gone), entertainment, etc.
As Stephen Ross illustrated, closed-ended funds trade at a discount due to management fees. In financial funds, those fees are typically one percent of assets, plus some expenses. You may ask why closed-ended funds exist. I did. Perhaps they are holdovers from the days when brokerage fees were high, liquidity was in shorter supply, as was information, and the best way for many investors to diversify was to buy a diversified fund.
None of those conditions are true today. That's why GE is an anachronism, as currently structured. It has no current reason for being.
To drive this home, let me relate what I heard yesterday morning on CNBC, Jeff's private (GE-owned) network. While discussing the plastics unit sale, he took the opportunity to once more attempt to fend off calls for splitting up GE. In particular, he argued that NBC/Universal was now turning around, and that they had a great slate of network programming and films on the way.
This was just hilarious. Jeff Immelt, corporate titan, is also a seasoned entertainment exec, with a sure eye for the next big hits on both the small and large screens of the world.
If you believe that, I have a bridge in Brooklyn to sell you.
As I contended in this recent post, Immelt is actually the only GE CEO in modern times not to have put his own stamp on the company. In this post, I explained why that doesn't matter to Immelt. He's already received a stupendous payday for nearly six years of abject failure.
Now, putting together today's Journal piece with Professor Ross' findings on closed-ended funds, it's much easier to see why GE should be dismantled into its standalone pieces, exchanging one share of GE for shares in each of its units. The discounted value as a whole conglomerate won't go away. But the plastics unit sale will now signal to the private equity crowd that there's money to be made simply by gaining control of the firm and releasing unrealized value in a breakup.
This should be a most interesting year for GE and the private equity funds.
One of Professor Ross' topics was the anomaly of closed-ended funds selling at discounts to their net asset value. Specifically, approximately 7.5% for financial funds. I wrote that Ross discovered,
It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.
What, you may ask, does this have to do with Jeff Immelt's GE? Plenty.
Today's Wall Street Journal carries a short article on page C14, by the paper's guest columnist, the online website breakingviews.com. Usually, these pieces are pithy, regurgitating what's already been in current discussion in the business media.
This morning, however, it raises the question of what GE's plastics division sale says about the rest of the conglomerate's valuation. To quote from the article,
"GE's vaunted premium to the sum of its parts, as estimated by analysts, has pretty much disappeared. Moreover, the plastics sale suggests many of GE's assets may have more value than investors and analysts are giving the company credit for in their models.....Companies that trade at a discount to their parts are prime targets for activist investors. Mr. Immelt should consider spinning off businesses such as GE Money and NBC Universal, before uppity investors dictate a more-Draconian corporate strategy for him."
I couldn't have said it much better, although I wrote it first. Here. Last August. Only it's not about spinning units off, but simply breaking the whole company into its constituent, standalone, unrelated businesses.
You see, Jeff Immelt is, in reality, simply an overpaid closed-ended fund manager. GE's shares are, well, shares of a closed-ended fund. The fund has invested in, actually acquired, a collection of unrelated businesses- finance, power systems, plastics (now gone), entertainment, etc.
As Stephen Ross illustrated, closed-ended funds trade at a discount due to management fees. In financial funds, those fees are typically one percent of assets, plus some expenses. You may ask why closed-ended funds exist. I did. Perhaps they are holdovers from the days when brokerage fees were high, liquidity was in shorter supply, as was information, and the best way for many investors to diversify was to buy a diversified fund.
None of those conditions are true today. That's why GE is an anachronism, as currently structured. It has no current reason for being.
To drive this home, let me relate what I heard yesterday morning on CNBC, Jeff's private (GE-owned) network. While discussing the plastics unit sale, he took the opportunity to once more attempt to fend off calls for splitting up GE. In particular, he argued that NBC/Universal was now turning around, and that they had a great slate of network programming and films on the way.
This was just hilarious. Jeff Immelt, corporate titan, is also a seasoned entertainment exec, with a sure eye for the next big hits on both the small and large screens of the world.
If you believe that, I have a bridge in Brooklyn to sell you.
As I contended in this recent post, Immelt is actually the only GE CEO in modern times not to have put his own stamp on the company. In this post, I explained why that doesn't matter to Immelt. He's already received a stupendous payday for nearly six years of abject failure.
Now, putting together today's Journal piece with Professor Ross' findings on closed-ended funds, it's much easier to see why GE should be dismantled into its standalone pieces, exchanging one share of GE for shares in each of its units. The discounted value as a whole conglomerate won't go away. But the plastics unit sale will now signal to the private equity crowd that there's money to be made simply by gaining control of the firm and releasing unrealized value in a breakup.
This should be a most interesting year for GE and the private equity funds.
Monday, May 21, 2007
Foreign Stock Brokers
Saturday's Wall Street Journal's Money & Investing section greeted me with an article that I had to start twice to be sure I was reading it right. Suffice to say, it lent more credence to my business partner's belief that the Journal's expansion to a weekend edition has seriously diluted the quality of its columns in that edition.
A guy named Jeff D. Opdyke wrote this piece, extolling the virtues of investing in overseas individual equities using foreign brokers.
According to Opdyke, many "bigger and more important markets" now include: Hong Kong, Auckland, and Cairo. Other markets one may ostensibly access from these include Shanghai, Shenzhen, UAE, Oman, Morocco and Turkey.
Apparently, liquidity and market manipulation are no longer considered risks in these outposts of capitalism. Forget about mutual funds that invest in foreign equities. Or the foreign exposure to be gained by investing in US global large-cap companies.
Further on in the piece, Opdyke warns of various risks, like one-day, 15% drops in the Thailand market due to government currency restraints, foreign exchange value risks, and unexpected closing of outfits like the Beirut exchange for days.
Honestly, I cannot understand who this article helped. Anyone with sufficient money to be able to, as Opdyke writes, "lose a chunk of it if their investments fall apart several time zones away while they are asleep," probably already uses a foreign country mutual fund. Those people would tend to understand these undiversifiable risks. That is why you pay professionals to enter markets like these.
Those who can't afford that, probably shouldn't know any more which helps them to hurt themselves. Frankly, the average retail investor in the US who already uses a broker is being sufficiently badly-served. Why compound the pain by introducing them to the same scourge in overseas markets?
I don't know anyone who still uses, voluntarily, a full-price, full-service retail broker. Between mutual funds and discount, execution-oriented brokers, the role of the stock broker in America is finally diminishing. Information is plentiful and cheap, if not free, while transactions costs are low and self-trading technology is excellent and likewise inexpensive.
When the service-oriented brokerage model is finally near extinction in the US, why is this Journal writer hyping its use in markets that are of far less quality and reliability than the American equities markets that already can deliver so much loss and pain to the average retail investor? This strikes me as, at best, irresponsible journalism and, at worst, reckless in inviting investors to lose even more money on specious investments beyond the reach of recovery for American investors.
A guy named Jeff D. Opdyke wrote this piece, extolling the virtues of investing in overseas individual equities using foreign brokers.
According to Opdyke, many "bigger and more important markets" now include: Hong Kong, Auckland, and Cairo. Other markets one may ostensibly access from these include Shanghai, Shenzhen, UAE, Oman, Morocco and Turkey.
Apparently, liquidity and market manipulation are no longer considered risks in these outposts of capitalism. Forget about mutual funds that invest in foreign equities. Or the foreign exposure to be gained by investing in US global large-cap companies.
Further on in the piece, Opdyke warns of various risks, like one-day, 15% drops in the Thailand market due to government currency restraints, foreign exchange value risks, and unexpected closing of outfits like the Beirut exchange for days.
Honestly, I cannot understand who this article helped. Anyone with sufficient money to be able to, as Opdyke writes, "lose a chunk of it if their investments fall apart several time zones away while they are asleep," probably already uses a foreign country mutual fund. Those people would tend to understand these undiversifiable risks. That is why you pay professionals to enter markets like these.
Those who can't afford that, probably shouldn't know any more which helps them to hurt themselves. Frankly, the average retail investor in the US who already uses a broker is being sufficiently badly-served. Why compound the pain by introducing them to the same scourge in overseas markets?
I don't know anyone who still uses, voluntarily, a full-price, full-service retail broker. Between mutual funds and discount, execution-oriented brokers, the role of the stock broker in America is finally diminishing. Information is plentiful and cheap, if not free, while transactions costs are low and self-trading technology is excellent and likewise inexpensive.
When the service-oriented brokerage model is finally near extinction in the US, why is this Journal writer hyping its use in markets that are of far less quality and reliability than the American equities markets that already can deliver so much loss and pain to the average retail investor? This strikes me as, at best, irresponsible journalism and, at worst, reckless in inviting investors to lose even more money on specious investments beyond the reach of recovery for American investors.
Friday, May 18, 2007
Investor Action At Citi
This weeks' announcement that hedge fund investor Eddie Lampert has bought more than 15 million shares of Citi seem to have finally triggered an explicit sense that the end is near for CEO Chuck Prince.
While the company has been languishing under Prince for years, as my various posts (search on the label "Citigroup" for my prior posts) have noted, Lampert's arrival is thought by many to signal that there will soon be action, one way or another.
True, Lampert isn't the largest stockholder in Citi, by far. However, after his radical moves resulting in the takeover of KMart and Sears, nobody seems to think he'll sit still while the stock continues to tread water.
