Thursday, December 30, 2010

Long Term Forecasts: Often Wrong, Never in Doubt

Think back to the middle years of the "Japanese Economic Miracle." American consumers were buying Japanese-made cars by the millions, first made in Japan, then made in Fremont and Marysville. Japanese banks were getting into equity research and investment banking. Japanese companies were buying trophy American real estate, like Rockefeller Center. We were all going to work for Japan, Inc. That forecast was outrun by reality.

The Japanese auto industry made its mark, and it made some smart moves by taking minority stakes in future manufacturing leaders like Hyundai. Eventually, however, companies like Toyota got too big and lost their way. They are entering the inevitable adjustment period. Japanese investment banks lost hundreds of millions of dollars, and they never took their places at the table of the Wall Street elite. Much of the real estate was bought at the absolute top of the market, and the buyers got whipsawed into selling near the bottom. Global economics and currencies forced adjustments that destroyed any myths about Japan, Inc. Political, social and demographic issues, forgotten by most quantitative forecasters, led to a Lost Decade.

Fast forward to the current forecasts about the Chinese economic juggernaut. The capitalist enterprise in China is growing up in a Wild West atmosphere, unfettered by economic, financial, legal or environmental regulation. Our western gold rush eventually turned into fools gold. We see occasional reports about homeless Chinese construction workers building Olympic venues, major health and pollution problems in the countryside, a forgotten prison population, and a central government that blithely believes it will forever keep the genie of political and social change in the lamp.

Martin Feldstein, not usually optimistic about economic trends, writes about self-corrective, economic mechanisms at work in adjusting the global savings-investment imbalance. He believes that we will see an increase in both U.S. private and government savings, the latter being driven by increased fiscal responsibility in future budgets. Feldstein also sees rising Chinese consumption, both public and private, driven by both income effects and by a real appreciation of the renminbi, which he estimates is already rising at a nine percent annual rate.

He estimates that a potential rise in the US savings rate to 7 percent of GDP, which after absorbing some of this to increasing fixed investment, would leave enough to reduce the current account deficit to about 1 percent of GDP without any large government regulatory changes. He could very well be overly optimistic, but it doesn't seem unreasonable.

If we as a nation were to to invest in rebuilding our manufacturing base into an efficient machine by global standards, and improve the productivity and training of our work force, then we could reap significant benefit from these medium to long-term adjustments. Forget those long-term forecasts, and Happy New Year!

Wednesday, December 22, 2010

What Did Ben Bernanke Say?

Commentators are hyperventilating about the Fed Chairman's apparently contradictory statements about the potentially inflationary impacts of QE2. Since Mr. Bernanke is now a full-fledged political figure, contradictory statements and a lack of clarity are basic tools in the sound bite arsenal.

He said that the effect of QE2 was not to increase currency in circulation, and therefore there was no need to worry about inflationary expectations increasing. This may be correct, but it is off the point and misleading. The unprecedented expansion of the Fed's balance sheet has not increased the amount of currency in the hands of the nonbank public. True enough.

However, the truth is that nobody really knows the effect of such a huge expansion of the monetary base on inflationary expectations. Historically, the impacts of other such expansions in foreign countries is mixed. Generally, if the expansion is viewed as temporary, and market participants believe that imbalances will be redressed in our case by fiscal policy restraints and budget balancing, then the expansion will serve its limited purpose and not have an inflationary effect. However, there is no reason to believe that our politicians will show any fiscal leadership or restraint. Where is the experience to show that they can rise to the occasion?

If the monetary base expansion is viewed as permanent, then it will almost certainly lead to higher inflationary expectations, and we will be in uncharted territory..again.

Boone Pickens: The Wind Dies Down

From today's Wall Street Journal, "The Dallas-based entrepreneur, who has relentlessly promoted his "Pickens Plan" since July 4, 2008, announced earlier this month that he's abandoning the wind business to focus on natural gas."

"Two years ago, natural gas prices were spiking and Mr. Pickens figured they'd stay high. He placed a $2 billion order for wind turbines with General Electric. Shortly afterward, he began selling the Pickens Plan. The United States, he claimed, is "the Saudi Arabia of wind," and wind energy is an essential part of the cure for the curse of imported oil. " There's nothing like a Texan hyping energy--except that Mr. Pickens didn't understand very much about wind as an energy source nor about relative prices.

Wind may have a minor role to play in a US energy portfolio, but for all the ancillary investment in grid connectivity, storage issues and the sheer visual and auditory blight of the towers, it is clear that natural gas and nuclear can have bigger impacts on curbing greenhouse gas emissions than wind ever will. Increasing fleet efficiency for cars and trucks, and cutting commercial and residential energy use are also ready channels for reducing electricity demand growth and hence the need for new plants, which means less greenhouse gas emissions than the current baseline trends.

Monday, December 20, 2010

An Unrepentant Financial Sector

What's wrong with the economic picture as we get to the end of 2010? There's a wide divergence of opinions about inflationary expectations. Looking at economic statistics, we don't see where non-monetary, demand-induced inflation is going to originate. We've always looked at the core inflation statistics, namely excluding food and energy prices. However, research from the Cleveland Fed has shown that focusing on this series alone reduces the power of inflation forecasts. Its Median CPI, or trimmed CPI, shows inflation rates on a trailing twelve month basis at 0.5%. Taking their approach to extract the forecasts embedded in financial asset prices, they come up with an expectation of 1.5%. Again, there are no alarm signals here.

Yet, the Treasury market has really tanked in December, and it's been reflected in the breathtaking drops in some of the best known bond mutual funds, including Pimco Total Return and Harbor Bond, also advised by Pimco. Both funds employ the "shake hands with the Government strategy" taken early in the crisis by Pimco, and consequently both funds are replete with government obligations. In some measure, though, this is the reversal of a few weeks ago when Treasuries rocketed in the wake of the Irish debt crisis and a flight out of the Euro. This latest move down is seen as a signal of higher expected inflation, but it seems hard to read higher inflation in the tea leaves based on this latest move in bond funds.

So, we believe there is almost no pricing power for manufacturers in the face of diminished consumer interest and limited consumer buying power in developed markets, apart from those consumers buying Louis Vuitton (lawyers, investment bankers and Keith Richards). The financial sector is virtually unaffected post-crisis, and there is even some optimism for near-comatose patients like Citi. The Financial Reform Commission has been an abject failure, and both parties are supplying duelling narratives about what caused the crisis.

In the meantime, on the real side, companies remain flush with cash and there is talk about a strong M&A market in 2011, probably driven by foreign buyers in US and European markets. There is precious little investment in new manufacturing capacity to pursue future growth in profits and employment. Share buybacks get the CEO's headlines, and not investing in the core businesses.

We've said this for almost three years now, but until the financial sector stops wagging the dog and the US manufacturing sector reinvents itself, it's difficult to imagine what will drive a durable recovery, a reduction in unemployment or a meaningful acceleration of inflation.

Friday, December 10, 2010

Tata's Nano Experiment: Lessons Learned?

The Tata Nano experiment was a very noble undertaking. Ratan Tata, the Chairman of Tata, is said to have tasked his engineers to build an affordable car for Rs. 100,000. This is the repeat of the Volkswagen undertaking, which was to create the "people's car." When Fiat came to the United States market, it came with low end 128's aimed at students and new graduates taking their first jobs. The first Datsuns weren't bad, but they were cars powered by motor cycle engines. When the Yugo came to these shores the mission was the same: affordable transportation that would launch a brand and open up other market segments.

What went wrong in all these cases? First and foremost, they were all lousy cars, but the Volkswagen's were the best of the lot. Mr. Tata should have modified his charge to his engineers: "Build me a Rs. 100,000 car that's safe, reliable, fun, and that you and your families wouldn't be ashamed to be seen in!" That would have ruled out the Fiats and the Yugo right away. The next, primary mistake is that these cars weren't really designed for their markets or their customers. The Fiats were badly underpowered and couldn't merge onto an onramp at 55 mph. The Yugo was a laundry list of disasters: incompetent, post-Soviet style engineering and low manufacturing quality were the real problems.

The Nano has the advantage of derivative styling that looks stolen from Nissan and others, but it's passable. The wheels are way too small, and the tires way too narrow for the awful Indian roads. Building small cars well is not a skill that confers itself automatically from being able to build light trucks or large sedans. It's a completely different engineering and consumer mindset. The Chief Minister of Gujarat is photographed supposedly entering the passenger side of a Nano in the NY Times, but judging from his girth and the opening of the door, he might have needed a shoehorn. Again, this is a design issue that a small car maker should be able to deal with.

The worst part of this story? The communications debacle. The Nano has been reported to have experienced a small number of fires. Instead of dealing with it quickly and decisively, foot-in-mouth disease broke out. First the company denied there were any issues. Beating a retreat from that untenable position, the company blamed the problems on "foreign electrical equipment." I'm sure that their supplier-partners loved to read that news. Just to be mensches about it, the company extended the warranty period marginally and said that they were going to improve the exhaust and electrical equipment, just for kicks. This pattern is the same one followed by Suzlon when their carbon fiber composite wind turbine blades failed on deployment in Minnesota. The excuses were just that. Not understanding the markets, not doing the homework, and not dealing with issues head on are present at every post-mortem of these commnication fires.

Tata will eventually get better, but the corporate mindset will have to become more open to change and listening to the market.

