Wednesday, October 31, 2012

Divergence Continues in Euro-Zone

From today's Spiegel,
"According to a report released on Wednesday by Eurostat, the European Union's statistical office, unemployment in the 17-nation common-currency area stood at 11.6 percent in September, the highest it has ever been.The numbers represent an up-tick against the 11.5 percent rate reported for August. In total, Eurostat estimates that 18.49 million people were out of work in the euro zone, up 146,000 over August. The rate indicates a significant rise against the euro-zone unemployment rate in September 2011, which was 10.3 percent.
The trend toward spiking unemployment rates was particularly strong in those countries suffering the most under the ongoing euro-zone debt crisis. Between September 2011 and the same month a year later, the unemployment rate in Spain rose from 22.4 percent to 25.8 percent and in Portugal from 13.1 to 15.7 percent. In Greece, unemployment rose from 17.8 to 25.1 percent from July 2011 to July 2012, the last figures available for the country.
With the euro-zone economy likely headed for a year of negative growth this year -- the ECB is forecasting a 0.4 percent contraction -- it seems unlikely that employment in the 17-country currency zone will improve any time soon"
Despite decades of a reasonably successful customs union and a less than stellar currency union, the perpetual struggle for EU hegemony between France and Europe continues to this day.   Italy's international leadership credentials have never kept pace with the nominal size of its economy.  The structure of the EU and the euro have created a further divide, called the "core" and the "periphery."

The whole notion of an EU consensus is a fantasy for academics and bureaucrats in Brussels.  Britain's electing not to be part of the common currency was, frankly, supposed to backfire on them as they stayed out of an economic powerhouse, a United States of Europe.  In a sense, Britain's assessment of the future was correct. However, it really detracts from the potential of an efficient EU to have Britain on the sidelines.

For the elected governments of the periphery nations, especially Spain, Portugal, Greece and Ireland, the only real attraction of the EU at this point is ready credit on subsidized terms with no budget control from Brussels.  That program isn't available.  Their view of a European consensus will have nothing to do with those of France and Germany.  They can't take much more pain without tearing their social compacts.

It seems, superficially, that Schäuble and Merkel are suddenly on the same page, nominally ruling out a "Grexit" and granting powers over national budgeting to Brussels. This is cynical posturing for the press and markets.  The closer such a system came to being implemented, with the specific rules for elections and voting visible, the more viscerally unacceptable this system would be to politicians and voters.  

Where will the funding for a Keynesian stimulus come from in the wake of a zero growth 2012, and prospects for a similar path in 2013?  Multilateral EU facilities are tapped out, or soon will be as they get overtaken by events. 

A German sovereign investment fund, which we've written about before, could only be an improvement over the current impasse.  It would be within national control and directed towards investments that created efficiency and return, hopefully with the cooperation of EU partners.  It isn't a solution to the EU malaise by itself, but it could be a step forward. 

Tuesday, October 30, 2012

The Euro Is Going Nowhere Fast

Greek President Antonis Samaras has ironically become a salesman for austerity, since he wants to avoid his coalition partners starting to chip away at individual provisions of the austerity and reform packages, limiting access to cash.  Reform of labor market practices, which is fundamental for improving Greek productivity and competitiveness, has already been vetoed by  coalition partners New Democracy and  Pasok.

The original goal for Greece to achieve a primary budget surplus (excluding interest payments on debt) equal to 4.5% of GDP by 2014 was, and is, absolutely ludicrous and unattainable.  The current backup plan is to give Greece another two years to achieve the target, but Spiegel estimates that this will require an additional 20 billion financing over the two year extension.  

The fundamental reason is the ongoing shrinking of the Greek economy.  Austerity and the global slowdown have caused the Greek economy to shrink by 20 percent over the past five years. This is why the world has witnessed genuine anger and anguish in the streets, as opposed to the usual gentrified student and government worker protests.  

According to Taggespiegel, lack of progress towards the budget surplus can't be blamed on "...any lack of austerity by the Government in Athens."  They point out nine months to-date in 2012, Greek government expenditures have been €2 billion less than required by the austerity budget. The problem has been the collapse of tax revenues, driven primarily by the contraction of output and income, as well as by capital flight and a collapse in tax collections.  The "Lagarde list" of wealthy Greeks with Swiss bank accounts is a national scandal, but nothing can be done about it.  Those who can fly have done so.  

It's hard to see a scenario continuing where the Greek government keeps wearing sackcloth and ashes, begging for more relief.  They can never achieve the 4.5% GDP target even in 2016.  What is the point of this two year long multinational charade? 

IMF Chief Economist Olivier Blanchard, whose organization has never met a consensus forecast it didn't like, now has a dire outlook on the Bernanke rescue.  To paraphrase what he says, we're in for a lost decade before recovery. 

Can Google Fix The Wireless Industry?

The U.S. wireless industry, often held up as a paragon of innovation, is morphing into just another classic American duopoly in which customers endure all kinds of psychic and economic abuse with gusto, in pursuit of the next great smartphone.

Remember the concept of "consumer sovereignty?"  Competition is everywhere, and atomistic firms get price signals from markets in which consumers vote with their dollars, driving innovation and product development.  Not any more.

When I was an equity analyst, my firms signed a corporate agreement where we could buy the earliest brick-like ATT cell phones, which could stand on their base and which had a long, rubberized antenna.  Eventually, I got to experience a Blackberry, again through a corporate relationship, and the "always on" capability together with my own obsessive-compulsive behavior led me to withdrawal and to Robert Frost's poetic junction.

I am not, by any means, a technology Luddite.  However, I want to exert my sovereignty and own a non-smartphone, simply to make calls and to send texts.  It has always worked for me, and the siren song of the smartphone does not call out to me.  After owning Nokia phones for a while, I have owned two very fine Samsung phones, including my current model.

It works like a charm, and its menus are simple and intuitive.  It also has a lot of very nice features which the carriers are having them remove from the newer phones.  For example, I can block crank or robocallers by using a very simple option in a menu.  I couldn't find a similar feature on any phones for my daughter when she was looking for a T-Mobile upgrade.  When I showed the feature to the salesman, he seemed astounded.  Now, my daughter could get the same functionality if we could pay a monthly fee of $2.95, and the calls would be blocked through the T-Mobile network only.  

For those of you crying out "EBay," please don't.  I have had my fill of dealing with folks who have all the stars in the world for recommendations, but who are not directly accessible when they fail to perform on a deal.  EBay takes no responsibility either.  I'd like to simply buy the unlocked phone of my choice, from a wide palette, through my retailer of choice.  If I have to deal with a return, I want to know who I'm dealing with.  This isn't possible in our brave new world.  

T-Mobile basically forces upgrades or unlocked phone purchases to be smartphones.  However, smartphones on their network must have a minimal data plan.  I don't want any data plan, and since I am the ultimate minimally resource-intensive customer paying gold-plated freight, I should be able to have my choice.  I can't.  I've been with all the carriers, with the exception of Sprint, and they're all equally lousy.  