Interestingly, some wags are just now suggesting that the real culprit in all of this is Chairman Bob Rubin. He is alleged by some to have been fiddling around, globally glad-handing while Prince has mismanaged the firm. Thus, a corporate governance issue has been raised, asking why Rubin, as the board's senior guy on station, hasn't done more to move Prince to action, or just remove him.
Either way, the 4% rise in Citi shares on Wednesday, following word of Lampert's investment, would seem to indicate that others are now piling on, in hopes of some value-releasing activity in the near future.
I say it's more than about time. Ideally, Citi needs to be split up into more easily led and managed, standalone units which may more nimbly respond to market and competitive forces in their particular financial service sectors. As a financial supertanker, Citi has proven unmanageable in a manner that performs consistently better than the markt for its owners. Can it really do worse as a number of smaller, more responsive entities?
While the company has been languishing under Prince for years, as my various posts (search on the label "Citigroup" for my prior posts) have noted, Lampert's arrival is thought by many to signal that there will soon be action, one way or another.
True, Lampert isn't the largest stockholder in Citi, by far. However, after his radical moves resulting in the takeover of KMart and Sears, nobody seems to think he'll sit still while the stock continues to tread water.
Interestingly, some wags are just now suggesting that the real culprit in all of this is Chairman Bob Rubin. He is alleged by some to have been fiddling around, globally glad-handing while Prince has mismanaged the firm. Thus, a corporate governance issue has been raised, asking why Rubin, as the board's senior guy on station, hasn't done more to move Prince to action, or just remove him.
Either way, the 4% rise in Citi shares on Wednesday, following word of Lampert's investment, would seem to indicate that others are now piling on, in hopes of some value-releasing activity in the near future.
I say it's more than about time. Ideally, Citi needs to be split up into more easily led and managed, standalone units which may more nimbly respond to market and competitive forces in their particular financial service sectors. As a financial supertanker, Citi has proven unmanageable in a manner that performs consistently better than the markt for its owners. Can it really do worse as a number of smaller, more responsive entities?
Thursday, May 17, 2007
More on Cerberus Offer to Buy Chrysler
As the week has progressed, more ink has been spilled over the Cerberus-DaimlerChrysler deal.
As one reads the numbers, it's just appalling to see how Daimler paid around $36B for Chrysler, and is now letting 80% of it go for $7.4B, and paying another $400-700MM in pension topups. Whatever the exact numbers, it marks a stunning end to Daimler's attempt to enlarge its automotive empire.
The Wall Street Journal's Tuesday edition had the requisite article discussing various aspects of the deal, along with a very interesting table. Entitled "Soured Deals," the exhibit reminds us of these gems from the past:
-PennCentral Railroad (1968) ended in bankruptcy 1970
-Revco's LBO (1986) ended in bankruptcy 1988
-ATT buys NCR (1991) spun off five years later for a $4.1B capital loss
-Quaker Oats buys Snapple (1994) sold off with a $1.4B capital loss nearly three years later
-Time Warner & AOL (2001)
I don't have the auto industry acumen that the staff of Cerberus evidently has. Perhaps they see a way to recover value from the weakest Detroit auto manufacturer, despite sector economics that would seem to be beyond the scope of Cerberus' internal management team to address and solve.
Never the less, I can't help but think that this deal forestalls the natural course of Schumpeterian dynamics. It's well understood that this sector has global excess capacity. The obvious high-cost, most excessive capacity is in American auto plants. That would seem to suggest that Cerberus is buying into a losing proposition.
Most pundits immediately rush to discuss the union/labor pension and healthcare cost issues. How Chrysler is saddled with uncompetitive, excessive costs per car that must be trimmed. Nevermind that prior Chrysler management freely negotiated to give these benefits to labor. And union labor leaders freely accepted the IOUs in exchange. In fact, this ill-considered bargain was the subject of one of my very first posts on this blog.
Perhaps Cerberus is after the combined auto loan portfolios of GMAC, which it already owns, and Chrysler. Then, some pundits argue, there is the tie between Cerberus' auto supply company holdings and Chrysler. But this would seem to actually be a burden, because what Cerberus cuts from Chrysler's buying may hurt its own other units. Of course, once the private equity firm takes its new acquisition behind the curtain of secrecy, there's no telling how the subsequent accounting and cash flows will make the deal ultimately pay off.
Swirling throughout all of this, and, one would think, very sensitive to that last point, is the UAW. How will it know that its members are getting the deal that the UAW believes them to be getting? Will UAW leaders get to pore over Cerberus' books, and comment on its executives' compensations? I just have a very hard time believing that Ron Gettelfinger, head of the union, is going to roll over and give some highly-paid private equity executives benefit and/or wage give-backs that he withheld from Daimler. If he is doing so, does this mark a conversion on the road to Damascus, so to speak, for the UAW? Will it now become sensible and cut its own members' compensation and deferred and accrued benefits, to save jobs?
Again, if so, this is big news indeed!
Assuming the deal closes, what about the product and marketing management issues still dogging Chrysler? It's vehicle lineup was not chosen by the guys and gals on the factory floor. Cerberus apparently cannot simply close dealerships without running afoul of some pretty stringent and expensive franchise law. To me, the union benefits and wage argument for why Detroit can't compete globally has always seemed a convenient smokescreen for the underlying current problem. That is, GM, Ford and Chrysler have consistently made poor product design and marketing decisions for decades. Combined with the legacy of poor labor relations and cost management left by earlier senior managers in the auto sector, the resulting burden seems, to me, just too much to expect the weakest of the three American auto producers to be salvageable.
Then there was the editorial in the Journal extolling private equity for taking a risk on Chrysler, so taxpayers would not, once again, be forced to do so. I guess there is some sort of benefit to this, in an indirect way. But I still have the sinking feeling that Schumpeter would have preferred to see the number three Detroit auto company just close up shop with its current losses, rather than prolong the pain and bleeding.
The fact that the various deals mentioned in the Journal's article, mentioned above, reminds us that, in prior years, other very intelligent and experienced people entered into some ill-advised transactions. Not every sector-restructuring deal ends happily and profitably.
If I had to bet, I would bet that the Chrysler-Cerberus deal will not meet the latter's expectations for ultimate profit and disposition of the assets it is buying.
As one reads the numbers, it's just appalling to see how Daimler paid around $36B for Chrysler, and is now letting 80% of it go for $7.4B, and paying another $400-700MM in pension topups. Whatever the exact numbers, it marks a stunning end to Daimler's attempt to enlarge its automotive empire.
The Wall Street Journal's Tuesday edition had the requisite article discussing various aspects of the deal, along with a very interesting table. Entitled "Soured Deals," the exhibit reminds us of these gems from the past:
-PennCentral Railroad (1968) ended in bankruptcy 1970
-Revco's LBO (1986) ended in bankruptcy 1988
-ATT buys NCR (1991) spun off five years later for a $4.1B capital loss
-Quaker Oats buys Snapple (1994) sold off with a $1.4B capital loss nearly three years later
-Time Warner & AOL (2001)
I don't have the auto industry acumen that the staff of Cerberus evidently has. Perhaps they see a way to recover value from the weakest Detroit auto manufacturer, despite sector economics that would seem to be beyond the scope of Cerberus' internal management team to address and solve.
Never the less, I can't help but think that this deal forestalls the natural course of Schumpeterian dynamics. It's well understood that this sector has global excess capacity. The obvious high-cost, most excessive capacity is in American auto plants. That would seem to suggest that Cerberus is buying into a losing proposition.
Most pundits immediately rush to discuss the union/labor pension and healthcare cost issues. How Chrysler is saddled with uncompetitive, excessive costs per car that must be trimmed. Nevermind that prior Chrysler management freely negotiated to give these benefits to labor. And union labor leaders freely accepted the IOUs in exchange. In fact, this ill-considered bargain was the subject of one of my very first posts on this blog.
Perhaps Cerberus is after the combined auto loan portfolios of GMAC, which it already owns, and Chrysler. Then, some pundits argue, there is the tie between Cerberus' auto supply company holdings and Chrysler. But this would seem to actually be a burden, because what Cerberus cuts from Chrysler's buying may hurt its own other units. Of course, once the private equity firm takes its new acquisition behind the curtain of secrecy, there's no telling how the subsequent accounting and cash flows will make the deal ultimately pay off.
Swirling throughout all of this, and, one would think, very sensitive to that last point, is the UAW. How will it know that its members are getting the deal that the UAW believes them to be getting? Will UAW leaders get to pore over Cerberus' books, and comment on its executives' compensations? I just have a very hard time believing that Ron Gettelfinger, head of the union, is going to roll over and give some highly-paid private equity executives benefit and/or wage give-backs that he withheld from Daimler. If he is doing so, does this mark a conversion on the road to Damascus, so to speak, for the UAW? Will it now become sensible and cut its own members' compensation and deferred and accrued benefits, to save jobs?
Again, if so, this is big news indeed!
Assuming the deal closes, what about the product and marketing management issues still dogging Chrysler? It's vehicle lineup was not chosen by the guys and gals on the factory floor. Cerberus apparently cannot simply close dealerships without running afoul of some pretty stringent and expensive franchise law. To me, the union benefits and wage argument for why Detroit can't compete globally has always seemed a convenient smokescreen for the underlying current problem. That is, GM, Ford and Chrysler have consistently made poor product design and marketing decisions for decades. Combined with the legacy of poor labor relations and cost management left by earlier senior managers in the auto sector, the resulting burden seems, to me, just too much to expect the weakest of the three American auto producers to be salvageable.