Monday, November 29, 2010

Consumer Protection and The Fed: A Bad Idea

The debate on Capitol Hill has been centered around whether or not Elizabeth Warren is the right person to head the new Bureau of Consumer Financial Protection. Economist Simon Johnson has been leading the chorus for Warren's candidacy, and in her speeches she seems to pay homage to the right themes. Who heads the agency is somewhat of a red herring; there's a bigger issue. The new consumer agency will be housed in the Federal Reserve Bank, and it will have a blank check as to the extent of its funding. That is a genuinely bad idea.

While the Fed has bank oversight in its charter, the key mandate for a central bank is to provide stability and liquidity to the banking system through monetary policy instruments that serve to maintain a stable currency. Over time, the mandate has been commingled with that of choosing a monetary policy path that keeps output close to potential. The most politically oriented discussions around the Fed have centered on its role vis-a-vis full employment and output growth. Until recently, the Fed has been able to maintain its independence around these aspects of its charter.

If the new Bureau of Consumer Financial Protection were housed and insulated within the Fed structure, it would bloat and dilute its charter. In addition, the new agency would be outside the purview of Federal Reserve regulation and control. This is a perfect situation for Congressional and Presidential meddling with no accountability. Since financial services are our biggest growth industry, the budgets and ambit of the new watchdog would expand uncontrollably over time.

St. Louis Federal Reserve President James Bullard is quoted by Dow Jones as saying, "The Fed's only engagement with this independent agency is to fund it." This is a bad idea for the Federal budget and a very bad idea for the continuing independence of the central bank. Let's focus on issues and stop focusing on personalities.

Don't Muck Around With Oil Sands

Canada is experiencing a mini-gold rush of multinational companies looking to develop projects around the Alberta tar sands. In the midst of the seventies oil crisis, one of my research groups did a lot of work on the Athabasca River tar sands, but not much development work came of it. There's no doubt that production from oil sands has become important for U.S. oil imports from Canada, but it's a questionable resource to be focusing on for environmental and economic reasons.

The Athabasca River deposits are bitumen deposits. The easiest way to think about this is to go out to an asphalt driveway and imagine that it were hot enough to melt the asphalt into a thick sludge. Now imagine mining, handling and processing this sludge for light and middle distillate products that industry and consumers need, like jet fuels, lubricants, and gasoline. The mining operations used to be strip mining, although it has moved away from that somewhat. The level and scale of the equipment is truly mind boggling. The energy input and the water requirements are enormous. The main reason these resources are garnering the attention is the relatively relaxed governmental regulatory structure in Canada versus places like Russia, West Africa, and the Middle East where more easily exploitable resources exist.

Using 2000 data, the global output of carbon into the environment was about 6.2 GtC/year, of which 1.7 GtC/year came from worldwide coal plants burning low grade coal at 32% efficiency. (Pacala & Socolow in Science) Increasing the efficiency of coal plants or, better still, switching to gas-fired base capacity can contribute one "stabilization wedge" to reducing the path of carbon emission, and one wedge is worth 1 GtC/year. This kind of project is eminently doable and gas is now plentiful in high quality resources. Building pipeline infrastructures would create demand for materials and jobs. The nuclear portfolio should also increase as the per kWh costs decline as plant designs are standardized and become more modular. In fact, the Chinese government's largest utility in Hong Kong has just announced such a plan to switch its electricity generation capacity away from coal and towards nuclear and natural gas. If China, as the largest emitter of carbon dioxide from burning coal, is thinking about this kind of future, why is America not doing so? And we chastise others for lagging on environmental issues?

A multi-fuel, portfolio approach using high quality fuels that can produce what consumers want is the way to go. Mucking around with heavy oil sands is not a sensible proposition.

Sunday, November 28, 2010

Al Gore Turns on Ethanol

The Wall Street Journal had an online feature on Al Gore's epiphany on ethanol. Speaking to some Greek financiers, he estimated that the benefits of ethanol were "trivial," according to the Op Ed piece. "It's hard once such a program's put in place to deal with the lobbies that keep it going." Wow! In a sentence, that's the problem with our legislative system, but that's for another occasion.

"One of the reasons I made that mistake is that I paid particular attention to the farmers in my home state of Tennessee, and I had a certain fondness for the farmers in the State of Iowa because I was about to run for President." Amazing.

We've talked about the ill-conceived ethanol cult in many posts, and it's always been clear to us that this was no silver bullet for greenhouse gases or for energy independence. If Mr. Gore is not running for any office, perhaps he should lead the choir about letting corn-based ethanol's subsidies and mandates fade away. No party is going to take this on, though.

Monday, November 15, 2010

Helping Haiti Won't Be Easy

The New York Times has two front-page stories on Haiti. The longer story, which earnestly strives to be a feel good story is about a private girls' school in Port-au-Prince that is striving to reopen post-earthquake. In a smaller, front-page story the Times told about the spreading cholera outbreak in Haiti, affecting six out of the ten national départtements; WHO estimates that over 270,000 people could be affected in the coming years. A telling item in the story? A Haitian epidemiologist is quoted commenting about the outbreak. Meanwhile, the Director-General of the Ministry of Health, M. Gabriel Timothee could not be found for comment.

The school story tells of a government study calling for a billion dollar investment in Haitian primary school education. The World Bank meanwhile calls for an emergency investment of $500 million. The simple fact of the matter is that Haiti, even in the most ideal case, could not absorb and deploy anything near these amounts effectively. It's sad, but it's reality. Not a feel good story.

The Johns Hopkins School of Advanced International Studies sent a group of student down to Haiti in 2007 to report on conditions and to frame short and long-term policy recommendations. It's a good precis of how Haiti got into its current condition. Haiti is currently #12 on the Fund for Peace list of Failed States. According to the SAIS report, there are "no institutions through which funds may be channeled." In turn, this requires that "they (the international donor agencies and organizations) take over the basic functions of the state." This is the fundamental dilemma. The donors have to step in and become the shadow government, which is resented by the Haitians as being demeaning and neo-colonialist.

However, the World Bank itself knows that between 1995-2005, over $585 million was deployed for infrastructure projects, especially roads to facilitate commerce and communication. To date, no account can be given for the money, and the infrastructure is still deplorable.

The report makes the salient point that Presidential power in Haiti tends to become highly personalized. A Presidential candidate traditionally gets strong support from one of the power groups: the elites, the urban masses and rural poor, and the armed gangs and militias. The candidate leans on one group and then demonizes the others. For example, Jean-Bertrand Aristide, a charismatic ex-priest spoke the language of liberation theology which resonated with the urban poor who swept him into office. Unfortunately, power corrupted Aristide to the point where the SAIS report describes his governing philosophy as "kleptocracy." As is often done in U.S. foreign policy, we chose to support Aristide, even as the Haitian elites and other groups had pushed him out, and we helped to bring him back for more disastrous rule. Government transitions in Haiti are also traditionally violent, despite the existence of all the trappings of French governmental administration.

Like many other Third World countries, "Pervasive corruption continues to undermine the Haitian state and is a central contributor to Haiti's ongoing conflict." So, despite the resilience of the Haitian people, the best intentions of religious and humanitarian organizations, and the nation-building programs of agencies like the World Bank, it is very difficult to see how the beleaguered people of Haiti can be lifted up from their current plight without a totally different model of deploying aid and holding the government accountable.

The United Nations Stabilization Mission for Haiti (MINUSTAH) has been deployed since 1990, but its role has become unclear. This is an international organization that could serve as a clearinghouse for coordinating the efforts of the patchwork quilt of private and public agencies at work in Haiti. Because of the cholera outbreak, and the continuing lack of potable water, electricity, and sanitation, don't expect significant progress until something fundamental changes.

Tuesday, November 9, 2010

Chevron Follows Exxon Mobil's Natural Gas Play

Chevron today announced the the acquisition of Atlas Resources, which greatly expands its production and reserve bases in both conventional and non-conventional natural gas. This is very much mimics Exxon Mobil's acquisition of XTO, which we've written about before. This latter acquisition is being blamed for the significant under performance of XOM.

If the United States is serious about reducing greenhouse gas emissions and reducing our dependence on foreign oil, then windmills are not the answer. To paraphrase Dorothy, "Toto, I've a feeling we're not in Holland any more." One way to make a significant dent in our carbon emissions would be to generate more of our electricity from natural gas rather than from coal.

Pacala & Socolow's 2004 article in Science laid out the concept of "stabilization wedges," meaning different ways of building up a significant wedge-shaped reduction in carbon emission by combining strategies like conservation, better buildings, and a changed fuel portfolio. It's still a fine article to read for its way of formulating solutions.

They write that it is possible to reduce the nation's carbon emission rate by 1 GtC per year (1 Gigaton of carbon=1 billion tons of carbon) by swapping gas baseload power for coal baseload power in electricity generation. In 1996, according to the Energy Information Administration, natural gas accounted for about 14% of electricity generation, whereas the proportion rose to 24% in 2009. Both Exxon Mobil and Chevron project rapid growth in demand for natural gas to 2030.

Natural gas power plants generate 1,135 lbs. of carbon per megawatt-hour of electricity generated, which is one-third to one-half the level of a coal-fired plant, depending on the grade of coal used, according to MIT research. As it is, many plants switch between coal and gas fuel sources at the margin. For example, in 2009 when natural gas prices fell sharply due to recession and inventory overhang, gas supplanted coal in many plants. However, the idea of this stabilization wedge would be to switch the baseload capacity to gas versus coal, which means replacing 1,400 gigawatts of 50% efficient coal-based capacity with new, natural gas plant.