Now, I read about Google's Nexus 4, which seems to be an unlocked phone with lots of nice features that seems to operate on GSM networks like that of T-Mobile, but without a data plan.  That sounds like it could be an interesting choice. I think the phone is too expensive for what I want, but it's still cheaper and potentially better than the overpriced phones T-Mobile offers.  

Google's model, according to Jeff Jarvis, is both open and partnering and disruptive.  He talks about Google taking aim at the cable companies.  Bravo!  A friend in the IT business told me that Google has a broadband experiment in Kansas City where they are offering customers the fastest broadband and online storage for a fraction of what the cable companies charge.  Go for it, Larry and Sergey!  

I do have concerns about what Google is doing: I am not an acolyte. However, if their targets involve monopolists and anti-competitive neanderthals like the wireless companies, then hopefully consumers may regain their sovereignty against the odds. 

Wednesday, October 24, 2012

Surface RT: Good News and Bad News

Following a recent post, Microsoft's launch of the Surface RT broke with the company's history in one, fundamental way.  Walter Mossberg, the widely reach technology guru at the Wall Street Journal, wrote,
"This isn't a cheap iPad knockoff. It's a unique tablet, made of a type of magnesium with a feeling of quality and care. The Surface starts at the same $499 base price as the large iPad, albeit with 32 gigabytes of storage, twice Apple's entry offering."
These are all home runs for the consumer impression. Mossberg's comment is consistent with some of ours about the engineering and design work that went into the product.  Note too, that because it is not a me-too knockoff the iPad, the question of price, which was the siren song of Wall Street analysts like Shaw Wu, doesn't appear.  This was the only way to go, as we said.

David Pogue, tech columnist for the New York Times echoes these thoughts,

"Now, for the very first tablet it has ever manufactured (in fact, its very first computer), Microsoft could have just made another iPad ripoff. But it aimed much higher. It wanted to build a tablet that’s just as good at creating work as it is at organizing it.
On the hardware front, Microsoft has succeeded brilliantly. Read the specs and try not to drool on your keyboard"
Where the folks at Redmond appear to have fallen down is on the software side!  The version of Windows 8  for the Surface, which is called RT, seems to be have some initial bugs and limitations.  The screen, which we talked about, is described as "sharp and vivid" by Mossberg, but inferior to the fourth generation of Apple's retina display.  If it's sharp and vivid and made for working, as opposed to running slide shows, which is what most of my friends use their iPad for, then I don't think this is a big deal.

The camera photo quality, and the battery life issues need to be fixed.

Here's a memo I would put out to the team if I were Steve Ballmer:
You've had a good launch, not a great one.  Make sure we stay in touch with everyone who has bought a Surface---use blogs, set up a special communications tool, but do not, under any circumstances, let our customers stew and get frustrated.  Put engineers on 800 numbers to answer questions.If you've better ideas to increase our customer intimacy, let me know. If we need to change what we do here, go ahead and change it. 
Let our customers tell us what the fixes should be. Mossberg and Pogue are great for initial validation, but we need to make sure that nobody feels bad about their decision to commit their dollars to our product.  We are going to make them feel good, no matter what it takes.  That will be the best testament to your hard work in bringing this product to market.  Thanks for bringing a unique tablet to market on time. Bill, the board, and I are right behind you.   
I hope they go forward from here, because there are definitely things that need fixing, but no show stoppers.

Sunday, October 21, 2012

Google Blows a Quarter: No Worries

I'm in the process of reading "What Would Google Do?" by Ben Jarvis.  I'm very skeptical of books that are written by acolytes or high priests of corporate worship, which is what this book's title suggests. This book does flirt with idolatry at points.  However, it is a very interesting and provocative book, ostensibly about Google but it is also about first principles of business models in the digital age.   

Google's share price was buffeted last week by  mistakes of carelessness and inattention by a vendor--someone pressing "Send" when they weren't authorized to do so and without reading what they were sending---and by disappointment in 3Q 2012 financial results.  The basic comment was that Google's take from a mobile ad was lower than that from a desktop ad because of lower rates; the stock swooned.  It was probably talked down so that buyers could find a better entry point.

From what I've read about Google, including from Jarvis' book, I would guess that none of Google's founders or senior executives would be the least bit concerned by Wall Street's quarterly hand wringing.

In fact, here is an excerpt from the recent Wall Street Journal online edition,

 "About half of all U.S. mobile ad spending goes toward search ads, more than the roughly 47% of total digital spending in Web search, according to eMarketer Inc. And Google takes a 95% share of mobile-search revenue in the U.S., estimates eMarketer."

Google CEO Larry Page said that at this point last year Google generated about $2.5 billion from mobile advertising, apps and content.  This year, they are on pace to generate more than $8 billion in revenue from these channels!  "I am not worried about this at all in terms of our business at all," he said.  That's the kind of confidence I like to see. 

By contrast, Facebook and Zynga have either been late to the mobile advertising party or slow to generate revenue growth.  So, even among its New Digital Age peers, Google is clearly at the head of the table.  

In traditional newspaper or media businesses, with considerable overhead and inefficiencies, a corporate strategy would have been to dip the toe into the water of mobile advertising, including "setting" rates at some desired, higher level.  Instead, Google's approach is to watch customers and partners create a mobile advertising platform on top of their search platform without any attempt to control or set the architecture or rates.  

Instead, Google focused on grabbing a 95% market share of a market which analysts say is only going to grow as corporate marketers themselves get more comfortable with this new advertising medium and move dollars there.  

Google, among other things, is all about speed and aggression.  One of their senior execs wrote another one of their principles, "Done is better than perfect."  Aggression, especially towards any of their competitors, used to be a chromosome in the Microsoft DNA.  Microsoft certainly didn't worry about Windows releases being perfect: they went the other way and released really awful bloated, bug-infested software.  Let's see how things go in the upcoming Windows 8 release and the uptake in Surface RT. It should be a new day for them.

I need to have a Google expert explain something to me.  Their practice of releasing all kinds of versions of Android OS on mobile phones: Ice Cream Cone, Cookie Monster....and not allowing users to easily update to the latest and best version: what is that all about?  This makes no sense at all: it borders on Microsoft arrogance, unless there's a nefarious upside I am missing.   

Meanwhile, according to CS analyst Stephen Ju, GOOG is selling at 11 times P/E-ex cash, which doesn't seem expensive on any absolute basis.  He rates the shares Outperform. (I don't own any shares). 

The Inevitable Franco-German Discord

Here we are in the fourth quarter 2012, and the Wall Street Journal is writing about growing Franco-German discord after yet another European summit.  Going back to mid-2011, we wrote,
"Turning to the ECB, it has relatively few options that will provide meaningful support to a dismal outlook in Europe. The Wall Street Journal naively suggests that the Germans, French and stronger European countries will withdraw from the European currency union and create their own "strong euro."