Then there was the editorial in the Journal extolling private equity for taking a risk on Chrysler, so taxpayers would not, once again, be forced to do so. I guess there is some sort of benefit to this, in an indirect way. But I still have the sinking feeling that Schumpeter would have preferred to see the number three Detroit auto company just close up shop with its current losses, rather than prolong the pain and bleeding.
The fact that the various deals mentioned in the Journal's article, mentioned above, reminds us that, in prior years, other very intelligent and experienced people entered into some ill-advised transactions. Not every sector-restructuring deal ends happily and profitably.
If I had to bet, I would bet that the Chrysler-Cerberus deal will not meet the latter's expectations for ultimate profit and disposition of the assets it is buying.
Wednesday, May 16, 2007
Stephen Ross on Behavioral Finance: From the Ridiculous to the Sublime
Last night, my business partner and I attended a wonderful event hosted by the local alumni group of one of his alma maters, MIT. The occasion was a talk given by Stephen Ross, now the Franco Modigliani Professor of Finance and Economics at that august bastion of quantitative learning on the Charles River.
By the way, for what it's worth, the far better University in Boston than its better-known, non-empirical neighbor in Cambridge, which shall go unnamed. The only clue being, the seasons changed, and Summers' gone now.....
Anyway, back to last night's dinner and talk.
For the ridiculous, the evening began with polite talk over drinks on the breezy, brick patio of a pleasant catering facility. We engaged in conversation with another couple, the woman of which was the MIT graduate. Her partner is a recently-retired businessman who has just sold his enterprise. Upon learning of my equity portfolio work, he eagerly began to describe his latest interest- a web-based trading site/system known as WiseTrade. Suffice to say, WiseTrade is to equity investing what 'no money down' home buying is to real estate finance.
What was humorous about the episode is that, while the man excitedly discussed how easy it was to buy or sell green- or red- shaded stock tickers, based upon their appropriately colored-lines on a chart, his MIT-educated partner pointedly asked whether the use of such a program by perhaps thousands of people at the same time might not affect the ability of "the program" to mint money at unheard-of rates?
Now, to the sublime. My partner and I were fortunate in being seated at "the finance" table, with about eight other alumni, and Prof. Ross. We caught occasional wisps of his conversation, seated, as we were, across a rather large table.
If I had been a little more aware, I'd be posting a (admittedly posed) digital picture of Prof. Ross and myself, with me, no doubt, looking pensive as he appeared to be making a sage remark.
As we worked through a very serviceable catered-style dinner, Prof. Ross gave a talk of incredible lucidity, insight, sensibility, and humor. MIT is very fortunate indeed to have lured him to its classrooms and research facility.
As concerns my interests, and this blog, Ross' remarks provided the following insights and reinforcements.
First, he clearly stated his belief that there are many unresearched anomalies in finance. Thus, he noted, simply because we do not know why an anomaly exists, or how it works, does not mean that neo-classical finance does not, or, in time, will not explain why.
To simply throw up our hands and resort to behavioral finance explanations in the absence of any other research is mistaken.
Second, Ross chose the anomaly of closed-end funds well-known pricing at a discount to their net asset value, to illustrate this point. He provided an excellent survey of the phenomenon, prior research, and conclusions by other finance academics. He then described his own simple, sensible hypothesis, and subsequent research which confirmed his hypothesis.
It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.
Third, and perhaps most important, Ross remarked that, in his opinion, the best research into various anomalies typically is not overly-complicated, nor dependent upon 'fancy statistics,' but, rather, usually involves sensible ideas and relatively straightforward quantification of the phenomenon to resolve the apparent anomaly. Higher-level math or complicated statistical models are not necessarily indicative of reliable research, in his opinion.
Fourth, he consistently focused on the fundamental neo-classical contention that returns and risk are linked. Excess, or unexpectedly high returns, are invariably linked to added risk, whether that risk is explicitly known, measured, or described.
In that vein, during the post-talk Q&A period, he fielded my question regarding the newly-developed dividend "index" funds by Jeremy Siegel, now allied with Wisdom Tree funds. His thoughts are that one can construct many different weightings for funds, which he pointedly did not call "index" funds, which outperform classical indices such as the S&P500. However, when such constructed weightings lead to higher returns than those of indices, he attributes the excess to unrealized risks inherent in the constructed portfolios. As such, he effectively said, without engaging in any personal comment on Siegel, that the dividend-weighted index funds owe any above-average returns to risks which they seem not to have yet identified.
Finally, in a review of various other 'schools' of finance theory- behavioral, physics, and biological, he stressed two of the hallmarks of neo-classical finance that remain important. One is the field's clear-cut theory of efficient pricing of risk and information in markets. The other is its ability to quanitfy effects, which, specifically, he believes behavioral finance cannot. He likened behavioral finance, with its focus on overall behaviors of investors, to economics, rather than finance. That is, as a professor of both, he noted that economics is concerned with average behaviors of many market participants who effect prices, whereas finance is concerned with behaviors of a few 'sharks' who ferret out and capture price and risk inconsistencies, at the expense of the many who are not similarly motivated or informed.
I came away from Prof. Ross' talk feeling that my own proprietary equity research, and the conclusions resulting from it, on which my equity portfolio strategy is based, are on very solid ground. According to Ross' views, I have identified a heretofore unrealized anomaly which may well continue to exist for decades. Due to some of the specific ways in which I classify and measure various attributes of stock performance, there may never be many, if any, other finance researches who identify precisely the type of return opportunities which I have found. Further, the research I designed and performed is remarkably simple. I used some fairly straightforward concepts from my quantitative market research background, off-the-shelf point-and-click statistical software, and basic analytical tools to discover the phenomena which I use in my portfolio strategy.
When a finance academic of Stephen Ross' caliber provides me with information and insights which dovetail with my own work and methods, I feel reassured and confident in the strength and longevity of the underpinnings of my equity portfolio management approach. While it is theoretically possible for all anomalies to eventually be reduced to understanding and, perhaps, eliminated, in practice, it's not possible. Further, as Prof. Ross pointed out with several examples, often times, explaining the anomaly does not eliminate it. It simply provides the reason why the particular investment approach works as it does.
As I told my business partner, it was a dinner well worth whatever he paid for it.
By the way, for what it's worth, the far better University in Boston than its better-known, non-empirical neighbor in Cambridge, which shall go unnamed. The only clue being, the seasons changed, and Summers' gone now.....
Anyway, back to last night's dinner and talk.
For the ridiculous, the evening began with polite talk over drinks on the breezy, brick patio of a pleasant catering facility. We engaged in conversation with another couple, the woman of which was the MIT graduate. Her partner is a recently-retired businessman who has just sold his enterprise. Upon learning of my equity portfolio work, he eagerly began to describe his latest interest- a web-based trading site/system known as WiseTrade. Suffice to say, WiseTrade is to equity investing what 'no money down' home buying is to real estate finance.
What was humorous about the episode is that, while the man excitedly discussed how easy it was to buy or sell green- or red- shaded stock tickers, based upon their appropriately colored-lines on a chart, his MIT-educated partner pointedly asked whether the use of such a program by perhaps thousands of people at the same time might not affect the ability of "the program" to mint money at unheard-of rates?
Now, to the sublime. My partner and I were fortunate in being seated at "the finance" table, with about eight other alumni, and Prof. Ross. We caught occasional wisps of his conversation, seated, as we were, across a rather large table.
If I had been a little more aware, I'd be posting a (admittedly posed) digital picture of Prof. Ross and myself, with me, no doubt, looking pensive as he appeared to be making a sage remark.
As we worked through a very serviceable catered-style dinner, Prof. Ross gave a talk of incredible lucidity, insight, sensibility, and humor. MIT is very fortunate indeed to have lured him to its classrooms and research facility.
As concerns my interests, and this blog, Ross' remarks provided the following insights and reinforcements.
First, he clearly stated his belief that there are many unresearched anomalies in finance. Thus, he noted, simply because we do not know why an anomaly exists, or how it works, does not mean that neo-classical finance does not, or, in time, will not explain why.
To simply throw up our hands and resort to behavioral finance explanations in the absence of any other research is mistaken.
Second, Ross chose the anomaly of closed-end funds well-known pricing at a discount to their net asset value, to illustrate this point. He provided an excellent survey of the phenomenon, prior research, and conclusions by other finance academics. He then described his own simple, sensible hypothesis, and subsequent research which confirmed his hypothesis.
It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.
Third, and perhaps most important, Ross remarked that, in his opinion, the best research into various anomalies typically is not overly-complicated, nor dependent upon 'fancy statistics,' but, rather, usually involves sensible ideas and relatively straightforward quantification of the phenomenon to resolve the apparent anomaly. Higher-level math or complicated statistical models are not necessarily indicative of reliable research, in his opinion.
Fourth, he consistently focused on the fundamental neo-classical contention that returns and risk are linked. Excess, or unexpectedly high returns, are invariably linked to added risk, whether that risk is explicitly known, measured, or described.
In that vein, during the post-talk Q&A period, he fielded my question regarding the newly-developed dividend "index" funds by Jeremy Siegel, now allied with Wisdom Tree funds. His thoughts are that one can construct many different weightings for funds, which he pointedly did not call "index" funds, which outperform classical indices such as the S&P500. However, when such constructed weightings lead to higher returns than those of indices, he attributes the excess to unrealized risks inherent in the constructed portfolios. As such, he effectively said, without engaging in any personal comment on Siegel, that the dividend-weighted index funds owe any above-average returns to risks which they seem not to have yet identified.