Were this to happen, gas production would go up by a factor of four from 2004 levels, according to Pacala and Socolow. What's keeping this kind of meaningful change from happening? First, it's easier to feed political pork to renewable fuel mandates, especially running up to the recent midterm elections. Second, companies are reluctant to invest in their basis businesses with a long-term horizon, and it's much easier to focus on share buybacks and financial engineering. Third, and most telling according to most researchers, is the failure to establish a carbon tax that would serve to internalize some of the externalities associated with dirty fuel sources like coal.

Some industry researchers were proposing carbon taxes of $40-$50 per ton. Now, along come some researchers from MIT who have a patent and pilot operations for natural-gas based, solid oxide fuel cell plant that they say will have the lowest lifecycle costs per killowatt-hour over straight natural gas or coal-based electricity. What's the problem besides the lack of a scaled-up plant? The capital costs are said to to be 3-4x those of conventional plants. Absent some sort of carbon tax, it will always be the case that pulverized coal will continue to be the cheapest fuel source, but one that has high environmental and public health costs. The MIT folks say that a carbon tax of $5-$10 per ton would be sufficient to switch the economics to their unconventional gas plant. Unfortunately, there seems to be little political will to start switching over from King Coal.

I get very concerned when I hear about shale gas and other unconventional sources as being our salvation, and I also believe that carbon sequestration is equivalent to having a high school biology class learn anatomy by doing brain surgery. There are much easier ways to make a dent in our carbon budget, and a switch to gas in power generation is a solution with which we already have a lot of experience.

The bets placed by Exxon Mobil and now by Chevron reflect, in part, some of these strategic market dynamics.

Monday, November 8, 2010

Join the Club, or Not.

President Obama's trip to India was overdue, and it seemed to have all the usual bells and whistles. Today came a big announcement: the United States supports the notion of India becoming a permanent member of the United Nations Security Council. There were smiles and warm fuzzies all around. President Manmohan Singh beamed, the Wall Street Journal reported.

There's just a few problems with the invitation to join this exclusive club. First, there was the suggestion that India should initiate a rapprochement with Pakistan first. This is unlikely to be of real interest to the powers in Islamabad; meaning the ISI, the Pakistani military, the Pakistani Talaban, and the weak central government. Pakistan and its enablers will not abide India's membership. Next, there was the suggestion that India could join after the Council restructured. It's unlikely that the current permanent members have any interest in doing this, except.....

Permanent members of the Security Council each have the power of the veto over any resolution that is politically unpalatable. "Restructuring," among other things could make some future permanent members of the Council join without the veto right. In other words, it's back to the image of barrister Mohandas Gandhi boarding a railway train with a first class ticket and being sent to steerage. Some are more equal than others. "The world is a ghetto," as the song by War goes.

Even though Indian educational, scientific and cultural exchanges with the Peoples Republic of China have been on the upswing for years, China is definitely not in favor of India becoming a permanent member of the Security Council. The PRC has both philosophical and pragmatic reasons for not wanting to share the global political platform with India, its neighbor and friendly rival.

Put this altogether, and the offer today to support India as a permanent member of the U.N. Security Council is nothing more than a photo opportunity and an empty promise.

On a different topic, the nicest images of the Obama visit are the President and the First Lady interacting with young children at different sites. They both are clearly enjoying meeting the kids and engaging with them; the kids are clearly pleased to see the First Lady and President of the United States as people with similar skin colors. Travel, even in the cocoon of a Presidential visit, can make deep impressions. This is good stuff, and over time good things may emerge from "First Contact."

Move My Office

If this keeps up, Federal Reserve Chairman Ben Bernanke should move his office to the White House. The cacophony about QE2 continues to undermine the Fed's independence and role in monetary policy, as it appears that there is now a philosophical divergence between the Federal Reserve Chairman and a number of Governors, who appear to be talking more like traditional central bankers.

Let's think about traditional, non-monetary sources of inflation, apart from commodity price shocks and one-time events. Pressures from non-monetary sources should be reflected in capacity utilization rates in key industries, or in labor market measures, such as hours worked, overtime, unfilled job orders, and hourly labor rates. On all of these measures, there is no evidence of imminent inflationary pressure to be found. In the Chairman's own words, "We see an economy which has a very high level of under utilization of resources and a relatively slow growth rate."

What's fundamentally wrong with the continuing reliance on monetary instruments like QE2? Fed Governor Kevin Warsh, quoted in today's Wall Street Journal, says, "The Federal Reserve is not a repair shop to fix broken fiscal, trade or regulatory policies." It is, however, acting as if it were such a repair shop, providing band aids for the continuing lack of any coherent fiscal policy initiatives to improve capacity utilization, investment, or the labor markets.

Chairman Bernanke has made comments about the effects of negative real interest rates helping consumers repair their balance sheets by driving equity prices higher. I thought we should have learned from former Chairman Greenspan's tenure that this isn't the brief of a central banker. The late Nobel Laureate economist Milton Friedman would be jumping up to object to this line of argument as well. For the broad swath of U.S. consumers, higher equity prices are primarily reflected in the market values of their 401(k)'s. Unless they were to take out loans against these, they should have no impact on consumption. In Friedman's theory, they would look through this paper effect and conclude that there was no true increase in their permanent income, and hence they would not raise their consumption levels. This entire line of reasoning is misguided and off-target.

Where the Fed's QE initiatives appear to be succeeding is in driving down the value of the U.S. dollar, and creating a new carry trade where the funds are flowing to emerging markets and commodities. Unfortunately, these policies stimulate reactions by our trading partners in a negative feedback loop. So, Wall Street wins and Main Street continues to have the street lights out. Let's see if an emboldened Republic leadership and a chastened Democratic leadership can cobble together some meaningful budget reductions and fiscal stimulus that encourages investment. That would be nice.

Tuesday, November 2, 2010

Closing the Book on JOE

I listened to the third quarter earnings conference call by the St. Joe Company, and I have to close the book on this story, but here's what I noted. After the usual formalities, and before the
Q&A, the CEO gave a verbal overview of the company's historical evolution and business strategy; he seemed to be doing an elevator pitch to answer the question, "What is St. Joe?" It is something that needs to be done on a grander scale and on a more thorough basis in their public disclosures. I'm sure that their shareholders encouraged something like this. It was a good start, but less than effectively realized.

Next, the CFO gave a very dryly formulated description of their impairment review process for long-lived assets, concluding with the statement that the process showed their long-lived assets to be appropriately valued at the end of the third quarter. The external auditors were cited as reviewing the analysis and process, although it was not clear what period the review covered. Later in the call, the CFO noted that the company had taken $196 million in impairments over the past three years, meaning that it was not averse to taking write downs where warranted. Again, it's good to deal with the issue directly, but it could have been done in the context of a positive statement about shareholder value.

The company did address at least two points that were covered in the Greenlight Capital presentation by David Einhorn. The first was the suggestion by Greenlight that Southwest Airline's investment in gates at Panama City International Airport was in tatters. St. Joe, which is on the hook to make up any Southwest losses for three years, noted that the Southwest Airlines investment in the gates was "profitable from day one," and that the third summer quarter exceeded the airline's expectations, generating the best profit since the signing of the agreement. There's no doubt that the talcum powder, white sands of the Florida Panhandle could make an attractive tourist destination, but the key questions are "For how many people with what kinds of budgets?" and "When?"

The second point addressed the suggestion by Mr. Einhorn that St. Joe had given away access to the airport site to the airport authority and now needed to get "through the fence access" in order to share in future development rights. On the face of it, this seemed like a giveaway. In fact, this isn't true, according to the company. Through the fence access rights were reserved to St. Joe and enshrined in the original agreement with the airport authority, and rights conferred on the authority were limited to the development of aviation infrastructure, such as runways and supporting structures.

The analyst questions from Raymond James, Keefe Bruyette Woods, JMP Securities, and Morningstar were alternately fawning, vague, and unlikely to produce research that would generate additional institutional ownership. Towards the end of the call, one analyst dwelt tediously on the specific lease terms for a single CVS drugstore, as if this by itself made any difference to the valuation of the company or its prospects. My advice to the company would be to work hard on telling your own story better, with clear financial metrics.

There was a question about cash burn rates relative to $196 million in cash and when the company would get to profitability. Unfortunately, the CFO didn't really complete the answer to the question. If I understood, his comment was that cash S,G&A expense, excluding one-time items, declined 21% year-over-year, so the management had their eyes on the till. He didn't venture a forecast on profitability.

We're going to close the book on this JOE story, but I wouldn't expect to see the company gaining additional shareholders until the runway to shareholder value creation becomes visible.

Sunday, October 31, 2010

The Curious Case of JOE

In following up the recent tempest about asset valuations at JOE, several curious things stand out. For an institutional stock with very concentrated holdings, it seems to have almost no significant Wall Street research coverage. The best known firm I can find is Keefe, Bruyette & Woods, long known for expertise in financial services but not necesarily for real estate. Their analyst is quoted as saying that the points raised by Greenlight Capital are "overdone." Nothing analytical that I can access to back that point up. The S&P report on the company is totally uninformative. If anyone has some current institutional research that they'd like to pass on, I would gladly peruse it.

S&P also lists no peer companies for JOE. The company's proxy report lists many peer companies for executive compensation purposes, and the list includes REITs. home builders, and developers. Plum Creek Timber is one of the largest private landowners in the US, and came out of a similar corporate history to JOE. Yet it is a REIT, and as such paid out $205 million out of some $312 million in CFO for the most recent nine months of the current fiscal year. JOE can't provide such income comfort to its investors, and its story appears entirely on the come.