This is extremely unrealistic and would not solve the fundamental problem of economic imbalances within the European Union. Germany is really in the driver's seat, but it too will be reluctant to detonate the charge that destroys the empire of the Brussels bureaucrats, of which many senior ones are French. A slow, economically inefficient unwinding is probably what's in store."
Looking at the original photo ops with former French President Sarkozy and Chancellor Merkel, it was evident to us from the start that the fundamental interests of France and Germany could never align.  Now, with a new French President with his own limitations and political agenda, the situation is worse than before.  At least former President Sarkozy and Chancellor Merkel had a cordial relationship; President Hollande, despite his having been trained at the Ėcole nationale d'administration, seems determined to establish a prickly relationship with Chancellor Merkel. 

President Hollande's attempt to be a broker between Germany and the European periphery is a recognition that the French hand is weak.  It is yet another path to painting German Chancellor Merkel as the reason for rioting in the streets in Greece and Spain.  This subterfuge won't work, because as we said in 2011, Germany is ultimately in the driver's seat.

Nicolas Veron of the Bruegel think tank agrees with us, as the Journal quotes him as saying, "Germany is pivotal in Europe, France is not." 

The edge has been taken off the crisis because the ECB has chloroformed the markets with it promises of a "bazooka" of liquidity.  The markets will eventually awaken again.

Saturday, October 20, 2012

Microsoft Surface Tablet: Take an Aspirin or Not?

Someone sent me a link to a presentation by Microsoft engineers, showing off the research and design work that went into the new Surface RT.  I was very impressed by, among others, an engineer who walked through what went into designing the display, both technically (screen aspect ratio, lighting and ppm) and from the point of view of user demographics.  Another engineer talked about her work designing the keyboard, based on her research of how users input data and their digital dexterity.

Articles in the press have talked about the pressure Microsoft is putting on its component manufacturers to meet the $499 introductory model price point.  Grousing has been constant about the continuing need for Microsoft to receive a fee for the installation of Office and the OS on the Surface.  All true, but probably not  critical issues.

Finally, Wall Street tech industry analysts like Shaw Wu of Sterne Agee feel that Microsoft has blown the pricing of the Surface, which may be undercut by the upcoming introduction of an "iPad Mini" and the lower end products of Amazon and Google.  The Apple blogosphere seems to dismiss Surface on its price positioning.

I think that Microsoft had no choice but to position the product price where they did. It's perfectly rational.  Racing to the bottom by competing with Amazon or Google Nexus would be to completely deny the value-added of Microsoft's technical research and engineering.  Once a price point is set, it is extremely difficult to then turn around and raise prices.  It's always easier to come down, either through discounting or combining with other offers.

A medical device company where I was the CFO faced a similar quandary.  Our engineering and technical literature droned on endlessly about the high tech engineering and design that went into our product's profile, deliverability, and performance. Specs and data were everywhere.  The spending to support the research and development weighed on the income statement.  However, when it came time to set a price, we always kept the price flat with the earlier generation product.

When I asked our marketing people "What gives?" the answer was "The customer just won't accept a price increase."  My message to them was "Either we believe what we're saying about we've put into the product and the value, or we should stop talking about it.  If we believe it, then the customer has to pay for that innovation, so we can stay in business.  It's a sales and marketing task to convince the customer about our value proposition."  Bottom line is that we raised prices on the improved product, gained the industry leading share and profits at the expense of the low end and continued to make incremental innovations.  The low end  was left to feed on scraps.

Innovation in computing products has a tremendous advantage compared to medical devices in that component pricing is always under pressure due to the commodity nature of the parts. Manufacturing is also relatively simple component assembly.  Those processor, drive, screen, and flash memory makers have to figure out a business model that works for them.  Microsoft isn't alone in putting pressure on them.  Look at what Apple does at FoxConn.

Microsoft appears to have engineered a credible, innovative, feature-laden tablet at an appropriate price point. A reasonable customer objection is "Microsoft is an unproven and unreliable vendor of consumer products.  Look at Zune. If  I am taking a risk, why should I pay an Apple price?" Answer that question for them, but not by taking an arbitrary, low end price.

The question now becomes, can they act like a consumer products company and tell their story to the customer?  Mistakes will be made. What Microsoft has to do is to fix everything right away for every customer, whatever the cost   This is a critical launch, and success won't be determined early.  Failure is not an option.

The cost of making every buyer happy is a better investment that buying back shares.  That cost is just another form of advertising and brand rehabilitation.  The lessons of Amazon's early days, and the lessons of Lands' End in its heyday were: take care of customer problems right away; give them a good, friendly experience; make them feel good about Microsoft and their decision to buy the product, and you've got a customer for life.

Apple are masters at this, especially through their stores.  Let's see if Microsoft has prepared for this battle.

Thursday, October 18, 2012

Comparing IBM and HP Recent Quarters

IBM's third quarter earnings announcement was characterized by the New York Times, as "mixed and somewhat unsettling."  Actually, it shouldn't have been too unsettling as IBM has missed its  revenue guidance for the past five quarters. This quarter also represents the first quarter in which the new CEO Virginia Rometty is putting her stamp on the style of the presentation, which was more cautious and spoke of the same macro headwinds referred to in the HP conference call.

The quarter reported against the background of the bold 2015 Road Map When a reader looks at the revenue growth rates over the period 2010-2015, especially for the base business excluding acquisitions, one sees the same GDP-type growth rates referred to by HP CEO Meg Whitman in their recent conference call.  For instance, IBM projects the CAGR of major market revenue, in constant currency, over the Road Map period as being 2%. Growth markets, which for IBM means ex-North America and developed Europe, are expected to increase revenue at 8% per annum in constant currency over the same period.  HP by contrast seems to have its OUS business more heavily exposed to the European Union, which is why CEO Whitman was so cautious about European macro headwinds.  IBM's global brand and reach has been built out over a longer time to a wider portfolio of nations.

IBM said that $20 billion of acquisitions will add revenue growth of 2% per annum to the company over 2010-2015.  HP, by contrast, will be hamstrung by its repeated history of disastrous acquisitions under the three past CEO's.

In the important areas of business analytics and cloud computing/data centers, HP and IBM look somewhat comparable in their presence and growth opportunities.  Today, IBM put out an industry press release announcing the launch of several new products in the data security field, aimed specifically at big data users who are concerned about data encryption, usability and security.  This makes it very clear, when taken together with the HP call, why Autonomy, though bungled from the outset, was a critical acquisition for HP to complete in order to stay competitive in cloud computing/data centers and analytics.

Where IBM leaves HP behind is in the services area, where IBM competes with Accenture at the top of the food chain.  HP is not yet in that category, but getting there would make a big difference to an HP profit turnaround.  IBM characterizes its services businesses as having gross margins in excess of 35% and pre-tax operating margins of 20%.