Finally, in a review of various other 'schools' of finance theory- behavioral, physics, and biological, he stressed two of the hallmarks of neo-classical finance that remain important. One is the field's clear-cut theory of efficient pricing of risk and information in markets. The other is its ability to quanitfy effects, which, specifically, he believes behavioral finance cannot. He likened behavioral finance, with its focus on overall behaviors of investors, to economics, rather than finance. That is, as a professor of both, he noted that economics is concerned with average behaviors of many market participants who effect prices, whereas finance is concerned with behaviors of a few 'sharks' who ferret out and capture price and risk inconsistencies, at the expense of the many who are not similarly motivated or informed.
I came away from Prof. Ross' talk feeling that my own proprietary equity research, and the conclusions resulting from it, on which my equity portfolio strategy is based, are on very solid ground. According to Ross' views, I have identified a heretofore unrealized anomaly which may well continue to exist for decades. Due to some of the specific ways in which I classify and measure various attributes of stock performance, there may never be many, if any, other finance researches who identify precisely the type of return opportunities which I have found. Further, the research I designed and performed is remarkably simple. I used some fairly straightforward concepts from my quantitative market research background, off-the-shelf point-and-click statistical software, and basic analytical tools to discover the phenomena which I use in my portfolio strategy.
When a finance academic of Stephen Ross' caliber provides me with information and insights which dovetail with my own work and methods, I feel reassured and confident in the strength and longevity of the underpinnings of my equity portfolio management approach. While it is theoretically possible for all anomalies to eventually be reduced to understanding and, perhaps, eliminated, in practice, it's not possible. Further, as Prof. Ross pointed out with several examples, often times, explaining the anomaly does not eliminate it. It simply provides the reason why the particular investment approach works as it does.
As I told my business partner, it was a dinner well worth whatever he paid for it.
Tuesday, May 15, 2007
CBS Tries Another Online Strategy
Monday's Wall Street Journal carried an article discussing CBS's abandonment of its proprietary website for video content. I last wrote about this topic here, in February. That post referenced my earlier piece, here, in October of last year, wherein I discussed Comcast's attempt to become the megaportal of the web for video.
While a worthwhile article to read in its entirety, here are some salient passages from the Journal piece,
A year ago, CBS Corp. announced the creation of Innertube, an entertainment channel on CBS.com designed to make the company a player in online video. It streams video of sporting events, news reports and reruns of shows such as the hit comedy "How I Met Your Mother."
CBS's new chief Internet strategist now jokes that the Web address for Innertube should be "CBS.com/nobodycomeshere."
CBS, after a year of experimenting with various Web initiatives, says that forcing consumers to come to one site -- its own -- to view video hasn't worked. Instead, the company plans to pursue a drastically revised strategy that involves syndicating its entertainment, news and sports video to as much of the Web as possible. It represents a stark departure for the TV industry. Most of CBS's major competitors, including Walt Disney Co.'s ABC, General Electric Co.'s NBC Universal and News Corp.'s Fox, are to some degree all betting that they can build their own Internet video portals.
"We can't expect consumers to come to us," says Quincy Smith, the president of CBS Interactive. "It's arrogant for any media company to assume that."
Joanne Bradford, chief media officer of MSN, says advertisers would be served better by buying online ads directly from Web sites rather than buying Internet packages offered alongside their upfront TV deals with the networks. "I'm a little irritated that the networks have put together a digital package that lets a marketer check a box and isn't as robust or deep," she said at a conference last week for advertisers in Seattle.
Advertisers will ultimately decide if CBS's new strategy is the right one. So far, media buyers are positive about the move, although they note that CBS has had troubles implementing some heavily promoted digital efforts in the past. CBS has already signed up major advertisers for its digital network such as Procter & Gamble Co., General Motors Co. and AT&T Corp.'s Cingular Wireless.
I take two messages away from the CBS experience. The first is a reinforcement of my original prediction that it will be unwise for anyone to plan to create and run the single, most-important media site on the web. YouTube happened more or less by accident. It is similar to EBay in that it hosts the work of others, but does not, per se, create content.
This is why I think Comcast is going to fail in its expensive quest to create a web media hub that is the ne plus ultra of the 'net.
The second message I note is how much what is old is new again. New technology, new empowerment of consumers with respect to what to watch, when, and how. Yet, advertising is still going to pay for all of that convenience.
Funny how that ad model keeps recurring for 80 years now, isn't it? It's followed media advancement from radio in the 1920s all the way to multi-media web video in a new century.
While a worthwhile article to read in its entirety, here are some salient passages from the Journal piece,
A year ago, CBS Corp. announced the creation of Innertube, an entertainment channel on CBS.com designed to make the company a player in online video. It streams video of sporting events, news reports and reruns of shows such as the hit comedy "How I Met Your Mother."
CBS's new chief Internet strategist now jokes that the Web address for Innertube should be "CBS.com/nobodycomeshere."
CBS, after a year of experimenting with various Web initiatives, says that forcing consumers to come to one site -- its own -- to view video hasn't worked. Instead, the company plans to pursue a drastically revised strategy that involves syndicating its entertainment, news and sports video to as much of the Web as possible. It represents a stark departure for the TV industry. Most of CBS's major competitors, including Walt Disney Co.'s ABC, General Electric Co.'s NBC Universal and News Corp.'s Fox, are to some degree all betting that they can build their own Internet video portals.
"We can't expect consumers to come to us," says Quincy Smith, the president of CBS Interactive. "It's arrogant for any media company to assume that."
Joanne Bradford, chief media officer of MSN, says advertisers would be served better by buying online ads directly from Web sites rather than buying Internet packages offered alongside their upfront TV deals with the networks. "I'm a little irritated that the networks have put together a digital package that lets a marketer check a box and isn't as robust or deep," she said at a conference last week for advertisers in Seattle.
Advertisers will ultimately decide if CBS's new strategy is the right one. So far, media buyers are positive about the move, although they note that CBS has had troubles implementing some heavily promoted digital efforts in the past. CBS has already signed up major advertisers for its digital network such as Procter & Gamble Co., General Motors Co. and AT&T Corp.'s Cingular Wireless.
I take two messages away from the CBS experience. The first is a reinforcement of my original prediction that it will be unwise for anyone to plan to create and run the single, most-important media site on the web. YouTube happened more or less by accident. It is similar to EBay in that it hosts the work of others, but does not, per se, create content.
This is why I think Comcast is going to fail in its expensive quest to create a web media hub that is the ne plus ultra of the 'net.
The second message I note is how much what is old is new again. New technology, new empowerment of consumers with respect to what to watch, when, and how. Yet, advertising is still going to pay for all of that convenience.
Funny how that ad model keeps recurring for 80 years now, isn't it? It's followed media advancement from radio in the 1920s all the way to multi-media web video in a new century.
Monday, May 14, 2007
Cheating At Colleges and Grad Schools
This Friday's Wall Street Journal featured an article discussing cheating at Duke University's Fuqua School of Business. It went on to mention the percentage of cheating reported in some other graduate disciplines, and undergraduate programs.
Rather than tackle the moral dimension of this sad situation, a simpler notion comes to my mind.
Does this prominent example of B-school cheating have anything to do with the increasing mediocrity we seem to see emanating from US businesses? Could we simply be seeing businesses increasingly hire graduates who have cheated so often that they simply don't have the skills which are expected to accompany the degrees they have allegedly earned?
Perhaps it's not so much the day-to-day, low-level skills and knowledge, but higher-level applications of that knowledge.
There will always be a few brilliant, driven young men and women who become tomorrow's innovators. Engineering, physics or chemistry students at universities like MIT, CalTech, Carnegie, Stanford, etc.
But what of the mass of middling graduates from so many other four-year programs? And graduate degree programs? I'm beginning to think that many students are so fixated on receiving (already inflated) grades, that they are simply skipping true learning, in order to secure an initial billet upon finishing their degree programs.
Of course, once you're in the work force, as a very wise grad school professor and mentor told me, it's rare people recall the school from which you graduated six months later. If they do, he intoned, you have a problem. Performance is what predominates in the workforce, although, of course, not in every case. Connections, relatives, alumni, can sometimes grease the skids for the somewhat-above, or just truly, mediocre. However, if so many students simply cheat to finish college, is it any wonder that they might not really have the knowledge that forms a foundation on which they, and their employers, can progress and improve?
According to the Journal article, undergraduate cheating hovers around 50%. Using a slightly looser definition, Donald McCabe, of Rutgers, found, in research for the Center for Academic Integrity, that undergraduate cheating approached 67%. The B-school average for students who cheat is reported to be 56%. That of other graduate programs is said to be around 50%.
Rather than tackle the moral dimension of this sad situation, a simpler notion comes to my mind.
Does this prominent example of B-school cheating have anything to do with the increasing mediocrity we seem to see emanating from US businesses? Could we simply be seeing businesses increasingly hire graduates who have cheated so often that they simply don't have the skills which are expected to accompany the degrees they have allegedly earned?
Perhaps it's not so much the day-to-day, low-level skills and knowledge, but higher-level applications of that knowledge.