Neophytes to the stock, like myself, go to the corporate web page and are greeted by references to the Deepwater Horizon incident, the prevalence of tar balls on beach properties, and the suggestion that the company is pursuing litigation to make things right. Huh? Cash out the door, years in litigation, standing in a long queue for a settlement. This is something for an investor to get excited about? The photos of some luxe developments are in stark contrast to those in the Greenlight Capital presentation. How can these contradictions be resolved? A company conference call is scheduled for November 2nd. Hopefully there will be some good Q&A on the call, and we'll all know more.

Thursday, October 21, 2010

Musing About Margins

When the global meltdown began a couple of years ago now, analysts all over the world agreed that the financial sector, particularly in the United States, had simply become too big. Whether measured by percent of GDP or percent of the S&P's capitalization, the lubricant of our economic system had become bigger than its wheels. We then tried to make this into slogans, "Too big to fail," or "To big to save." Reading the news in the current earnings season, the financial sector continues to live large.

Cleveland-based Eaton Corporation (NYSE: ETN) reported outstanding results for a global leader in power management systems, hydraulics, automotive and aerospace. My former colleague, Norm Klopp of Midwestern Investment Management, always liked this stock. Core revenues were up 18% for this global leader, and operating EPS rose 32 percent year-over-year. Segment operating margins increased to 13%. Good company, with good management and a business model leveraged to strong volume increases, and it's as good as it gets.

Now move over to medical devices, a sector with which I'm familiar first hand. This sector offered great demographics, unmet clinical needs, technological innovation, and proprietary technologies. Multiples were in the ozone years back. St. Jude Medical (NYSE: STJ) reported an 11% revenue increase for their fiscal third quarter, and operating EPS up 5% year-over-year. Operating margins increased to 26%. That is a pretty nice margin for a manufacturing business, and it reflects characteristics of the device business. St. Jude is selling at 13x this year's projected operating EPS, reflecting uncertainty about reimbursement and healthcare reform. Remember, STJ's operating margins are twice those of the more industrial Eaton.

So, what made me wring my hands this morning? BlackRock (NYSE: BLK) reported a 74% increase in third quarter earnings, besting all analyst estimates, driven by its acquisition of Barclay's Global Investors, the leader in indexed fund products. Current operating margins were 33.8%, projected by the CEO to move to 40 percent, which will be driven by asset inflows into indexed equity and fixed income funds. I don't mean to single out BlackRock, because the large banks would also be poster children, but it was the absolute value of the operating margin that drew my attention.

In the funds business, there's no metal bending, no R&D, no product development risk, no product liability, no price controls, no FDA regulation, and no accountability for poor performance, since indexed products mimic the market risk. Goldman Sachs is reported to be ready to redeem Berkshire Hathaway's $5 billion convertible because, among other things, it has $1 trillion in excess liquidity with the Federal Reserve Bank. Something is wrong with this picture, and it could be that some numbers, particularly for banks as opposed to asset managers, are illusory.

We've written before about this issue. Simon Johnson takes a stab at guesstimating the unrecorded bank portfolio write downs as being $50-$100 billion, with a ten percent probability of losses being multiples of his estimated range. Really, really big in other words. Even if we careen to this scenario, there will be no reform and no accountability. Former CEO Angelo Mozilo of Countrywide Financial, one of the great enablers of Fannie who poured jet fuel over the early flames of the mortgage crisis, walks away with no life style changes, while the housing sector is beginning yet another episode of cardiac arrest. I took a Rolaids with my coffee.

Tuesday, October 19, 2010

Доверяй, но проверяй (Trust, But Verify)

Fairholme portfolio manager Bruce Berkowitz, whose fund owns 29% of JOE, is quoted in the Wall Street Journal today, in response to valuation questions raised by David Einhorn's Greenlight Capital: "There are auditors, a CFO and that stuff gets looked at on a quarterly basis." For Mr. Einhorn to be correct, that would mean "the auditors are sleeping," Berkowitz added.

No kidding! Where have we heard this before? Early in my career as an analyst, after I got burned by a few charismatics CEO's, I adopted the tenets of the Russian proverb loved by the late President Ronald Reagan. Start with the financial statements and notes, sure, but always look for independent validation. One only has to go back to the Anton Valukas Examiner's report on the collapse of Lehman Brothers to find failures by auditors, boards, CEO's, CFO's and legal teams. The savvy value investors I dealt with as a CFO really did their homework, which is why they were often early in a story, and often right. They also looked for a margin of safety.

Mr. Berkowitz also suggests that the management of JOE should hold an "analysts day" and take investors through the properties! I can just see the internal legal team choking on their bagels as they read this suggestion. Isn't it a bit late for what would now be seen as a PR stunt?

Fairholme has had a huge influx of cash since its early success and subsequent awards by the financial press, including Morningstar. It's not possible to tell from the website, filings, or reports how big a research staff Fairholme has. One wonders how such a large stake in JOE could be accumulated without these significant asset quality issues having been independently vetted by Fairholme. It wouldn't give me comfort to then see increasingly large stakes taken in AIG by Fairholme, since AIG was always an incredibly complex company with a dismissive attitude towards analysts, and a poor history of governance and transparency.

JOE has been very silent itself on the issues raised by Greenlight Capital. Now, JOE is in a reactive position, which is risky and undesirable. However, it has no choice but to try and help the market decipher where reality lies between the positions of its large stakeholders, for the benefit of all its constituencies.

Sunday, October 17, 2010

Termites and Foreclosures

We wrote in a 2008 post:
"The banking industry has never been set up to effectively and humanely handle large volumes of foreclosures, because it is something that they're not good at and something that was never anticipated on a large scale. The participants in the foreclosure business are yet another unregulated, unseemly lot. Unleashing this process on a large scale is like introducing termites into a house."

Now, yet again, Congress and the pundits are focusing on symptoms like documentation and robosigners. The media discussion, which will feature lots of political posturing and horse trading in front of the upcoming elections, will deflect attention from the fact that tranches of MBS's need to be written down which will again raise questions about portfolios where the paper is held.

Even potentially positive events for consumers, like sales of foreclosed homes have been revealed to be poisonous. Auctioneers have transferred homes to reasonably informed buyers with attached first and second mortgages! No one is responsible for even providing this kind of information to bidders. There's no accountability anywhere in this dismal financial chain and we wonder why consumers are not leading the recovery.

Thursday, October 14, 2010

A Cup or A Thimble of Joe?

David Einhorn of Greenlight Capital gave a terrific presentation at the Value Investing Congress, titled "Field of Schemes." His target is what's left of the old St. Joe Minerals Company, which shrunk down to a land trust holding timber and mineral assets, now called St. Joe, a public company.

Bruce Berkowitz, manager of the Fairholme Fund, is a lionized investor whose motto is "Ignore The Crowd." Fairholme owns 29% of JOE, according to the last company proxy. Other large owners include T. Rowe Price at 15% and Janus at 12%. Fidelity is shown as owning 6% of the outstanding equity.

As a preface, Einhorn mentions that representatives of the company refused to speak to him as he was doing his research. This violates one of my first principles, paraphrased as "speak to everyone with a legitimate interest in the company, and give them their due." Short sellers often do the best research on Wall Street, with a few exceptions. The other place where good research is done are the distressed debt desks of places like the old Lehman Brothers, and Larry McDonald's book is definitely worth reading for how good research is married to trading.

A CFO can always learn from speaking with the quality, institutional short sellers. There's an old Arab proverb that applies:"Keep your friends close, and your enemies closer." JOE's blowing off David Einhorn was bad judgment, bad business, and bad for the existing shareholders. I also suspect that Einhorn himself tried to speak to Bruce Berkowitz--it would be the first stop given Fairholme's stake--but the NYT reports that Einhorn's calls went unanswered.

The first thing I noted was the trouble beginning when JOE chose a CEO, Peter Runnell, who came from Disney. A decisive step was taken to turn JOE into a real estate developer, a competence for which the company had no history, no depth of management, and no relevant experience on the board of directors. Runnell left in 2008.

Much of the work shown in Einhorn's presentation represents good, solid, fundamental grunt work, with his staff poring over local government filings and regulatory filings which filled in the mosaic where the company's disclosures were inadequate or uninformative. I've spent lots of time in court houses and government offices as an analyst, and there are rich veins of information, but it is tedious and time consuming to go through it. Kudos to Greenlight Capital for doing the work.

Einhorn notes that over the past ten years, JOE has earned some $710 million in pre-tax profits from the sale of low basis cost properties from its beginning portfolio. In other words, its quality of earnings was not good, because of one-time items like gains and because it was not sustainable. Half of the quality portfolio has been sold, according to the presentation.

The company's pitch shifted once much of the quality real estate was sold, and Fairholme reports were about JOE owning land for the Panama City Airport, the construction of which would open Bay County to a huge influx of tourism into an area where JOE was developing resorts, conference centers, homes and golf courses. Einhorn goes into the realities of the fact that JOE's current land holdings are outside of the airport, and the company can't benefit directly from development because it had to give some of the land away to governmental bodies in order to develop it. Only one gate out of seven in the airport can accommodate the jumbo jets flown by Southwest and other major carriers. Current prospects for the airport are uncertain.

Other issues surround the lack of transparency in JOE's disclosures about the amount of capital investment it has made in its properties, the capitalization of expenses, and the fact that properties are reported as developed if one home has been built though the majority of the site is fallow. Einhorn estimates, with reasonable logic, that developed lots in the RiverTown development project are carried on the books at $74.5 million versus his estimated market value of $6 million. He goes through several other projects. The bottom line is that the company has taken relatively little in the way of impairment charges to-date, and based on the fact that the Florida market has been hurt significantly worse than most other US markets, current market values suggest that significant additional write-downs need to be taken. Einhorn's provocative floor for the share price is $7-10 versus a quote of $20.20 at this writing.