IBM enterprise software and middleware represent 44% of 2011 revenue.  The company says that only 40% of the operating profit from software comes through transactions for systems and hardware, meaning that it has a strong annuity component.  Again, this reinforces for us the importance of the new software CEO at HP and his reporting directly to CEO Whitman.

One thing which seems sub-optimal to me about IBM's 2015 Road Map is the preponderant contribution of share buybacks and dividends in the historic and expected future total return to shareholders.  IBM is not exactly a screaming buy, and it hasn't been since the stock's exceptional 2011 performance. I would aim to increase the dividend yield, take the foot off the buyback pedal, and look to selectively reinvest in the growth businesses.

CEO Meg Whitman, according to my notes, said in their conference call, "I believe in creative destruction." Of course, this is Hayek's term, but it is also the title of a business book by two McKinsey consultants. I pulled a dusty copy off my bookshelf, and I believe that Whitman's reference was to this book. Many of the case studies in the book are technology companies, from Storage Tech to IBM.

If CEO Whitman believes in the Hayek concept, then when will she start that process for the HP portfolio?  The new PSG, now that it includes printers and personal computers, could be sold much as IBM did decades ago; values are rock bottom, and the company has claimed buying synergies which argue against selling this business.  IBM has shown that having some hardware system sales does help software and consulting sales too.  So, the jury's out on this one.

The other candidate is the old EDS business, which has been sharply written down.  This might very well be a place to begin the creative destruction, but in the short run CEO Whitman's focus has to be on cultural change, operational efficiency and repairing the balance sheet.

The reports of both companies show how difficult it is to consistently generate above GDP revenue growth, ex-currency, in this tepid recovery, now almost three years old, from the financial crisis.

Tuesday, October 16, 2012

The Citi Never Lets You Sleep

Just when it seemed as if Citi were turning the corner with its financial performance, growing core revenues while holding what some analysts estimated as $11 billion in "excess reserves," the company makes a CEO change after the earnings conference call.

Having grown up in New York, we were all introduced to the ATM through Citibank, its retail presence was so ubiquitous that it sometimes dominated four corners of major midtown intersections with branch offices. Because of its ATM branch network, came the motto, "The Citi Never Sleeps," because you could make deposits and withdraw funds 24 hours a day.  That was quite an innovation at the time. John Reed, a banker, seemed to articulate a clear vision of where the bank was going: grow nationally and expand its significant presence internationally. 

In walks deal-maker Sandy Weill, who I believe coined the term, "financial supermarket" in relation to the new Citi.  The clash of personalities and cultures resulted in the cobbled together mess that became Citicorp, which became the Retail Bank and the Investment Bank. 

Now ironically, the Wall Street Journal writes,
"Over the past decade, Citi has had a deal-maker, a lawyer and an investment banker in charge. It's high time a seasoned banker was given the chance to tie it all together."
Citi still has a premier global commercial and personal banking franchise, with a strong brand in Asia, despite the problems at home. Their credit cards in Asia represent a large opportunity.  The investment bank, like those owned by a number of other international banks like Société Générale or Nomura, has never found a footing among Wall Street's top players.  No CEO is going to change this, especially a banker.

Since all the problem assets are in Citi Holdings, it seems as if Citi eventually returns to the franchise it had before John Reed was ousted in favor of deal-maker Sandy Weill.  Decades of value destruction, and we might go back from where we came. 

Softbank: Mr. Son Channels Muddy and Bo.

I like Softbank CEO Masayoshi Son's style.  It is a very definite break with the general behavior of Japanese CEOs of multinational companies, with the exception of some of the Japanese auto makers.  The Wall Street Journal quoted Mr. Son saying, "I'm a man."  Since he went to school in the U.S., and since the blues are popular in Japan, it just hit me that he must be referencing Muddy Waters' iconic anthem of the same name.  It fits well with Mr. Son's message that he strives to be number 1.  Muddy performs with Little Walter and Bo above.

The Journal, echoing our sentiments from yesterday, characterizes the deal as "one of the more unusual deals in U.S. telecom history."  A decade long business relationship between Mr. Son and Sprint CEO Hesse dates back to when Hesse was CEO of TerraBeam and Mr. Son was a Cisco board member.  This is pretty traditional in most cross-border megadeals.

In an investor presentation yesterday, the WSJ reports Mr. Son telling investors,
"When two rich firms rule the market like a duopoly, we see this as a real opportunity for a challenger," Mr. Son said during a two-hour presentation to reporters Monday, referring to the two largest U.S. carriers, AT&T Inc. and Verizon Wireless."
Amen to that.   When he bought Vodafone's Japanese business, Mr. Son introduced discount marketing and quickly went from losing customers to rapidly gaining share.  Sprint went on the same kick in the U.S., but it hasn't proved sustainable, and they bet the farm, late in the game, on the iPhone.  It remains to be seen if SoftBank, which is now the third largest cellular carrier worldwide, can pull off a disruptive model in a U.S. market duopoly and thrive.

Mr. Son has a pretty good sense of humor, as the Journal reports him saying,
"In the last two days, Softbank's market capitalization fell by ¥1 trillion. That means we provided ¥1 trillion worth of anxiety to you. But when that money returns from its journey, it will come back to you many times larger in the form of multiple trillions of yen," said Mr. Son. "That's how I want you to see it."

U.S. consumers will benefit if Mr. Son can pull this off.  I'll be rooting for him.

Sunday, October 14, 2012

Moshi Moshi!: Softbank Calling

More head scratching news from the U.S. cellular industry: Japan's Softbank is apparently close to a $20 billion deal for Sprint.  Despite the Sprint CEO's valiant attempts to make the company more relevant as a major player, Sprint's leadership, if you can call it that, is in the lower margin, prepaid customer base.

In the meantime, it seems that it is holding on to existing post pay customers by giving away unlimited data and calling plans.  It doesn't seem like a good business model for the long term. Softbank's acquisition seems to solve Sprint's problem of how to finance its 4G network build out  which analysts say will require $8 billion.

U.S. regulators, in the short term, should be pleased because nominally, the U.S. industry doesn't become anti-competitive, as Sprint gets life support.  The Wall Street Journal suggests that the end game for Sofbank/Sprint would be a consolidation of T Mobile.  This would seem to be anathema for regulators and seems unlikely.

Perhaps because of our legacy with wired telecom, our wireless industry business model has not delivered a world class service to consumers.  Sprint and T Mobile are devolving into low end players.  Verizon seems to be on the way to becoming like the old ATT, while ATT seems to be looking like the old MCI.

No carrier has spotless national, or even major metro signal coverage.  We pay too little for our phones, and too much for our monthly service.  Ordinary phone customers are subsidizing the "eat all you can" data plan customers.  Phone only consumers are being forced to upgrade to smart phones, with a minimum commitment to a $10 data plan, even if the consumer wants a new phone and no data plan. What happened to consumer choice?  What about listening to your customers?