There will always be a few brilliant, driven young men and women who become tomorrow's innovators. Engineering, physics or chemistry students at universities like MIT, CalTech, Carnegie, Stanford, etc.
But what of the mass of middling graduates from so many other four-year programs? And graduate degree programs? I'm beginning to think that many students are so fixated on receiving (already inflated) grades, that they are simply skipping true learning, in order to secure an initial billet upon finishing their degree programs.
Of course, once you're in the work force, as a very wise grad school professor and mentor told me, it's rare people recall the school from which you graduated six months later. If they do, he intoned, you have a problem. Performance is what predominates in the workforce, although, of course, not in every case. Connections, relatives, alumni, can sometimes grease the skids for the somewhat-above, or just truly, mediocre. However, if so many students simply cheat to finish college, is it any wonder that they might not really have the knowledge that forms a foundation on which they, and their employers, can progress and improve?
Chrysler's Latest Rescue
As I wrote in this post in the fall of 2005, I expected at least one of America's Big Three auto makers to have some sort of change of control by 2010. My exact wording was,
"Judging from where GM and Ford appear to be putting much of their energies these days, I’d say we’re going to be shy at least one major US-based car manufacturer before the decade is out. It may involve a merger among onshore rivals, if Congress is afraid to let so many UAW workers lose their jobs at once through a total financial failure of GM or Ford. But I'm willing to bet there will be one less automotive CEO in Detroit when 2010 dawns."
My verbiage was, I suppose, focused on the still-independent companies. My intent was to predict a change of ownership in one of the three, if not bankruptcy.
Today's sale by Daimler, to Cerberus, the private equity group, of its Chrysler unit, in my opinion, qualifies as meeting my prediction.
What puzzles me, though, is how Cerebrus plans to actually operate the weak man of Detroit at a continuing profit, amidst the general consensus about excess capacity in the sector. Sure, they own some suppliers, and maybe even have a few old auto company hands. Does that mean John Snow & Company can turn back the tide of industrial economics in the sector, and restructure and rehabilitate Chrysler's product line, financial situation, and marketing so thoroughly, successfully and quickly as to create value where nobody else could?
We all know that the UAW can break any deal for Chrysler. Or the other two- GM and Ford- for that matter. Whether they can actually make the deal....that's another question.
I have my doubts. So many analysts, including many of today's commentators on CNBC, focus on the labor costs when they discuss these auto makers. But it was the white-collar managers who led GM, Ford and Chrysler to where they are now. I don't think the machinists and assemblers down on the factory floors can remedy those ills.
Of course, once Cerberus gets its hands on Chrysler and drags it behind the impenetrable curtain of its private balance sheet, there's no telling what will come back out, and with what profitability dynamics. I'm eager to see this one come out the other end.
"Judging from where GM and Ford appear to be putting much of their energies these days, I’d say we’re going to be shy at least one major US-based car manufacturer before the decade is out. It may involve a merger among onshore rivals, if Congress is afraid to let so many UAW workers lose their jobs at once through a total financial failure of GM or Ford. But I'm willing to bet there will be one less automotive CEO in Detroit when 2010 dawns."
My verbiage was, I suppose, focused on the still-independent companies. My intent was to predict a change of ownership in one of the three, if not bankruptcy.
Today's sale by Daimler, to Cerberus, the private equity group, of its Chrysler unit, in my opinion, qualifies as meeting my prediction.
What puzzles me, though, is how Cerebrus plans to actually operate the weak man of Detroit at a continuing profit, amidst the general consensus about excess capacity in the sector. Sure, they own some suppliers, and maybe even have a few old auto company hands. Does that mean John Snow & Company can turn back the tide of industrial economics in the sector, and restructure and rehabilitate Chrysler's product line, financial situation, and marketing so thoroughly, successfully and quickly as to create value where nobody else could?
We all know that the UAW can break any deal for Chrysler. Or the other two- GM and Ford- for that matter. Whether they can actually make the deal....that's another question.
I have my doubts. So many analysts, including many of today's commentators on CNBC, focus on the labor costs when they discuss these auto makers. But it was the white-collar managers who led GM, Ford and Chrysler to where they are now. I don't think the machinists and assemblers down on the factory floors can remedy those ills.
Of course, once Cerberus gets its hands on Chrysler and drags it behind the impenetrable curtain of its private balance sheet, there's no telling what will come back out, and with what profitability dynamics. I'm eager to see this one come out the other end.
Friday, May 11, 2007
On Statistical Distributions: A Review of "The Black Swan"
A few weeks ago, the Wall Street Journal published a review of the book, "The Black Swan," written by Nassim Taleb, and reviewed by David Shaywitz.
Taleb is currently a hedge fund manager, and, as such, takes particular notice of the distributions of various types of events. Distributions are important....they can undermine models when inappropriately chosen. Parenthetically, this Friday's Journal carried a piece on the recent cheating scandal at Duke University's Fuqua Business school, and I could not help wondering how much such cheating results in even more mediocre, mis-educated people wind up in positions where they can do real damage to others.
From other reading about Taleb, I know that he is keenly sensitive to a specific sort of anomaly- that of sudden and unpredicted market swings of the type experienced on the heels of Long Term Capital Management's difficulties in 1998. The following passage is from a 2002 New Yorker article about Taleb,
"Physical events, whether death rates or poker games, are the predictable function of a limited and stable set of factors, and tend to follow what statisticians call a "normal distribution," a bell curve. But do the ups and downs of the market follow a bell curve? The economist Eugene Fama once studied stock prices and pointed out that if they followed a normal distribution you'd expect a really big jump, what he specified as a movement five standard deviations from the mean, once every seven thousand years. In fact, jumps of that magnitude happen in the stock market every three or four years, because investors don't behave with any kind of statistical orderliness. They change their mind. They do stupid things. They copy each other. They panic. Fama concluded that if you charted the ups and downs of the stock market the graph would have a "fat tail,"meaning that at the upper and lower ends of the distribution there would be many more outlying events than statisticians used to modelling the physical world would have imagined."
In effect, the behaviors of people which follow power-law distributions can screw up financial theories and their implementations. e.g., LTCM, when those theories and their implementations are based upon the wrong distributional assumptions.
The larger lesson from Taleb, beginning with Fama's observation, is that purposeful, goal-directed human behavior is probably not random. Thus, it should not be assumed to approximate a normal distribution of possible occurrences.
Personally, I am not at all surprised by this phenomenon of mistaking one distributional assumption for another. It's been my experience, and belief, since 1985, that the inclusion of powerful statistical tools in spreadsheet programs began the inexorable slide in the quality of statistical analytical applications in business. In that year, a University of Chicago-educated MBA colleague of mine at the Chase Manhattan Bank managed to mangle a rather straightforward piece of stock price movement attribution analysis, thanks to his access to a regression analysis tool in Lotus 123, and an ignorance of how to build valid models.
This example of how a little knowledge can be a dangerous thing has, I suspect, been multiplied many times since in portfolio management and trading operations the world over.
Taleb's key insight is that what are often seen as 'once in a lifetime' events which are unrelated, per se, are, in fact, neither 'once in a lifetime, nor, strictly speaking, unrelated. To quote Gilda Radner's SNL character, Roseanne Roseannadanna,
"....it's always something......"
It certainly is.
1987: a major market drop of proportions not seen in one day since 1929.
1989: Chase Manhattan Bank's failure lend to UAL's ESOP for a buyout triggers this 'little crash.'
1995: Barings Bank fails due to Nick Leeson's trading losses and fraud in concealing them.
1997: Asian financial markets crash.
1998: LTCM's incorrect assumptions regarding various hedged financial instruments' behaviors under stress results in the firm's demise, and a brief but severe market downturn.
2001: 9/11 attack on World Trade Center towers causes a market slide already in progress for a year to deepen and lengthen.
2006: Amaranth hedge fund fails from overly-risky, wrong bet by one trader on natural gas prices.
Thus, courtesy of Fama and Taleb, we see that there is considerable risk in assuming that severe market disturbances of the sort which occurred in 1929 do not recur very frequently. And a market composed of investors and traders who predominantly model strategies with risk metrics that employ the wrong, normally-distributed assumptions about the frequency of occurrences of various outcomes, is inevitably going to react badly to the actually more-frequent occurrences of extreme outcomes which affect financial markets.
Perhaps my own approach, using consistency of membership in a class, rather than forecasting the value of each member of the class, is less susceptible to this type of risk.
However, it goes even further. Thanks to reading this review of Taleb's book, and the 2002 New Yorker article, my partner and I have developed a powerful new variant of my equity strategy which explicitly takes into account Taleb's preoccupation with extreme market occurrences.
I'll write more about this in an upcoming post.
Taleb is currently a hedge fund manager, and, as such, takes particular notice of the distributions of various types of events. Distributions are important....they can undermine models when inappropriately chosen. Parenthetically, this Friday's Journal carried a piece on the recent cheating scandal at Duke University's Fuqua Business school, and I could not help wondering how much such cheating results in even more mediocre, mis-educated people wind up in positions where they can do real damage to others.