He derives the $7-10 number from market value estimates of the remaining rural land in the portfolio, leaving aside some unknown value for 41,000 additional acres of entitled acres that could be developed in the future.

It will be interesting to see where this discussion goes and how the board and the auditors deal with the questions raised. Stay tuned.

Wednesday, October 13, 2010

Tea Leaves

The Ceridian-UCLA Pulse of Commerce Index uses real time purchase volumes for diesel fuel as a proxy for over-the-road trucking volumes, which in turn relate to the volume of goods-in-process and final goods moving to distributors and retailers. According to the latest publication, the consecutive monthly declines for August and September have not been seen since 2009 and suggest that the economic momentum for inventory rebuilding has come to an end. The performance of this index is said to lead turns in the Federal Reserve's Index of Industrial Production. While we haven't worked with this Index directly, we have tried to use diesel fuel volumes as an indicator before, but never had the data that Ceridian can generate by providing financial services to volume purchasers. It's not a good sign.

At the same time, a friend who is in the market for rail cars indicates that cars are, and have been, coming out of mothballs, which is a positive for the rail car mode. Rail cars are associated more with movements of fuels, grains, fertilizers, chemicals and agricultural commodities. What he's seeing correlates well with the movement in grain prices, and it seems to be also related to growing export demand, despite the grousing about currencies. The problem with this indicator is that is seemingly more contemporaneous than leading. We'll have to wait and see, but the great results reported by Cargill yesterday reflect strength in the types of commodities that ship by rail, and to a lesser extent trucks.

Finally, the European Central Bank has published a paper by de Bondt, Maddaloni et al. that surveys the relationship between low rates in the run up to the financial system collapse, and it suggests that central banks may again be keeping rates too low for too long. The Fed is due to make more august pronouncements this week, and it may have painted itself into a corner. Backing away from the low rate commitment is off the table, especially given the pending mid-term elections. However, it is a very reasonable question to ask, namely the diminishing power of monetary policy to effect a meaningful boost of adrenalin to the economy going forward.

Thursday, October 7, 2010

Duelling Pundits

It's one thing to have sports commentators or journalists talking over each other on the air. That's like bear baiting at the Globe Theater: an uncivilized sideshow. I can't remember anything like the daily spectacle of Federal Reserve Bank Presidents talking over each other in speeches and press releases. This practice should be reined in because it's unseemly and disconcerting. The Fed is in danger of being trivialized.

Dallas Federal Reserve Bank President Richard Fisher gave a good speech at the Economic Club of Minnesota. It covers quite a few points we've made before about the huge liquidity trap resulting from the unprecedented "quantitative easing." He quoted a statistic that is from the classic central banker paradigm: member banks at the Fed are holding more than $1 trillion in excess reserves with the central bank! I have an idea to mop these up. Do like the gift card issuing banks do with consumers: make the excess reserve balances decline monthly at a 2% annual rate. In other words, use 'em or lose 'em.

In Fisher's conversations with small business leaders, he says access to credit is rarely their number one concern. Interesting, and surprising too.

Aside from share buybacks and dividend increases, big company leaders have told Fisher that they don't see the case for investing in capital beyond their depreciation, and the biggest factor is uncertainty about the political situation and the subsequent roll out of regulations from health care reform and financial system reform. This makes some sense, but it also makes the global executives seem to be indecisive leaders.

The upshot of Fisher's speech is that additional expansionary policies by the Fed would be "pushing on a string," and that's something that we've said for a long time. He is one of the few Fed Presidents to really put the onus on fiscal policy going forward as a key to relieving the angst felt by big company executives.

Wednesday, October 6, 2010

Choking on Disclosure

The newsletter Compliance Week reported on a symposium of general counsels, risk and compliance officers from a variety of public companies, mainly mid to large cap companies. These officers generally felt overwhelmed with the current and evolving structure of disclosures and filing regulations. Having gone through SOX as a first generation, accelerated filer, I can speak personally about the pressures this Act put on a small, efficient finance and accounting function. The people in the CW Symposium have very large staffs and access to sizable outside resources, and they feel overwhelmed!

They also felt that their boards had been forced into a checklist mentality, which has taken them away from their most important function which is to formulate, implement and monitor the company's strategic growth initiatives.

The example of the new SEC disclosures on climate risk is cited as an egregious example of regulation without purpose or value. Responsible scientists globally have a difficult time quantifying what climate change is, let alone "climate risk." Take this down to the level of an individual corporation: the concept of a corporation being able to describe or measure the effects of its actions on its incremental climate risk is laughable. Nevertheless, trees will be felled, paper wasted, and expensive lawyers will draft opaque prose that meets the standard, but which also will be glossed over by institutional investors for whom this provides no guidance on whether or not to buy or sell shares.

Ken Jones, the Chief Compliance Officer of Huron Consulting said, "We spend three times as much money...on executive compensation reporting than we did two years ago." This is a CAGR of 73%! The Dodd-Frank bill will add considerable complexity to the already foggy bog of executive compensation reporting.

To be fair, there's another side to the executive compensation issue. The previous disclosure was woeful, and in light of egregious practices that came out during the financial meltdown, it was clear that this was, and is, a serious issue of misappropriation of shareholder funds as well as an issue of economic rent capture. Since nothing substantive was achieved to address the fundamental issues that Rakesh Khurana has so clearly identified for so long, it was inevitable that a crushing set of regulations, yet to be implemented through rules, would emerge from the vacuum.

What about smaller public companies, which is where I have served as a CFO and a board member? Kevin Fry, the general counsel of PACCAR, said "You can't be a little public company anymore." That is not good for economic vitality.

Tuesday, October 5, 2010

VW Loses Its Way

VW is shaking up its top executive management and changing its strategy to focus on the American market, and it couldn't come at a worse moment. The North American market is probably permanently downshifting to a lower level of sales, and it is narrowing the mass market segment, while also increasing segmentation in the luxury segment.

VW's always had wonderful, German characteristics: tight, precise steering; great brakes; a good front suspension; reliable gearbox and short throws, to name a few. Plus, they were economical and flat-out, fun to drive. My last VW, a German-built diesel got 50 mpg in New York City driving in the eighties and cost me nothing to maintain.

Now comes the news that they are going to "Americanize" the car. Big mistake. They were so close to having the right car in the Jetta, which had Rabbit-like performance in a big, comfortable sedan. They never got it quite right, but they were very close. They should go over the finish line with the Jetta platform. Apparently, it's back to the drawing board, and I don't think it will work. We have Saturns, Hyundais, Accords, Camrys, Nissans and Mazdas. Another me-too model won't work, and without the Teutonic flavor, VW will lose all its distinctiveness.

Some consumers regarded VW higher-end Jettas as BMW for the Ordinary Joe. Now their cup of Joe is going to become a cup of Sanka. Too bad.

Thursday, September 30, 2010

Marketing an Accent and Coming Clean

BBC America runs a funny series of commercials about how British accents elevate the receptivity of the audience to a character, and their good example is Patrick Stewart as Captain Picard on Star Trek. I definitely would take him more seriously than Captain Kirk!

I was in a Minneapolis restroom looking to dry my hands, and I came upon a new hand dryer that was different from the ubiquitous down spouted, hot air blowers we've all seen. This one was made of a familiar grey plastic, and was dubbed an "Air Blade" dryer or some such name. It was made by Dyson, the company that has made a fortune selling bagless vacuum cleaners that "never lose their suction." More on this later.

The Dyson dryer was said to be more efficient at drying and more sanitary than wiping your hands. You put your hands together, fingers pointing down, into a slit-type opening and air dries your hands. I couldn't see the difference compared to the old, Edsel-style dryers. Dyson's great advertisements feature its very studious, well coiffed founder speaking in a great British accent. The first time I heard him, I ran out and bought the first Dyson vacuum cleaner. After all, he was an engineer, an innovative problem solver, and he personally hated vacuums that lost their suction, just as I did! What could be better? He had my implicit trust, and the accent was key.

This wasn't David Orek, who sounds like a carnival side showman, lifting bowling balls with his little vacuum cleaner. Dyson had size, design, plastic, and style.

Where am I going with this? One of Dyson's messages is that it solves the important problems, like unsanitary conditions from poor hand washing and vacuum cleaners that clog and lose suction. A recent Mayo Clinic study looked at hand washing in public facilities and found no relation between the use of towels versus the use of air dryers and better sanitation. The important variable in reducing germs and improving sanitation was technique in washing and time spent drying. Spend the right amount of time, and good old, brown paper towels are just fine. So, Dyson didn't solve a problem that was specific to the drying medium (towels), but it might have fed our own laziness that we'd rather have blown air than our own muscle power to dry our hands. Not to mention that lower waste from towels is offset to some extent by the constant repair and replacement of the air units, in addition to their energy costs. To paraphrase Alexander Graham Bell, "What have we (sic) wrought?"

Finally, as I sit here cleaning out my Dyson vacuum , I can come clean. Yes, the vacuum cleaner has no bag, and therefore it cannot lose suction from a full bag or a blocked filter. However, it does lose suction, often and unpredictably. There are some vents in the cyclone housing that clog up easily with lint or dust. Once these are blocked, the Dyson, cyclonic moving air mechanism comes to a halt and nothing is picked up. Yes, they got rid of the bag problem, but they substituted another problem, which is really the same issue. I really wanted to believe Jim Dyson, I really did, but he wasn't honest with me or millions of other consumers.