Sprint's $8 billion investment is being made for the benefit of a relatively small number of users who aren't paying their freight.  It's hard to understand Softbank's motives for making this transaction  unless they are going to tear up Sprint's business model.  This, however, would not be the traditional Japanese style.  I would guess that Softbank analysts downgrade their ratings if this deal goes through.

Thursday, October 11, 2012

Fracking and Groundwater Contamination: Conclusions Unclear

The EPA and USGS have been working on a site in Fremont County, near Pavillion WY to gather groundwater samples, looking for contamination from hydraulic fracturing.  This site is near a very small agricultural site, where fracking has been taking place since the 1960's.  In terms of having a site with a long history to trace infiltration, it's probably a good choice.  On the other hand, it would seem like much of the fracturing activity was probably fairly artisanal for much of the period.  To use this site as a comparison for larger commercial sites, using the best engineering practice, might not be the best choice.

I prefer to look at USGS reports in preference to EPA reports, which have much more of an overtly ideological tone.  USGS reports suffer from the opposite problem: they are geeky to the lab rat level, and words are generally kept to a minimum.  It comes from being written by geological survey engineers or by hired engineering companies.  Here's a link to the USGS report on Pavillion.

This report seems broadly inconclusive about groundwater contamination from fracking. If I have any engineers among my blog readership, I would welcome  comments. Overall, the quality of the groundwater itself is not the best for drinking.  There is a presence of diesel related compounds, but this isn't surprising in farmland where there is probably non-compliant disposal of fuels and lubricants for machinery and small motors.  The compounds usually associated with fracking don't seem to have high concentrations.

The Federal government should have a much more thorough, focused and transparent program for coming to a rational assessment of the risks of hydraulic fracturing for hydrocarbons.  We are not there at all. 

Wednesday, October 10, 2012

Thinking About Huawei

I'm not generally a fan of public hearings on Capitol Hill, as they most often serve as political grandstanding platforms for ambitious Chairs and senior members of committees. Just think about mortgages, housing and the financial crisis, and I rest my case.  The Report of the House Permanent Select Committee on Intelligence on Huawei raises interesting questions in several areas we've considered in this blog, e.g. foreign policy, trade policy, national security, enterprise risk management, and corporate governance. 

Here's my first question. We are home to several global leaders in telecommunications equipment, including Cisco and Juniper.  In Europe, we have Ericsson, which has a long history of innovation and proven products in telecom equipment, as well as Alcatel-Lucent, which also has a history of doing business with U.S. carriers and is itself a product of a cross-border merger with a U.S. company.  Alcatel-Lucent, is in a weak financial position, which is something to be taken into account for future business orders, but let that pass for a moment.

Why on earth would U.S. corporations, particularly public ones, be considering switching to a unproven vendor like Huawei?  For telecom equipment, it would have to be cost, performance or innovation.  We already know from data center equipment ordering that pure, unadjusted cost dollars rarely carry the day for IT purchasing.  Shrink-wrapped banks of generic servers may be inexpensive as a stand-alone purchase, but the IT executive building the data center won't get any kudos for saving a few bucks if the system suffers downtime or outages.  The project has to be looked at as a whole. 

The other, missing piece could be innovation, and I confess to not knowing what the issues are first-hand. According to one industry analyst,
"Just as a point of clarification, the (House Permanent Select) committee focused primarily on the communications equipment used for service providers to build out 4G wireless networks, for which there are no viable U-S.-based options."
Does this mean that there are no non-Huawei options, or does it mean that there are European options?  In any case, this argument needs to be fleshed out, and the customers are the ones to ask. 

Trade, economics and industrial policy are inseparable, foundational tools of Chinese foreign policy.  Chinese companies are nowhere near as transparent as Western public companies. Indeed, the Permanent Select Committee's investigations were hampered by this issue, according to their report.
"Despite hours of interviews, extensive and repeated document requests, a
review of open-source information, and an open hearing with witnesses from both
companies, the Committee remains unsatisfied with the level of cooperation and
candor provided by each company. Neither company was willing to provide
sufficient evidence to ameliorate the Committee’s concerns. Neither company
was forthcoming with detailed information about its formal relationships or
regulatory interaction with Chinese authorities. Neither company provided
specific details about the precise role of each company’s Chinese Communist
Party Committee. Furthermore, neither company provided detailed information
about its operations in the United States. Huawei, in particular, failed to provide
thorough information about its corporate structure, history, ownership, operations,
financial arrangements, or management. Most importantly, neither company
provided sufficient internal documentation or other evidence to support the limited
answers they did provide to Committee investigators."
So, let's switch to the viewpoint of a public company.  If the company is looking at adding Huawei to their approved vendor list, would the purchasing, finance and internal audit functions feel comfortable with the level of documentation?  Kick it upstairs to the enterprise risk management function.  How would they weigh risks to the company's data, IP or other key assets? 

Great Britain has taken to a a peculiar system of third party verification of these issues through a jointly funded certification of Huawei systems within a larger installation.  Australia has chosen to exclude Huawei from being a vendor in its national broadband expansion project. 

Overall, it seems, at best, that there may be marginal benefit for a potentially expensive downside for sensitive telecommunications infrastructure.  Why even go here?

Cisco has already locked horns with Huawei over its alleged unlawful use of Cisco's  IP for a routing protocol.  The litigation was settled in Cisco's favor, but terms of the settlement remain confidential.  This issue dates back to 2003-2004. 

Chinese mass markets for products as diverse as automobiles and personal computers will remain protected by non-tariff barriers.  These are choices of Chinese national policy and serves their economic and foreign policy  interests. We should look to our interests in the sensitive field of telecommunications equipment with a full cost-benefit analysis for our interests and security.

The House committee has moved its recommendations to the Executive branch, which it rightly should do. The Federal government should take the House committee's work deeper, using its competencies in intelligence, defense, and IT systems.  There's no need to rush to judgment on these critical decisions.

EADS-BAE: This Deal Couldn't Fly

Right from the get-go, I never thought that this deal should fly, most especially for the BAE shareholders. Today, the Wall Street Journal reports that it has officially been put into the dustbin of failed deals.

We came at it from the bad economics of the deal structure, and the cobbling together of two businesses that had no real synergies, despite protestations to the contrary, especially by the EADS management.  Reading an occasional commentary on the negotiations, probably the most unappealing factor facing a combined business would have been the presence of sovereign shareholder representatives on a governing board.  It would have been impossible to achieve efficient governance over things like capital allocation and utilization of production facilities for the combined companies with representatives of European governments on the combined board.  

BAE shareholders should raise a toast to Invesco Perpetual's taking the lead on airing these issues.

Tuesday, October 9, 2012

Bernstein Sheds Some Light on Solar

In our 2011 post, "Sunset for U.S. Solar Industry?" , we wrote about the fact that there was no conceivable way a solar investment could show a reasonable payback, citing a local example in my city, which couldn't work even with generous subsidies. 