From other reading about Taleb, I know that he is keenly sensitive to a specific sort of anomaly- that of sudden and unpredicted market swings of the type experienced on the heels of Long Term Capital Management's difficulties in 1998. The following passage is from a 2002 New Yorker article about Taleb,
"Physical events, whether death rates or poker games, are the predictable function of a limited and stable set of factors, and tend to follow what statisticians call a "normal distribution," a bell curve. But do the ups and downs of the market follow a bell curve? The economist Eugene Fama once studied stock prices and pointed out that if they followed a normal distribution you'd expect a really big jump, what he specified as a movement five standard deviations from the mean, once every seven thousand years. In fact, jumps of that magnitude happen in the stock market every three or four years, because investors don't behave with any kind of statistical orderliness. They change their mind. They do stupid things. They copy each other. They panic. Fama concluded that if you charted the ups and downs of the stock market the graph would have a "fat tail,"meaning that at the upper and lower ends of the distribution there would be many more outlying events than statisticians used to modelling the physical world would have imagined."
In effect, the behaviors of people which follow power-law distributions can screw up financial theories and their implementations. e.g., LTCM, when those theories and their implementations are based upon the wrong distributional assumptions.
The larger lesson from Taleb, beginning with Fama's observation, is that purposeful, goal-directed human behavior is probably not random. Thus, it should not be assumed to approximate a normal distribution of possible occurrences.
Personally, I am not at all surprised by this phenomenon of mistaking one distributional assumption for another. It's been my experience, and belief, since 1985, that the inclusion of powerful statistical tools in spreadsheet programs began the inexorable slide in the quality of statistical analytical applications in business. In that year, a University of Chicago-educated MBA colleague of mine at the Chase Manhattan Bank managed to mangle a rather straightforward piece of stock price movement attribution analysis, thanks to his access to a regression analysis tool in Lotus 123, and an ignorance of how to build valid models.
This example of how a little knowledge can be a dangerous thing has, I suspect, been multiplied many times since in portfolio management and trading operations the world over.
Taleb's key insight is that what are often seen as 'once in a lifetime' events which are unrelated, per se, are, in fact, neither 'once in a lifetime, nor, strictly speaking, unrelated. To quote Gilda Radner's SNL character, Roseanne Roseannadanna,
"....it's always something......"
It certainly is.
1987: a major market drop of proportions not seen in one day since 1929.
1989: Chase Manhattan Bank's failure lend to UAL's ESOP for a buyout triggers this 'little crash.'
1995: Barings Bank fails due to Nick Leeson's trading losses and fraud in concealing them.
1997: Asian financial markets crash.
1998: LTCM's incorrect assumptions regarding various hedged financial instruments' behaviors under stress results in the firm's demise, and a brief but severe market downturn.
2001: 9/11 attack on World Trade Center towers causes a market slide already in progress for a year to deepen and lengthen.
2006: Amaranth hedge fund fails from overly-risky, wrong bet by one trader on natural gas prices.
Thus, courtesy of Fama and Taleb, we see that there is considerable risk in assuming that severe market disturbances of the sort which occurred in 1929 do not recur very frequently. And a market composed of investors and traders who predominantly model strategies with risk metrics that employ the wrong, normally-distributed assumptions about the frequency of occurrences of various outcomes, is inevitably going to react badly to the actually more-frequent occurrences of extreme outcomes which affect financial markets.
Perhaps my own approach, using consistency of membership in a class, rather than forecasting the value of each member of the class, is less susceptible to this type of risk.
However, it goes even further. Thanks to reading this review of Taleb's book, and the 2002 New Yorker article, my partner and I have developed a powerful new variant of my equity strategy which explicitly takes into account Taleb's preoccupation with extreme market occurrences.
I'll write more about this in an upcoming post.
Thursday, May 10, 2007
On Murdoch's Bid for Dow Jones
There was a very interesting piece in Monday morning's Wall Street Journal. It detailed the Ottaway's and retired Wall Street Journal executive Peter Kahn's opposition to Rupert Murdoch's offer of $60/share to buy Dow Jones.
On the surface, it appears to be a rather complex situation.
On one hand, Kahn, Ottoway et. al. sound antiquatedly quaint in defending journalistic integrity and independence. That's the sort of thing we used to hear from broadcast newsrooms, before cable television put them under.
In this case, blogging and cable TV have pressured print journalism. Why else the tie-up between CNBC and the WSJ?
Further, as a letter to the editor in today's Journal noted, the Bancrofts and The Wall Street Journal are all for capitalism, until it comes home to roost at their poorly-performing, partially publicly-held company. In that case, however, they argue for morals, standards, and eschew the same free market winds that they claim must blow throughout the economy.
For the record, the closing price of Dow Jones Inc. rose from $36.33 on April 30th, to $56.20 on May 1st. That's a 55% increase in the market price, nevermind Murdoch's promise of $60, which would be a 65% increase in the value of the stock. On an economic basis, it's clear that the time has come for someone else to create value with the Dow Jones stable of assets.
The nearby Yahoo-sourced chart of the Dow Jones stock price, versus the S&P500 Index for more than thirty years, tells a sorry tale indeed. The media firm has barely managed one-third the return of the market over this time, and has been flat for the last five years and declining over the last seven years.
On the other hand, there is the argument of journalistic independence. Critics say Murdoch will sell out the vaunted Journal staff that has won Pulitzer's for covering investigative stories in China. Kahn was reported to be concerned that, under Murdoch, the WSJ would not have earned those two Pulitzers for covering stories critical of China and its government.
Now, that sounds like something to consider. Kahn pointed to Murdoch's many actions calculated to placate the Chinese, so that his BSkyB service could beam into the country. He is reputed to have eliminated BBC from the satellite service, cancelled Chris Patten's last book deal, and sold the South China Morning Post, all to remove material offensive to the Chinese government.
Such accommodation worries Kahn.
At first, it worried me, as well. Do you force private equity to afford such ethics? Can Dow Jones afford this, on behalf of its shareholders, independently? Or is this something capitalism will simply cost out and, if necessary, eliminate as too expensive? Trusting someone else to do the investigative reporting and write the needed criticisms of China.
Then, while discussing this issue with my consultant friend, S, I stumbled upon the real answer. Murdoch's answer, actually.
The reality is that print is a dead, bygone medium. The CBS franchise program, 60 Minutes, breaks tons of stories. How? By using television, not print. Do you think for a moment that the same program, as a print medium, could ever have lasted? Not a chance.
What Murdoch understands is that by marrying the Dow Jones assets and brands, particularly The Wall Street Journal, to his existing multimedia empire, he will enable those brands to actually create more value while doing even more investigative journalism.
The Dow Jones board's recent Chair has been trying to goose the company's performance, to little avail. My guess is that most investors understand that the old media pond within which Dow Jones lives is going to overwhelm the effects of any one firm's individual efforts. It's time for a more modern media vehicle to properly invest in and use the Journal's brand franchise.
No, the narrow version of the journalistic independence argument won't work for a publicly held company. Maybe if Ottoway and the Bancrofts wanted to take the firm private. But that's not what they want. They want top dollar and journalistic immunity from any economic realities.
The likely best outcome for the Journal and the rest of Dow Jones' media assets is to join a modern, global multimedia entity which can leverage their values further than is possible currently, while affording investment in them to retain their current competitive attributes. More than anyone else in media, Murdoch fits this description.
The crocodile tears over a potential loss of editorial independence and a standalone media presence are misplaced. This is about a too-small, old media company which has failed to properly take advantage of its best brands to create shareholder value. It's time for the Bancrofts to put up or sell. Either commit to investing in Dow Jones to enable it to consistently earn superior returns and realize its brand values, or sell it to someone who can.
On the surface, it appears to be a rather complex situation.
On one hand, Kahn, Ottoway et. al. sound antiquatedly quaint in defending journalistic integrity and independence. That's the sort of thing we used to hear from broadcast newsrooms, before cable television put them under.
In this case, blogging and cable TV have pressured print journalism. Why else the tie-up between CNBC and the WSJ?
Further, as a letter to the editor in today's Journal noted, the Bancrofts and The Wall Street Journal are all for capitalism, until it comes home to roost at their poorly-performing, partially publicly-held company. In that case, however, they argue for morals, standards, and eschew the same free market winds that they claim must blow throughout the economy.
For the record, the closing price of Dow Jones Inc. rose from $36.33 on April 30th, to $56.20 on May 1st. That's a 55% increase in the market price, nevermind Murdoch's promise of $60, which would be a 65% increase in the value of the stock. On an economic basis, it's clear that the time has come for someone else to create value with the Dow Jones stable of assets.
The nearby Yahoo-sourced chart of the Dow Jones stock price, versus the S&P500 Index for more than thirty years, tells a sorry tale indeed. The media firm has barely managed one-third the return of the market over this time, and has been flat for the last five years and declining over the last seven years.On the other hand, there is the argument of journalistic independence. Critics say Murdoch will sell out the vaunted Journal staff that has won Pulitzer's for covering investigative stories in China. Kahn was reported to be concerned that, under Murdoch, the WSJ would not have earned those two Pulitzers for covering stories critical of China and its government.
Now, that sounds like something to consider. Kahn pointed to Murdoch's many actions calculated to placate the Chinese, so that his BSkyB service could beam into the country. He is reputed to have eliminated BBC from the satellite service, cancelled Chris Patten's last book deal, and sold the South China Morning Post, all to remove material offensive to the Chinese government.
Such accommodation worries Kahn.
At first, it worried me, as well. Do you force private equity to afford such ethics? Can Dow Jones afford this, on behalf of its shareholders, independently? Or is this something capitalism will simply cost out and, if necessary, eliminate as too expensive? Trusting someone else to do the investigative reporting and write the needed criticisms of China.