He really does make the best commercials though, and he has that great accent.

Thursday, September 23, 2010

GE CEO on Energy Policy

GE CEO Jeff Immelt is quoted at the Gridwise Global Forum, "This is a great country. But, you know, we have to have an energy policy. This is just stupid what we have today." I hope that he doesn't apologize later for his remarks, and I also hope that his refreshing candor stimulates some response from his fellow CEO's who either produce or use energy, which is pretty much every company.

In talking about clean energy and reduced greenhouse gas emissions, it is difficult to conceive of meeting any environmental goals without having a place for nuclear energy. In this respect, it is curious that we always cling to European examples when we bemoan our own health care industry. Yet, we ignore the European model when it comes to nuclear energy. Almost 80% of French electricity is generated by nuclear power. Wind and ethanol won't make a meaningful difference to the total energy demand in the U.S. for the foreseeable future. While coal is abundant, the problems with cleaning the coal and then sequestering CO2 byproducts are expensive, technologically challenging and potentially very harmful to the environment. Granted that GE is talking its book to some extent, given its leadership in nuclear power, but we applaud Mr. Immelt's taking the discussion to the public forum in a decisive fashion.

He did say something that might be confusing for GE shareholders, and that is that he no longer sees GE as being exclusively a purveyor of high end, expensive products in its market segments. Rather, in the future, he wants to have "the value product all the way up to the high end product" in every segment, to keep out the Indian and Chinese competition. I think this is both bad strategy and bad economics. If Indian and Chinese companies can, for example, produce low price, low margin, low tech consumer appliances for their own markets, then why not let them? This is the law of comparative advantage. If GE can bring to bear innovation, technology, and high quality manufacturing for demanding customers in any country, why not focus on this? Over time, it will be interesting to learn what he meant by this remark.

Wednesday, September 22, 2010

The Feeling's Mutual

As institutional shareholders have rightly been crying aloud for proxy access to submit their candidates for corporate director positions, the position of those institutional shareholders that are mutual fund management companies needs to be examined.

Wall Street and Main Street intersect in Mutual Fund Square. 90 million Americans are said to hold mutual fund investments, either in individual or retirement plan accounts. Carolyn McPhillips notes that mutual fund ownership is the "primary means by which individual investors participate in the financial markets." Institutional investors control about 70% of the shares traded on exchanges, according to John Bogle. Have you ever read the annual report of your mutual fund(s)? Have you ever looked at your fund's trustees? If I recognize 5% of the trustees, that would be a stretch. Many are attorneys at obscure law firms and it's completely unclear what qualifies them to be a trustee. Hopefully, as with corporate directors, we may see some explanation for why the boards are populated as they are.

Since funds have "unitary boards." which oversee five or more mutual funds in a family, a "nod your head Yes" director affects a large volume of assets. Although the Dodd-Frank bill has paid lip service to proxy access for mutual fund issuers, it will be exceedingly difficult for shareholders to make significant changes. Does this matter? It sure does.

The governance of mutual fund companies, with exceptions such as Vanguard and Dodge & Cox, does not meet the standards of transparency, disclosure, and shareholder friendliness that are being imposed on corporate issuers. If governance were to improve, then over time, one would expect fewer duplicative fund offerings, elimination of multiple share classes, lower fees, and better performance. That would be nice for those 90 million of us who are owners of mutual funds.

Friday, September 17, 2010

Half Full or Half Empty?

Stock market gurus have noted mutual fund inflows and outflows for the latest quarter, which show continuing outflows from equity mutual funds and large inflows into bond funds, particularly intermediate bond funds. The conclusion, the gurus say, is that the retail investor will continue to be a contrary indicator, getting out of stocks when the risk is low and potential returns high. These are definitely "glass half full" kind of guys.

The confluence of economic and financial data continues to justify skepticism about equity market performance, which is a "glass half empty" perspective that I share.

We know that the last decade was one of the worst on record for average household income, driven by no real wage growth and fattening of the upper tail of the income distribution curve. Today, the Federal Reserve has reported second quarter household net worth falling by 2.8%, the first drop since the beginning of the financial crisis. Permanent income, which is related to wealth, should theoretically be the driver for future consumption, so this is not encouraging news for the consumer's contributing to the recovery, as was always the case in past cycles.

The University of Michigan Consumer Sentiment Index, which has a decent record as a leading indicator of business cycle turns, fell to 66.8 in early September, the lowest level since August 2009. This is after Cash for Clunkers, Dough for Down Payments, Shovel Ready Infrastructure programs, and other useless Federal programs have failed to effect the popular psyche.

Households continued to pare their debt, but this arithmetic happens because consumer credit card balances and some mortgage debt has been written off. Total household debt fell by $77 billion to $13.5 trillion outstanding at the end of the second quarter. Statistics reported by the Journal show that bank write offs in the second quarter were about $70 billion, almost all of the reported decline in household debt outstanding. We also believe that there is more risk in the pool of outstanding mortgages, not subprime, but prime.

Credit card lenders, if you haven't read your mail, are looking for balance transfers and not for raising lines or lowering rates and fees. So, the consumer can't go back to this well to finance consumption in the future. Bank lending for small business expansion is at a stand still. Bank C&I loans fell 1.9% to $91 trillion. So, it's unreasonable to expect small business creation or expansion to lead the recovery.

On the flip side, nonfinancial corporations now have a cash hoard equal to almost 7% of assets, the highest levels since 1963, according to a Journal chart. Other than share repurchases, there are no large uses of cash being trumpeted, with the exception of some large acquisitions by super-giants like J&J. The point is, to use the language of Keynes, there is a distinct lack of "animal appetites" among the corporate sector capitalists, and so the huge expansion of liquidity and credit has become trapped in corporate cash balances. There is little desire to invest in plant and equipment for expanding operations. With the large layoffs, labor force productivity will rise in the short-term because of the higher capital-to-labor ratio.

For the medium-term, it seems really difficult to find an engine that will pull the U.S. economy out of a low growth cycle. The talk of tax increases offset by spending cuts, proposed by David Stockman, seems like the early supply side theory in a mirror. That theory, as formulated by people like Dr. Mike Evans of Chase Econometrics and the University of Pennsylvania, said that taxes should be reduced with a simultaneous, equal dollar amount reduction in Federal spending. In fact, that theory was never tried. Now, we have Stockman's peculiar, toxic reformulation. There is not much clear thinking about tax and fiscal policy either, which has frozen the markets into a trading pattern.

To finish on a positive note, the Minnesota Twins, once neck in neck with the Chicago White Sox for the division lead, have faced down the big city bad boys with Midwest small ball, and failing a meltdown look like a shoo in for the title. A nice way to end the Summer and lead into Fall.

Wednesday, September 15, 2010

IBM Writes Rx for HP

IBM CEO Sam Palmisano made some incisive comments about HP's recent public travails. "HP used to be a very inventive company," he is quoted as saying in the Wall Street Journal. This is one of the key issues: it has been living off its printing and consumables franchise for many years now, while failing to innovate around its corporate systems businesses.

While the former HP CEO is rightly criticized for a number of things, I take issue with Palmisano's comment that Hurd "cut out all the research and development." For its most recent fiscal year, HP's R&D spend was $2.8 BILLION, or 2.5% of revenue, versus $3.5 BILLION, or 4% of revenue in the first year of Hurd's tenure. Only someone in the Federal government could call this cutting out all spending. On the face of it, a reasonable investor doesn't have the information to make any sense of this number.

What ongoing projects are in both numbers? What percent is related to new products versus product line extensions versus think tank expenditures? IBM and AT&T grew new businesses from their expenditures at IBM Labs and Bell Labs. Those were headier days of monopolies, bigger margins, and weaker customer power. Shareholders would need explanations if these kinds of projects were being funded to a large extent, which I doubt.

My suspicion is that much of HP's R&D is under managed and unproductive. This is the obvious explanation for the pressure to go out and seek exorbitantly priced acquisitions. Boards, shareholders and analysts should demand to see what's under the covers of numbers like $3 billion in annual R&D.

Tuesday, August 31, 2010

Dodd-Frank and Shareholder Rights

The SEC is rapidly going about formulating regulations around the Dodd-Frank bill, which is the first significant regulatory reform affecting share ownership in decades. This process will generate much too much commentary, but I had a few thoughts from where I've stood over the years, as the officer of an issuer, an investment analyst, and as an institutional shareholder.

Congress and the SEC are hoping that institutional shareholders will act like "sheriff's deputies" in the Old West, watching out for bad corporate behavior, taking action, and reporting the behavior to the badge. Unfortunately, having read many hundreds of proxy voting records for my institutional clients over the years, I can say that if I've seen a dozen instances of specific votes against a management proposal, that is an overestimate. Granted, this was before the advent of the proxy voting firms, which I consider overpriced , rife with conflicts, and of little value in their current incarnations. Nothing I've seen recently changes the lack of active voting by institutional money managers or mutual fund managers.

Institutional proxy voting has routinely been handled by legal departments. 'nuff said. They are checking boxes. The typical, diversified mutual fund will have about 2% or less of assets in a full equity position. So, that's fifty positions that the portfolio manager has to care about from the corporate governance side. In order to thrive in the business and generate good investor inflows, portfolio managers focus on short-term, absolute and relative performance, marketing, fund governance, staff supervision, and portfolio inflows and outflows. Finally, the senior managers of traditional funds are really afraid of getting too entangled with their companies. They fear learning of developments that might make them insiders and inhibit trading. Their analysts are focused on working their models to the third decimal point and know very little about corporate governance.