Catherine Wood, Chief Investment Officer of AllianceBernstein, has a fascinating post that updates solar's lack of competitiveness with natural gas fired plants, even with the gas plant being burdened with a carbon tax!  Here is the answer to the big question,
"So when is solar going to become cost competitive without subsidies? In three to five years? Try never. But if it did, society would have to pay out trillions of dollars to get there."
Wood also cites Germany's much publicized, heavily subsidized and failed experiment with solar. 

If we were serious about continuing to meaningfully reduce carbon emissions and building a better power grid to support our data-centric economy and a manufacturing renaissance, then we would be subsidizing investment in the grid and a faster conversion to natural gas.   

Monday, October 8, 2012

The ECB Wakes Up To Labor Markets

In a recent post about Europe's needing a new vision of itself, we wrote,

"For all the freer movement of goods and capital within the EU, the labor markets are not free. A combination of regulations, quotas and different work rules, as well as taxes serve to remove labor markets from the adjustment mechanism.

Without a freeer EU labor market, a move to budgetary integration is nonsensical."

The Wall Street Journal today reports the ECB publishing a 126 page report on the importance of labour market reforms. If the EU, specifically the economic union, is to fulfill its basic promise, Europe has to come to a consensus on these issues. Instead, European media continues to focus on meetings of Brussels eurocrats talking among themselves about nothing but preserving their own jobs.

Friday, October 5, 2012

The Sound of Cannons: Thoughts on HP's Week

HP shares lost 14 percent of their value this week and touched levels not seen since 2003.  Analysts who liked the stock at much higher prices, with outlandish targets, reduced their ratings. Gee, thanks for the advice! 

Given the recent outlook from Analyst Day, it's safe to put away my HP folder for a while.  I have a few closing thoughts, which diverge from the "new consensus" on HP:

  1. The same trends that are buffeting HP, such as commoditization of hardware, next generation data centers, and cloud computing, are weighing on the other large competitors, such as Cisco, EMC and others.
  2. Margin compression is not, and will not be, unique to HP.  Cisco's sixty percent plus gross margins can't be sustained for truly commodity products.  Even though they have managed it well, the recent quarterly compression was the biggest in recent history. 
  3. Some HP analysts now have Dell as a "Buy" and HP as a "Hold/Sell."  Dell is the ultimate commodity player: it's how they defined their offering.  Although they are purchasing other companies like Compellent to diversify the offering, it's not clear to me that theirs is a superior strategic path that will be executed without hiccups and surprises.  
  4. VMW is a force to be reckoned with, but they too had issues in 2008-9, and their TTM revenues for 2012 are $4 billion or so; this is about the size of the HP software business.  The new HP software leader should be a big plus in moving this business forward, with at least VMW operating margins, or better I would believe.
  5. HP services cannot become Accenture or IBM, nor should they try to morph into these models. 
  6. Changing the pricing alternatives for the next generation IT buyers is going to be a challenge for all the players. HP seems to recognize this, based on Analyst Day. 
I really believe that the biggest challenges to the CEO and her new management team are internal.  The reference to macroeconomic headwinds, like currency and potentially cratering European demand, should not have been news to anybody, but they are now fully disclosed risks. 

Managing the loss of a large number of employees, letting the ongoing organization work through a grieving process, attracting a new generation of talent with different skills, meshing them into an organization that is large, but hopefully not sclerotic, and instilling belief into the organization that it can win---these are the things that will carry the day. 

If people believe that HP is a place to mark time while they look for other opportunities, then it will be in real trouble.  Unfortunately, none of these issues can be tracked externally with numerical indicators.  Customers, competitors, partners,and savvy observers, however, will all know. 

The board of directors that CEO Whitman needs to help her move the company forward is a different one from what is there today.  Now that the CEO has finished the fact-finding, channel checking and strategic reset, she should take on this task because it will be critical, in my opinion, for moving the company away from some of the flawed assumptions of the past which led to the acquisition of EDS and the absurd price paid for Autonomy. 

Turn that focus inward, HP.  Make the next corporate management retreat at a Zen center!  It will take that kind of focus for HP to succeed. 

Thursday, October 4, 2012

HP Gives A Peek Into Autonomy

I got a question about the "Autonomy demo" at the HP Analyst Day.  I happened to see the demo on the webcast.  Let me give a setup to what I remember.  Chief Marketing Officers of large corporations are now supposed to be sensitive to, and savvy about social media.  "What are customers saying about our product?"  "What's the buzz about Benneton's new ad campaign?"

Instead of hiring an agency or devoting corporate resources to monitoring Twitter, blogs, and the river of digital information, the marketing officer would use Autonomy's IDOL technology, which is an indexing engine much like Google deploys, to provide the user with a real-time dashboard.

The audience saw a real time demo of IDOL monitoring every Internet news, broadcast news, online services, blogs and Twitter.  As it monitored, it found key words or phrases, aggregated and counted them; then, in what looked like a streaming ticker, more frequently occurring terms or phrases appeared in caps or in different colors.  It was a real time "heat map" summary of market sentiment. 

Leaving out the cost-benefit analysis of tracking social media to begin with, there's no doubt that this kind of real-time, high volume coverage, tracking, sorting and indexing couldn't be done without a powerful data gathering and analytical engine in the background.  This would be the IDOL technology, which is one of Autonomy's three or four core technologies. 

The demo certainly did put meat on the bones of the presentation that talked about IT spend going beyond the CIO.  One could easily have imagined a similar kind of monitoring being done for a compliance officer in the corporate legal department. 

There is an asset in Autonomy.  CEO Meg Whitman made a remark about the migration to the cloud requiring HP to be "ahead of the curve."  Building something like Autonomy had inside HP would have been a long, expensive distraction from the focus the CEO wants.  The board must have felt that buying it, even at an outrageous price, was the only way to go.  It will take two years to turn around Autonomy to make it a sustainable source of profitable revenue; after that, we'll know for sure if it was a good decision.

HP Begins the Long Journey

A Russian proverb goes, "The longest journey begins with the first step."  After yesterday's Analyst Day, the share price closed at a ten year low, and in early trading today, the stock continued downward testing the 52 week low. 

In August, we wrote,
"Aside from looking at metrics relative to HP history or industry comps, it's hard to make a bull case for HP. This argument sometimes appears as, "It can't get much cheaper." Investors who got in at $20-25 felt this way, and we disagreed in prior posts. Unless HP as an organization believes it is in trouble and acts that way, as Gerstner says, then it may be a short-term trade from depressed levels, or a value trap. Time will tell, and it's very early in this story, with no clarity."
Based on an earlier post, we believe that, to a large extent, the CEO and her management team did what had to be done yesterday.  In many prepared remarks and in some small asides, HP was portrayed as an organization in trouble. 