Then, while discussing this issue with my consultant friend, S, I stumbled upon the real answer. Murdoch's answer, actually.
The reality is that print is a dead, bygone medium. The CBS franchise program, 60 Minutes, breaks tons of stories. How? By using television, not print. Do you think for a moment that the same program, as a print medium, could ever have lasted? Not a chance.
What Murdoch understands is that by marrying the Dow Jones assets and brands, particularly The Wall Street Journal, to his existing multimedia empire, he will enable those brands to actually create more value while doing even more investigative journalism.
The Dow Jones board's recent Chair has been trying to goose the company's performance, to little avail. My guess is that most investors understand that the old media pond within which Dow Jones lives is going to overwhelm the effects of any one firm's individual efforts. It's time for a more modern media vehicle to properly invest in and use the Journal's brand franchise.
No, the narrow version of the journalistic independence argument won't work for a publicly held company. Maybe if Ottoway and the Bancrofts wanted to take the firm private. But that's not what they want. They want top dollar and journalistic immunity from any economic realities.
The likely best outcome for the Journal and the rest of Dow Jones' media assets is to join a modern, global multimedia entity which can leverage their values further than is possible currently, while affording investment in them to retain their current competitive attributes. More than anyone else in media, Murdoch fits this description.
The crocodile tears over a potential loss of editorial independence and a standalone media presence are misplaced. This is about a too-small, old media company which has failed to properly take advantage of its best brands to create shareholder value. It's time for the Bancrofts to put up or sell. Either commit to investing in Dow Jones to enable it to consistently earn superior returns and realize its brand values, or sell it to someone who can.
Wednesday, May 09, 2007
More On GE's Breakup: The Right Idea
Today's Wall Street Journal featured an article concerning GE's breakup. It's in the middle of the Money & Investing section's front page. The headline is a complimentary "For GE, No Lack of Ideas."
As I wrote recently, here, even as the Journal touches this potential third rail topic, it is doing so gingerly. Here are some of the more forgiving (of Immelt and GE) quotes:
But some shareholders and analysts argue that GE's sprawling businesses are better off together than apart. GE's big umbrella, these investors say, can balance differing product and economic cycles, while helping all its businesses financially. And that would boost the stock price over the longer term.
The "keep GE together" crowd appears to have a strong ally in Mr. Immelt, who has resisted past calls to sell NBC Universal. Mr. Immelt has repeatedly expressed his frustrations with GE's stock price, which is down 7% since he took over in September 2001, while the Dow Jones Industrial Average is up 35% over the past five years.
What's more, splitting off big pieces of GE could ultimately lower the entire company's valuation. If, for example, it divested itself of NBC Universal, the company would be even more heavily weighted toward financial-services businesses, which generally get lower valuations than the industrial units. In the first quarter, financial services already accounted for more than 60% of GE's profit.
What I noticed about the above-cited text was that no salient, sage investors were actually named as the 'some shareholders' who 'argue that GE's sprawling businesses are better off together.' Who are these shareholders- seasoned hedge fund managers, or your great aunt Hilda, who has held GE in her portfolio since 1980?
To say that GE CEO Immelt 'appears' to want to keep GE whole is an understatement. After six years presiding over this failed conglomerate, do you really think he's ready to throw in the towel and fire himself? Because that is the logical conclusion of beginning any divestiture, or the complete breakup into all its six constituent units.
I wrote about a GE breakup here, last August. Contrary to the sentiment expressed in the third paragraph I cited above from the Journal article, I think a split up would result in more value all around for shareholders. If one unit becomes valued as a financial service company, so be it. That's what it is. Shareholders would be free to sell shares of that spun off company.
Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen.
In fact, even GE went through such change in the past. Besides publicly available information, I have additional knowledge from my old mentor and boss at Chase Manhattan Bank. He worked for the CPO of GE as it moved between CEOs Fred Borch, Reg Jones, and Jack Welch.
Few today realize how Jones, of whom I have heard it said, "once a beanie (accountant), always a beanie,' stripped much of the strategic vision from GE that Borch had instilled through his business unit investments. Jones retooled the company to be a cash machine because, well, he was an accountant. He liked cash.
Welch, upon taking the helm from Jones, faced an unprecedented period of high inflation and a wide array of non-strategic businesses at GE. He rapidly cut and pruned the company's businesses, earning the now-forgotten moniker "neutron Jack." I can't believe it's so long ago that I probably need to explain the meaning of this nickname to younger readers. At the time, the neutron bomb was under development. Its salient characteristic was to 'kill the people but leave the buildings standing." You can figure out the reason for the nickname from that.
Today's large firms are usually focused on a particular product/market. Diversified conglomerates are pretty much a thing of the past. Mediocre analysts and fund managers might confuse large focused global firms, such as Intel, Cisco, or ExxonMobil, with yesteryear's broadly diversified giants. You should not. I don't think investors do, either. That's why GE's stock is in suspended animation. Everyone can diversify more cheaply today than they can by paying an enormous tax on operating earnings of GE's business units in order to keep them under one administrative regime.
What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled.
In the past, the company was led by CEOs who were unafraid to put a significant personal stamp upon the shape of GE. Immelt, however, eschewed that approach. Instead, he's pretty much kept the cards Welch left on the table. Too bad it's evidently not the right hand for today's business environment.
As I've argued in prior posts (which you may find by searching on the label 'GE,' and following links to even earlier posts), Immelt has been paid far too much for simply keeping Welch's seat warm, but not even managing to beat the S&P. How many of Immelt's own managers do you think he would keep for six years if they had his performance record?
Where's the business media's outrage at Immelt's egregious overcompensation? Oh, yes, that's right- GE is a big advertiser. Wouldn't want to offend a company that lines the coffers of so many print, network and cable media firms. Same with most of the financial service firms.
However, I firmly believe that, now, lurking somewhere in the shadows, are the private equity wolves. Perhaps they are beginning to form a pack and slowly circle the ailing, misled GE. It may take a private equity offer to loosen the business media's collective tongue on this matter, but don't expect too much until they are pretty sure that GE is well on the way to some sort of break up before they feel it's safe to agree with everyone else and proclaim the wisdom of a GE dissolution.
As I wrote recently, here, even as the Journal touches this potential third rail topic, it is doing so gingerly. Here are some of the more forgiving (of Immelt and GE) quotes:
But some shareholders and analysts argue that GE's sprawling businesses are better off together than apart. GE's big umbrella, these investors say, can balance differing product and economic cycles, while helping all its businesses financially. And that would boost the stock price over the longer term.
The "keep GE together" crowd appears to have a strong ally in Mr. Immelt, who has resisted past calls to sell NBC Universal. Mr. Immelt has repeatedly expressed his frustrations with GE's stock price, which is down 7% since he took over in September 2001, while the Dow Jones Industrial Average is up 35% over the past five years.
What's more, splitting off big pieces of GE could ultimately lower the entire company's valuation. If, for example, it divested itself of NBC Universal, the company would be even more heavily weighted toward financial-services businesses, which generally get lower valuations than the industrial units. In the first quarter, financial services already accounted for more than 60% of GE's profit.
What I noticed about the above-cited text was that no salient, sage investors were actually named as the 'some shareholders' who 'argue that GE's sprawling businesses are better off together.' Who are these shareholders- seasoned hedge fund managers, or your great aunt Hilda, who has held GE in her portfolio since 1980?
To say that GE CEO Immelt 'appears' to want to keep GE whole is an understatement. After six years presiding over this failed conglomerate, do you really think he's ready to throw in the towel and fire himself? Because that is the logical conclusion of beginning any divestiture, or the complete breakup into all its six constituent units.
I wrote about a GE breakup here, last August. Contrary to the sentiment expressed in the third paragraph I cited above from the Journal article, I think a split up would result in more value all around for shareholders. If one unit becomes valued as a financial service company, so be it. That's what it is. Shareholders would be free to sell shares of that spun off company.
Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen.
In fact, even GE went through such change in the past. Besides publicly available information, I have additional knowledge from my old mentor and boss at Chase Manhattan Bank. He worked for the CPO of GE as it moved between CEOs Fred Borch, Reg Jones, and Jack Welch.
Few today realize how Jones, of whom I have heard it said, "once a beanie (accountant), always a beanie,' stripped much of the strategic vision from GE that Borch had instilled through his business unit investments. Jones retooled the company to be a cash machine because, well, he was an accountant. He liked cash.
Welch, upon taking the helm from Jones, faced an unprecedented period of high inflation and a wide array of non-strategic businesses at GE. He rapidly cut and pruned the company's businesses, earning the now-forgotten moniker "neutron Jack." I can't believe it's so long ago that I probably need to explain the meaning of this nickname to younger readers. At the time, the neutron bomb was under development. Its salient characteristic was to 'kill the people but leave the buildings standing." You can figure out the reason for the nickname from that.
Today's large firms are usually focused on a particular product/market. Diversified conglomerates are pretty much a thing of the past. Mediocre analysts and fund managers might confuse large focused global firms, such as Intel, Cisco, or ExxonMobil, with yesteryear's broadly diversified giants. You should not. I don't think investors do, either. That's why GE's stock is in suspended animation. Everyone can diversify more cheaply today than they can by paying an enormous tax on operating earnings of GE's business units in order to keep them under one administrative regime.
What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled.