So, though it's romantic to think of fund managers as sheriff's deputies, they are more like the ranchers, who support the marshal, but care deeply about their personal issues like land, water and keeping their own cattle.

The first draft of the regulations hands primacy to shareholders with positions of 3% or above. An interesting, and completely arbitrary number. Ironically, it is very possible to get a 3% position in a diversified mutual fund, and very easy to get it in a concentrated, non-diversified fund. However, it seems as if the Act will hand over primacy to hedge funds which will routinely have large, concentrated positions, assuming they can be measured properly. The last thing American corporations need is to cede their mediocre corporate governance to hedge funds, which can be counted on only to generate benefits for themselves and not for the long-term benefit of the enterprise and its stakeholders.

If you are in a position to comment on the regs, please do: they need a lot of work.

Friday, August 27, 2010

Signs of Financial Froth

The economy may be swooning, but the M&A markets in August are finding a way to enrich managements and bankers while destroying value. The boards of both Dell and H-P ought to be castigated by their shareholders and Wall Street analysts for throwing money at 3PAR's management and shareholders.

What are some signs of financial froth? A headline in the Wall Street Journal, "Valuations May Not Matter," in the 3PAR duel. Someone asking the question which company more desperately needs the acquisition? Discussion in print and electronic media of the strategic importance of the acquisition with no reference to valuation.

Every day that goes by with media comments also raises the prices of any company in the solutions business, even smaller ones like Compellent and CommVault. Volumes go up in the shares and bets are placed, but does it make any sense?

Dell is no longer a technology growth company, but a cyclical growth company dependent on product cycles and replacement demand. It probably needs 3PAR badly to enhance its product offering to larger corporate customers. H-P meanwhile, has undertaken several large acquisitions in recent years, and it isn't clear at all if these have been digested, both financially or operationally into the sales channels. With no permanent CEO in place, it is odd that its bidding is so wild, given that the CFO is acting as the CEO. It goes back to the boards.

With the financial crisis, the press and academics were writing about the primacy of risk management activities. Yes, that's necessary, and it's well and good to have documented processes. However, the fundamental responsibilities of the board include the strategy for evolution, growth and financial management of the company. That certainly includes understanding what is a reasonable or unreasonable price to pay for a target company relative to the opportunity cost of funds and prospective returns.

Since the CEO of 3PAR is a former H-P exec, he surely has some insight into what might be driving their vision for the acquisition, and this will benefit 3PAR shareholders. Dell may lose by winning, and perhaps lose even more by letting this fish off the hook.

Wednesday, August 11, 2010

The Fed Fires Another Blank

Today's readers of the Fed tea leaves were not impressed, as the market decline continued into day two. To paraphrase the press release code, the recovery is underwhelming. Macquarie Asia economist Richard Jerran, quoted in the Wall Street Journal, cites a very interesting paper by Hiroshi Ugai, "Effects of the Quantitative Easing Policy," which draws eerie parallels between the actions of the Bank of Japan (BOJ) in the aftermath of the late 1990's crisis and the current actions of the Fed.

From March of 2001 through March of 2006, the BOJ substantially increased the monetary base by increasing the current account balances (CAB) held by member banks with the BOJ through increasingly massive monthly purchases of securities. Incidentally, JP Morgan estimates that the Fed will account for 15% of Treasury demand as a result of the latest policy guidelines.

At the same time, BOJ made a decisive commitment to a zero interest rate policy (ZIRP) until the day that the CPI stopped declining. Although the Japanese economy showed several, short-lived recovery episodes, prices declined continuously from 1998 until the autumn of 2005.

Instead, Ugai concludes that the real benefit from the BOJ policy was not due to quantitative easing at all, but to the ZIRP, or commitment to keeping interest rates low indefinitely. We know that the Fed has studied the Great Depression, but perhaps the better analogy now would be the Japanese experience.

It was troubling to read in the Fed press release that lending by banks "has continued to contract."

Looking at corporate results from Cisco, which exceeded earnings expectations, we see that revenue was below Street expectations. This in spite of the fact that economic statistics, though reported with a lag, show double-digit year-over-year spending increases for equipment and software.

CIO's Michael Cembalest and Hans Olsen of JP Morgan's private banking group make a very telling point about what's driving the current profit recovery. They note that corporate profits have beaten expectations for the past five quarters. At this stage in the recovery, a 5% growth rate would reflect nominal GDP growth in excess of rising unit labor costs. However, the current profit rebound comes from declining labor costs, low real wage growth and sustained high labor productivity. The JP Morgan team believes that this kind of engine for recovery should not command a very high P/E multiple because it is not sustainable. The latest readings on productivity, the slowing of export growth, and weakness in Britain and Germany all reinforce the notion of a lower market multiple.

The JP Morgan team point out that macroeconomic trends are unusually important in evaluating investments in the current world economic cycle, and we agree.

Tuesday, August 10, 2010

A New Theory about HP

The H-P boardroom has seen the circus come to town on prior occasions, with the board spying on itself. Now, CEO Mark Hurd walks the plank over seeming peccadilloes amounting to $20,000 of expense reports which were reimbursed after audit. These compare to a four-fold rise in the share price over a five year tenure. Institutional investors quoted in the press said that the 8% first day decline in the stock price was overdone, so in their minds, the CEO's management of corporate assets and above-market returns are what matters. Never mind that much of it was market timing, but these investors prefer profits and ROE over peccadilloes.

Meanwhile, much of our avowed governance reform is about codes of ethics, and like the Old West, there's only one code for everybody. In reality, the board made the only decision that it could possibly have made, by taking control of the issue. Had the contractor-in-question remained a mystery, the issue would have been framed in the tabloids and she would have had a much bigger stage, with the company constantly on the defensive. However, just like the Toyota sudden acceleration story, the HP episode makes very little sense, starting from the process of hiring the contractor, to the supposed marketing duties, to the efforts to conceal the ongoing relationship. For the ongoing lack of judgment and circumspection, and for any additional risk down the road, the board took the only appropriate decision it could.

Now, the newspaper stories report employees delirious with delight at Mr. Hurd's resignation because of his"Chainsaw Al"-like crimes of cost-cutting. Quite a few people quoted are engineers. It has always seemed that HP has been dominated from its founding by an engineering culture. I suspect that former CEO Carly Fiorina's difficulties with the board and company culture were not so much about Compaq as they were about offending the inbred, engineering culture.

One of the lead marketing tag lines from her time was "HP: Invent," and that legacy lives one in the "Invent" centers in Geneva and Mumbai. This was probably dismissed internally as being the product of a marketing person who didn't understand innovation anyway. CEO Hurd further went on to attack a bloated cost structure, something that engineers really don't like. In their view, ordinary executives aren't smart enough to understand how difficult good (read perfect) engineering is; putting out new products isn't something that can be held to a quarterly timetable, they whine.

HP is positioned well as a result of decisions taken by recent CEO's, including Ms. Fiorina and Mr. Hurd, but it really hasn't fulfilled its potential yet. I suspect that it still relies too much on profits from its consumables businesses, where it has marginally innovated and effectively raised prices, while completely defeating movements like the refillable cartridge businesses. This was done mainly through marketing and only secondarily by engineering. Giving away printers didn't hurt either, another marketing decision.

So, HP shares continue to look like a value play, but I suspect that there's a very large, cultural elephant in the room that could slow any transformation into a sustainable, growth story. The next choice of a CEO might best be someone who is known and acceptable to the insiders, rather than another, charismatic outsider.

Friday, August 6, 2010

What Recovery?

The Minneapolis Fed has updated charts comparing the current recovery to the ten postwar recoveries, in terms of output and employment. The beginning of the last downturn is dated July 2007, and the recovery is said to have begun in July 2009. What is shown is not a pretty picture.

The decline in employment during the last downturn was significantly steeper than other downturns, and U.S. employment is shown to have declined overall by 5.6% from the onset of the recession. What's worse is that the decline shows no sign of turning upward, and overall U.S. employment numbers are still 1% below those at the start of the recovery in July 2009. This is unprecedented. The consternation in financial markets today is a reaction to what's suggested in these comparisons and in recent monthly data.

The bullish economic commentators, like Joseph Carson at AllianceBernstein, point out rightly that the contribution of consumer spending and housing to the current recovery is about 25% of the contribution expected at this stage of other postwar economic recoveries. However, AB then appeals to strength in manufacturing and exports as reflecting a changing mix of contributors to the economic recovery. I just can't understand how exports can sustain a contribution to growth when it's only China whose economy appears to be having robust growth, and the Chinese economy has not traditionally had a large appetite for high tech, manufactured U.S. exports.

A more fundamental issue is the long-term damage caused by discouragement and loss of productivity and employability of large segments of the labor force imposed by the reluctance of large and small employers to add workers. Extending unemployment benefits for some workers may earn votes but little of any significance for the economy as a whole.

There is very little that the Federal Reserve has left in its toolbox to address lack of income and employment growth as well as deficient demand. It has to get its balance sheet in order and get out of the Greenspan economic wizard business. Business leaders have to get beyond reporting the next quarter and start investing in their businesses. The business leaders should demand that Washington stop trying to phony up numbers for November elections and start working on rational fiscal policies, including revenue raising through an efficient tax system, in order to generate a real recovery.