Big conclusions for me:
  1. Spinning off the Personal Systems and Printer Group makes no sense.  It was considered, according to the CEO, and customers told her that it would be anathema to them.  The forward looking strategy makes no sense with a break-up option on the table. 
  2. Stop the share buybacks.  Apart from the dividend, plow any free cash flow into bringing the improvement in the business forward in time from 2015.  Actually, looking at the quarterly buyback rates, buybacks have been slowing from 2011 to the present. Stop the financial engineering and use the cash for the businesses. The employees will see the use of cash for the business as confirmation of their commitment to a protracted turnaround.
  3. Do not even consider any mergers or acquisitions, even though this option appears on the CFO's slide set.  Much of the material presented during Analyst Day points to a lack of ability to manage and optimize the current portfolio.  An acquisition would defocus the management team, confuse employees, and would break faith with the larger, value-oriented shareholders.   The team has enough on its plate, and HP has the elements for a robust product offering for the evolution of customer IT needs.
CEO Meg Whitman defined HP the "world's largest provider of technology hardware infrastructure," and she noted that hardware and infrastructure comprise 70 percent of corporate revenue.  Hardware is in the corporate DNA, she said.

Expanding on her frequent references to "execution issues," she noted that HP has "too many products, services and geographies."  Autonomy has 200 products, for example.  HP does business in 114 countries around the world, and yet 80 percent of the revenue is generated in just 14 countries.  These points also refer to her characterization of HP's "lack of sharp competitive focus." 

Accountability and compensation are not aligned to maximize profits.  As an example, the top 200 corporate account executives will not have full profit and loss responsibility for their portfolios until 2013.  Up to now, the volume of business written was all that mattered, whether the business was profitable or not. One wonders what any of the previous CEO's were doing when they reviewed the operations. 

The CEO also referred to an underinvestment in R+D and in IT systems that support business management.  HP has several large professional consulting practices within the business segments. In a professional service practice, there are only four meaningful metrics: rate, margin, utilization and leverage. Yet, the CEO said that HP doesn't have an internal software platform to manage staff engagements on a project level.  It was initially decided to defer this kind of purchase until 2014, but she now decided to use some of the enhanced restructuring savings to acquire this software in 2013.

The CEO's presentation was frank, but still optimistic overall. Fiscal 2013 was described as being a period of "broad-based profit decline, but more constrained than in 2012."  Fiscal 2014 would be the period of "recovery and expansion."  As the typical institutional inevestor would say, "The stock is dead." 

The CFO's presentation laid out FY2013 non-GAAP EPS guidance of $3.40-$3.60, which was about 18 percent below the hapless analysts' most recent consensus.  The operating margin would decline on a year-over-year basis!  The smart phones in the room were probably buzzing with emailed sell instructions to trading desks. 

The company's use of  acronyms for their businesses and the changing definition of segments are confusing.  The big news in the CFO presentation was in "Enterprise Services," a $25 billion business, which the CEO described as being number 2 worldwide in its segment.  ES includes Infrastructure Technology Outsourcing (ITO) and the Application and Business Services group (ABS). 2013 revenue was projected to decline by 11-13 percent year-over-year, with operating profit margins of 0-3 percent.  Over time, ES was business was characterized as a modest grower, with not a lot of promise for margin expansion. 

The revenue loss was largely attributable to the rolloff of four major customers, one of which was likely Commonwealth Bank of Australia, which had a six year contract with the former EDS, now owned by HP under ES. In its last reported quarter, HP took a gargantuan charge to write off the former EDS operation.  We made the following observation, based on our reading of HP's own presentations, contained in a footnote,
"Impairment of goodwill and purchased intangible assets doesn't affect cash. It does represent the loss of value in these assets over time. Expense associated with the loss in value is not in non-GAAP measures and doesn't reflect the full economic effect of the loss in value of these assets."

Analysts get too fixated on dismissing non-cash impairments, immediately going to the non-GAAP number, an economic fiction.  The other shoe has now dropped on the former EDS business.  There is significant loss in value at Enterprise Services.  The company's characterization of the future margin opportunities in the business are not at all encouraging.  This business itself might roll off and eventually be shuttered, unless dramatic changes are made. 

The most impressive executive, who gave the most lucid and illuminating presentation, was George Kadifa, Executive Vice President of HP Software, a $4-6 billion business, which would be the sixth biggest software company in the world.  Mr. Kadifa comes from Silver Lake Partners, where he was an operating partner in the Value Creation Group, after a long career at Oracle.   He reports directly to CEO Meg Whitman, which also says something about the importance of his portfolio. 

HP Software counts 94 percent of the Fortune 100 companies among its customers.  It is #1 or #2 in its Enterpise Software segments.  I tried to put together some information from several slides with perhaps different bases, but I believe that this is correct to an order of magnitude:
  • In IT Management, HP pioneered an industry standard product, HP OpenView;
  • In Cloud Management, HP pioneered two leading products, HP Service Virtualization and HP Cloud Service Application.  Togther IT Management and Cloud Management represent about $3.4 billion in revenue.  So, to the question "What is HP doing in the cloud?" it appears that the answer is "pretty substantial business."
  • Enterprise Security features well known industry products like "HP Enterprise View," and "HP Data Protector" and there is about $500 miilion in revenue in this business. 
  • Big Data Analysis is comprised of the Vertica brand in HP, some $40 million.
  • Meaning-based Computing is essentially Autonomy, and this business would seem to be over $900 million in revenue.  This suggests that some of the initial rapid deterioration in the Autonomy business was arrested.
George Kadifa's strategy is to integrate the disparate components which exist within HP Software, most of which were developed in response to critical customer problems, discovered after HP had sold some hardware into the account.  The next step would be to leverage the best components into solutions or suites, and finally to grow the business, by rationalizing and improving the sales models for differrent customers.
This business should grow at 2-3x the GDP growth rate with 20 percent or better operating margins. He also mentioned the notion of embedding additinal software-driven functionality into HP hardware, like printers. 

His view of evolving IT spend was very interesting to hear.  IT spend, Kadifa says, will migrate away from the CIO, to include the Chief Marketing Officer, the Chief Information Security Officer, and the Chief Compliance Officer.  He might have added the Chief Risk Management Officer, particularly for financial institutions.  He reckons that the addressable market opportunity for a suite of products aimed at marketing, information, security, data analysis and compliance is around $54 billion.  If he is correct, the operating margins should be well north of 20 percent.  He gave an example of one engagement with McKesson that related to the filling of electronic prescriptions, which is an issue that a number of smaller companies are rapidly trying to address.

Autonomy, he said, is operationally in a start-up mode. Their sales model was not scalable, and the basic back office product development machine was also not scalable.  I suspect it was HP scrutiny on the Wild West nature of Autonomy's operating culture which generated the negative comments about "HP bureaucracy."  His experience with Oracle and his experience as an operating executive in Silver Lake's portfolio companies gives George Kadifa the credibility to carry out what he says will be a two year process of readying Autonomy to be a much larger player in its segments. 