In the past, the company was led by CEOs who were unafraid to put a significant personal stamp upon the shape of GE. Immelt, however, eschewed that approach. Instead, he's pretty much kept the cards Welch left on the table. Too bad it's evidently not the right hand for today's business environment.
As I've argued in prior posts (which you may find by searching on the label 'GE,' and following links to even earlier posts), Immelt has been paid far too much for simply keeping Welch's seat warm, but not even managing to beat the S&P. How many of Immelt's own managers do you think he would keep for six years if they had his performance record?
Where's the business media's outrage at Immelt's egregious overcompensation? Oh, yes, that's right- GE is a big advertiser. Wouldn't want to offend a company that lines the coffers of so many print, network and cable media firms. Same with most of the financial service firms.
However, I firmly believe that, now, lurking somewhere in the shadows, are the private equity wolves. Perhaps they are beginning to form a pack and slowly circle the ailing, misled GE. It may take a private equity offer to loosen the business media's collective tongue on this matter, but don't expect too much until they are pretty sure that GE is well on the way to some sort of break up before they feel it's safe to agree with everyone else and proclaim the wisdom of a GE dissolution.
Tuesday, May 08, 2007
Dana Telsey v. Warren Buffett on Wal-Mart
Yesterday on one of CNBC's morning programs, retail analyst Dana Telsey gave a wonderfully informed, sensible analysis of Target as preferential to Wal-Mart. It happened to coincide with an excellent interview of the company's leaders in that day's Wall Street Journal.
As is often done, the network placed a Wal-Mart booster opposite Ms. Telsey. All he could really do, though, was reiterate that he hoped Wal-Mart CEO Lee Scott might be fired by year's end, leading the stock to be 'value priced' for some sort of hoped-for turnaround.
As it happens, Warren Buffett had recently (perhaps at his Berkshire Hathaway annual meeting last weekend?) proclaimed himself a buyer of Wal-mart stock.
Thus, Mark Haines of CNBC ceaselessly hectored Dana Telsey with comments like, 'so you think Buffett's wrong,' and 'so you're disagreeing with Buffett' throughout pauses in her remarks.
Hey, Buffett has made his share of mistakes- US Air and Salomon Brothers, to name a few. I believe Mark Haines is wrong to deify the guy. In fact, yesterday on CNBC, one critic described Buffett as basically over the hill, with less-than-stellar recent returns.
He characterized the current search for a new CIO as essentially much ado about nothing, counseling viewers to find the 'next Warren Buffett.' With many billions of dollars to allocate, the commentator (I wish I could recall his name) rather irreverently, but, I believe, correctly suggested that Buffett isn't the same as he was when he was younger, with less money to invest, and that his successor will be unlikely to keep the assets around for long.
With that in mind, I pulled the Yahoo-sourced chart on the left (please click on chart to see a larger version) comparing Berkshire vs. the S&P500 for the past five year. The firm appears to pay no dividends on its stock. Thus, this price chart is essentially a picture of total returns as well. Frankly, I was stunned at what I saw. Berkshire has not significantly outperformed the index over the entire period. For most of the years, it tracks nearly on top of the S&P, with a less pronounced dip in 2002, and a less pronounced rise in 2004. Lately, it's paced the index. Not exactly the kind of return performance that would draw attention, were it any other company than the one Buffett operates.
Back to Target vs. Buffett's pick, Wal-Mart. Dana Telsey noted that a buy of Wal-Mart is for turnaround, but that Target is poised to perform much better. On that note, the Journal interview revealed a stunningly smart, confident team of executives who don't look at their business as cost-cutting discount retail, but, rather, designer-brand and unique-retail experience marketing to selected customers.
Furthermore, they regularly take a common consumer problem and make it part of "The Big Idea" contest. To quote the article, Michael Francis, EVP of Marketing said,
"I challenge my team to solve a problem or see things a new way. We've done everything from what's the next consumable product that we would like to repackage to what product in your pantry frustrates you the most. The winner gets a cash prize, recognition and sometimes we create the product or campaign.
I have people who are brilliant all over the country and they feed in ideas on a regular basis. I probably have about a dozen of them- trend people, movie people, advertising people. We pay them. And we get monthly missives- emails or letters.....it's people who we trust, who we know have the right taste level, who understand our brand."
On that subject of brand, CEO Bob Ulrich said,
"We created the whole trend of designers making products for discounters, starting with architect Michael Graves in 1999....These things keep evolving. You can't just be unique in one category. You can't be really mundane in small electrics if you're trying to be innovative in textiles. You can't be really forward in linens and beat down in shoes, so you have to start to get more consistency across the board....our guests, who are on average about 20% more affluent, more highly educated, come from more sophisticated areas."
As is often done, the network placed a Wal-Mart booster opposite Ms. Telsey. All he could really do, though, was reiterate that he hoped Wal-Mart CEO Lee Scott might be fired by year's end, leading the stock to be 'value priced' for some sort of hoped-for turnaround.
As it happens, Warren Buffett had recently (perhaps at his Berkshire Hathaway annual meeting last weekend?) proclaimed himself a buyer of Wal-mart stock.
Thus, Mark Haines of CNBC ceaselessly hectored Dana Telsey with comments like, 'so you think Buffett's wrong,' and 'so you're disagreeing with Buffett' throughout pauses in her remarks.
Hey, Buffett has made his share of mistakes- US Air and Salomon Brothers, to name a few. I believe Mark Haines is wrong to deify the guy. In fact, yesterday on CNBC, one critic described Buffett as basically over the hill, with less-than-stellar recent returns.
He characterized the current search for a new CIO as essentially much ado about nothing, counseling viewers to find the 'next Warren Buffett.' With many billions of dollars to allocate, the commentator (I wish I could recall his name) rather irreverently, but, I believe, correctly suggested that Buffett isn't the same as he was when he was younger, with less money to invest, and that his successor will be unlikely to keep the assets around for long.
With that in mind, I pulled the Yahoo-sourced chart on the left (please click on chart to see a larger version) comparing Berkshire vs. the S&P500 for the past five year. The firm appears to pay no dividends on its stock. Thus, this price chart is essentially a picture of total returns as well. Frankly, I was stunned at what I saw. Berkshire has not significantly outperformed the index over the entire period. For most of the years, it tracks nearly on top of the S&P, with a less pronounced dip in 2002, and a less pronounced rise in 2004. Lately, it's paced the index. Not exactly the kind of return performance that would draw attention, were it any other company than the one Buffett operates.Back to Target vs. Buffett's pick, Wal-Mart. Dana Telsey noted that a buy of Wal-Mart is for turnaround, but that Target is poised to perform much better. On that note, the Journal interview revealed a stunningly smart, confident team of executives who don't look at their business as cost-cutting discount retail, but, rather, designer-brand and unique-retail experience marketing to selected customers.
Furthermore, they regularly take a common consumer problem and make it part of "The Big Idea" contest. To quote the article, Michael Francis, EVP of Marketing said,
"I challenge my team to solve a problem or see things a new way. We've done everything from what's the next consumable product that we would like to repackage to what product in your pantry frustrates you the most. The winner gets a cash prize, recognition and sometimes we create the product or campaign.
I have people who are brilliant all over the country and they feed in ideas on a regular basis. I probably have about a dozen of them- trend people, movie people, advertising people. We pay them. And we get monthly missives- emails or letters.....it's people who we trust, who we know have the right taste level, who understand our brand."
On that subject of brand, CEO Bob Ulrich said,
"We created the whole trend of designers making products for discounters, starting with architect Michael Graves in 1999....These things keep evolving. You can't just be unique in one category. You can't be really mundane in small electrics if you're trying to be innovative in textiles. You can't be really forward in linens and beat down in shoes, so you have to start to get more consistency across the board....our guests, who are on average about 20% more affluent, more highly educated, come from more sophisticated areas."
And, again, Michael Francis, on brand advertising and promotion,
"I don't want to be on a billboard along some freeway in some dense metropolitan area. I want to be where there is a smart, sophisticated audience, who's experiencing that venue for reasons other than brand awareness......(the buzz is) a powerful, powerful component of what we do. Buzz has had an astonishingly important ability to amplify our entire marketing message."
What struck me about these comments in the Journal interview is how much Target's management and strategy is about consumer needs satisfaction and problem solution, not just logistical cost-cutting. They practice a flair for dramatic, exciting retailing that Wal-Mart never had. So when the latter saturated its market segment, going upmarket, as I wrote in a post in late 2005, was very difficult, if not impossible (as I predicted). Target, on the other hand, has kept a finger on the pulse of its more upscale market segment, and continued to give them reasons to return to its stores.
Thus, as the Yahoo-source price chart for Target, Wal-Mart and the S&P500 on the left shows, Target has outperformed Wal-Mart over the past five years. However, even Target has not quite surpassed the index, which explains why it's not on my equity portfolio selection lists. Further, Target seemed to be experiencing similar performance pattern as Wal-mart up until late 2004, when it finally deviated from Wal-Mart's downward path, and began to soar. Still, in those two years, Target has only just would have outpeformed the index.
So, personally, I'd side with Telsey, although Target is not in my selection list. I've seen Telsey for years on retail and luxury beat, and she appears to know her stuff. Combining Buffett's recent performance, and the pictures of Target's and Wal-Mart's recent performances, along with information about Target's more consumer-focused strategy, I would be inclined to back Dana Telsey's prediction that Target will continue to outperform Wal-Mart in the years ahead.
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