Monday, July 26, 2010

No Rabbits Out of the Hat

Changing the top kick in charge of the Afghanistan theater and believing that this will have a material, long-term impact on the success of our effort there is delusional. There won't be any rabbits to pull out of the hat, like another surge, to turn things around quickly.

In the Spring of 2009, we spoke to a number of academic and international experts fresh from Central Asia; putting the current reports together with my own . In the post from a year ago, I wrote:

"Pakistan as a state, is near collapse and the policy choices here are not attractive, in the short run. The Inter-Services Intelligence (ISI) is a shadow government in Pakistan, operating outside of the control of a moribund civilian government and of the divided, discouraged military."

That is hardly news to any knowledgeable observer of the India-Pakistan disputes since Independence. The Wikileaks undifferentiated trove of documents will make the discussion too diffuse. Like the shadow banking system in our own financial crisis, the ISI will defy attempts to characterize it or regulate it; it will operate freely and independently, unless a cataclysmic event intervenes, which I hope does not happen.

The material about the Haqqani network is old news also. United Nations reports from 2004-6, as well as Human Rights Watch reports from 2007 painted a picture of a very dangerous and effective military operations and training organization with ties to Al Qaeda. Jalauddin Haqqani was a CIA asset in the 2001 time frame when the US propped up the Afghan jihad against the former Soviet Union. His son, Sirajuddin, has been in charge of daily operations of the organization for the past several years, and he is said by knowledgeable observers to have extensive connections in the Pakistan tribal areas with all interested parties.

The foreign policy machinery of the current US Administration seems to be chasing its tail on this whole issue. Despite energetic and intensive personal diplomacy on the part of the Secretary of State, there doesn't appear to be any real consensus on what to do about the significant divergence in interests between the U.S., Pakistan and other external actors in Afghanistan.

Friday, July 23, 2010

Humanistic Education

Professor Roosevelt Montas of Columbia University gave a lecture that I attended last year in New York, about the Core Curriculum, which is the distinctive foundation of undergraduate education at Columbia College, my alma mater.

It turns out that institutions in Asia are looking at making their undergraduate education more humanistic and less mechanistic. It's ironic that as they are humanizing their model, we are frantically trying to emulate the model that they're abandoning, but that's another topic.

In 2009, the University of Hong Kong and Lingnan University held their 3+3+4 Symposium on Core Curriculum, at which Professor Montas delivered a Keynote Address. With some of the volunteer teaching I do, and with a history of undergraduate and graduate teaching, it really made me think about the value of humanistic education and its relation to our recent financial misadventures.

Here's a quote from Professor Montas, ", true education involves personal must be a place of moral education in a deepest sense, education about how to be human, education that fosters habits of self-examination, critical skepticism and an openness to the new."

Looking at the financial meltdown apart from the arcane discussion about derivatives, value-at-risk models and financial regulation one comes back to some of the fundamentals qualities of education that were lacking among the small and large actors in the crisis. Where was the self-examination during the lengthy process of foisting off toxic products onto customers for whom they were not suited? Where was the critical skepticism when looking at misleading and incomplete disclosures or risk models with poor foundations? What if the efficient market tenets didn't hold and a massive bubble was building? Then, some new thinking would have been in order.

Trading floors, executive suites, and board rooms may have been rife with mechanistically trained number crunchers who were all indoctrinated with the EMH and the CAPM, but their moral educations were sorely lacking.

For my undergraduate vintage of the Core Curriculum, we had to read Virginia Woolf's "To the Lighthouse." I confess to not remembering a great deal about the novel, but I was very taken by this quote from the author, writing in 1938 as European elites built up to the inevitability of World War II. Virginia Woolf wrote that she felt compelled to "doubt and criticize and question the value of professional life--not its cash value;that is great;but its spiritual value, its moral, its intellectual value...If people are highly successful in their profession, they lose their senses."

She had it right then, and now.

Wednesday, July 21, 2010

Free Trade

Professor Jagdish Bhagwati of Columbia has a note about the twin barriers to freer global free trade being the US and India. He has a point, although how he doesn't include India's neighbor to the north, I don't know. He exaggerates to make a point, and that's okay here.

He theorizes that the US refusal to end its agricultural subsidies has triggered India's resistance to endorsing the Doha Round, because of fear that its subsistence farmers would be wiped by subsidized U.S. exports. This in turn hamstrings the government of Dr. Manmohan Singh, an economist by training and an orthodox, free trader. So, we are hurting one of our supposedly stronger allies. Ever heard this before? Typical U.S. issue-by-issue foreign policy.

The constituencies aligned in favor of ending agricultural subsidies, especially corn and other grains, are many and varied: those concerned about obesity and the links to high fructose cornCheck Spelling syrup, to those concerned about the impacts of high intensity fertilization on dead zones in the Gulf of Mexico, all the way to orthodox economists and deficit hawks. Yet, the relatively few, but powerful Midwestern senators and representatives carry the day, and everybody pays.

Neither political party wants to spend the political currency to take on the problem of agricultural subsidies, but the benefits from addressing this issue, in spite of some near-term dislocations, would be substantial for our economy and for the economies of our trading partners.

Thursday, July 15, 2010

Good Reading on Financial Reform

As the ham-handed, absurdly complex financial reform bill has just moved closer to Senate passage, I wanted to recommend a new, free down loadable book about the brave, new post-reform world published through the London School of Economics.

It features essays by, among others, Lord Adair Turner of the FSA and by Simon Johnson, former Chief Economist of the International Monetary Fund and frequent contributor to the reform debate. I respect the analysis and refreshing perspective that these knowledgeable observers bring to the table. It will take me a while to get through the book, but I really appreciate the distribution model LSE has taken to get the work out.

Incidentally, the Davis Polk law firm's initial analysis of the reform bill suggests that implementation will not be a walk in the park; some 67 studies are required by aspects of the bill, and the regulation development process is labyrinthine. In the meantime, the uncertainty created by the content and timing of the final regs will impose significant costs on businesses and consumers.

I am proud to say that Mick Jagger and I both have spent time studying at LSE. I suspect that his economics training is why the Stones have managed their musical business affairs so well over the years!

Wednesday, July 14, 2010

Global Telecom The Indian Way

On the right is a photo taken a few months ago by my cousin, who was an executive in the software industry in Mumbai for several years before moving into biopharma. It's almost too much for words, but it says everything about the reality of electrical, telecom and cellular infrastructure in India.

No entity controls the connections to the pole, and anyone is free to add theirs to the jumble, without any consideration for external effects on existing connections. The local utility doesn't care about this situation and has no power to enforce regulations anyway. Everyone shrugs their shoulders and life goes on, until the daily brownouts or a failure. When you hear about the need to invest in Indian infrastructure, this is an image to keep in mind.

A recent study by McKinsey estimates that by 2030 India will, for the first time in its history, pass from being a country of villages to the majority of its citizens being urbanized. Mumbai will have about 28 million inhabitants, Pune will have 6 million, and Chennai some 8 million. McKinsey estimates that $1.2 trillion will have to be spent on infrastructure alone by 2030 to accommodate the needs of the urban population throughout the country. Some big chunks in their calculation are water and sewers, the latter being something that never receives public investment to any meaningful degree. Roads, trains and subways are critical investments also. $120 billion is required on an annual basis, according to McKinsey. They size this by saying that it's equivalent to adding infrastructure for a city the size of Chicago every year for twenty years.

Now if something like this were done, there would be tremendous export potential for US companies, since the materials and services requirements would be beyond domestic capabilities. Of course, India would have to export more in order to pay for this effort, but these are the kinds of things that should be the subject of Indo-American dialogue, not just selling more fighter planes and arms to the Indian government.

Tuesday, July 13, 2010

We Apologize For the Previous Apology

Monty Python, and John Cleese in particular, often bit the hand of their benefactor, the BBC, in their sketches. At the end of a rude sketch, they would then run a B&W written apology for the offensive sketch, gravely intoned by Cleese. Immediately afterwards, they would issue an apology for the previous apology, retracting some of the statements read by Cleese. It's a classic Python device, and I laugh every time.

However, the recent flap over GE CEO Jeff Imelt's comments at a Rome business meeting reminds me of the Monty Python bit. GE's PR department spokesperson first said that Imelt's comments were taken out of context, the evergreen apology phrase. Then, the spokesperson apologized for that apology and said that Imelt's views were not those of the company! Have some courage--he's the CEO, that's what he and other company leaders believe, and that's what the American Chamber of Commerce in China has been saying for years.

Here's the quote from the Financial Times, "I'm not sure that in the end they (the Chinese government) want any of us to win or any of us to be successful." The European Chamber of Commerce has echoed these sentiments, along with the American Chamber.

What's the problem, you say? The FT says that lots of companies are making money selling consumer products, like soft drinks. The problem is that GE is producing and selling engineered products like wind turbines and highly engineered systems like avionics, where the interests of GE and the Chinese state enterprises will eventually diverge.

The Chinese can easily mix sugar, water and caramel coloring to shut out foreign soft drinks, but they don't care enough about it to do so. They do care deeply about technology, about technology transfer and about being a global player and exporter, which is in line with their "beggar thy neighbor" trade and currency policies.

GE has been a model citizen in how they have approached the Chinese markets, and their actions are fodder for lots of business school case studies. However, the unfortunate truth is that the discounted present value calculations for some of their investments will have a shorter horizon and a lower terminal value than GE and other industrial conglomerates are used to seeing.

No amount of jawboning or complaining is going to change this. The question is: "How to live with the new reality?" There's nothing wrong with politely speaking one's mind and putting the cards on the table. No apology needed.