I've expressed reservations about the way in which the IT buyers might handle a move to either private or public cloud computing. HP made an interesting presentation in which they talked about the different approaches to taking a company's computing functions to the cloud. 
  1. The DIY approach: this would involve the individual purchase of best-of-breed, open architecture components in a vendor-agnostic approach.  All the integration and testing would be handled in-house.  While theoretically possible and economically low-cost, it is deemed too risky for most CIO's.  I would say, fair enough. 
  2. Single Vendor: a CIO would not be criticized, especially if the vendor were an industry bellwether.  However, the customer would be compromising with some components, and it would be lower risk than DIY but higher cost.
  3. Paid Integrator: this could cover a DIY approach, but using an external paid integrator, who might also help with component selection.  If the component selection or system performance were faulty, the customer would have problems assigning responsibility for fixing the problem.
  4. "Integrated by design."  This would the HP approach to market.  Build individual components designed to work in a system for particular applications and working environments. The components would all be open architecture and have a services overlay, with the service areas chosen by the customer.
Listening to this and thinking more about it, there is definite merit in an AE approaching an enterprise-wide sale under a broad product banner, like HP. 

The cloud was referred to as "another form of oursourcing," which was an interesting definition.  Cisco CEO John Chambers expressed his opinion about HP's future in a migration to cloud computing with disruptive technologies.  Some HP executives opined on their competition and they noted that Cisco, VM Ware, and IBM each had technology, margin, or solution limitations.  HP seems well positioned because of its diverse portfolio to significantly grow its $4-6 billion cloud computing business.

As we've said many times before, value stocks sometimes become "better" values before they generate returns.  The jury is still out on HP, and a stock holder could earn a 3.7% dividend yield while waiting for earnings to grow, assuming that there are no more suprises, which is not guaranteed.

The Analyst Day was a good start towards putting mangement's cards on the table, introducing the new management and operational teams, and putting some numbers on the profile of the turnaround.  Investors do have better information on which to do their research and to make a decision. 

Tuesday, October 2, 2012

Embers of War: Lots of Foreign Policy Lessons

Going to high school in the Sixties, the Vietnam War was a nightly feature on the B+W television news.  Before our engagement in South East Asia ended, endless "histories" had already been written, but they all seemed unabashedly partisan and poorly researched, since there wasn't much original source material available.  It was a war that none of the kids in our neighborhood understood, even though we had endless pictures, speeches and newspaper articles filling our heads. 

Fredrik Logevall's "Embers of War" begins with the Paris Peace Conference of 1919, and builds to the climactic French defeat at Dien Bien Phu, the bloody outcome of which was referred to only obliquely by French representative Bidault at the Geneva Conference in May 1954.  This beautifully written book of history is thoroughly researched, well written and tells a gripping tale. The author uses his extensive sources to construct a seamless narrative.  The relatively few black and white photographs speak volumes by themselves. 

When world leaders were gathered in Paris to rebuild a peace after the Great War, we begin the story with a young Ho Chi Minh (née Nguyen Ai Quoc) who is captivated by what he reads in Woodrow Wilson's Fourteen Points, especially number 5,
"A free, open-minded, and absolutely impartial adjustment of all colonial claims, based upon a strict observance of the principle that in determining all such questions of sovereignty the interests of the populations concerned must have equal weight with the equitable claims of the government whose title is to be determined."
Unfortunately, his expansive reading of President Wilson's "anti-colonial" intent was misplaced. Ho is an ardent Vietnamese nationalist who sees the tide of post-war history spelling doom for the commercially driven interests of the French colonizers. He goes home convinced that hard cultural, economic and political work must be done to prepare for the inevitable day of Vietnamese independence.  Logevall is not blind to some of the tactics that Ho had to use in consolidating his hold over a unified Vietnam, namely terror and routine killing of dissident village leaders.  Ardent nationalists don't attain their objectives by wearing "flowers in their hair."

French intransigence, World War II and shifting global objectives among Britain, France, Russia, and the United States all conspire against the dream of independence.  Ho and the nationalists had to navigate the presence of both the French and the invading Japanese during World War II.

Personal relationships, and in particular personal mistrust, play a critical role in foreign policy at the highest levels. Nowhere is this better seen than in the relationship between de Gaulle and President Franklin Roosevelt.  Logevall writes,
"Roosevelt has not yet met de Gaulle, but he knew enough to dislike him. ...That de Gaulle fully shared Vichy's desire to preserve the French Empire only enhanced Roosevelt's disdain.  By the time of Pearl Harbor, he (Roosevelt) had become a committed anticolonialist."
Ho was personally attracted to the openness of American society and to its commitment to independence, expressed by Roosevelt, for the innumerable colonies and trust territories throughout the world.  Decades after his visits, Ho talked about his visits to Harlem and his impressions of New York, with its many nationalities living side by side.  He firmly believed that America would unfailingly align itself with a Vietnamese independence movement because of what he read and hear first-hand in the speeches of President Roosevelt.

Because of the sclerotic hierarchy in diplomatic structures, Ho remained a relatively unknown quantity to our State department and to foreign policy advisers.  There were always suspicions that he was a Communist.  He never disabused our policy makers of that notion, because he knew that Indochina would be eventually a battle ground for the eventual players in a Cold War.  His potential allies might include Russia or Communist China.

After the Allied victory in World War II, Archimedes Patti, a U.S. intelligence operative was sent to Indochina to negotiate the release of Allied POWs held in Japanese camps. Patti meets both Ho and the even lesser known Vo Nguyen Giap.  Giap, referred to as General Giap in my school days, is now regarded as one of the greatest military leaders in the history of modern warfare. 

Patti, perhaps because he grew up the son of immigrant Italian parents in New York, connected with Ho and Giap.  He understood exactly what they were after, namely independence and close economic ties to the United States.  He wrote these ideas up in his communiqués.  They were roundly ignored, since Patti was from intelligence and not from the foreign policy cadre.  Tone deafness and a lack of acuity have always been a limiting factor in our ability to conduct foreign policy, as they still are today.

The author writes about Roosevelt in 1944,
" 'The ideas of independence have become more familiar to the populations so far submitted to the authority of European countries,' the president said.  'I believe that if we do not wish to be thrown out by these people, we must find a general formula to resolve the relationship between the White and Yellow races' "
It seemed as if Ho's reading of American policy evolution would prove correct. Ho's dreams were crushed when Roosevelt collapsed of a cerebral hemorrhage and died in April.  The Truman administration began with its own foreign policy interests. These, along with the ambitions of his White House staffers conspired to take Roosevelt's themes off the table.  Roosevelt's ideas had been overtaken by events, even before his untimely death.

The Truman White House, pressured by European allies, moved to the side of supporting a French "recolonization" of Indochina, for economic reasons and to add an important ally in Southeast Asia as a counterbalance to Japan and an unstable situation in China.

The story careens forward from here.  Ho is soon forced to reach out to the Communist Chinese government, which eventually supports his war effort with materiel in the amount of 500 tons per month.  The French, at the peak of the seven year war, are using 8,000 tons per month.  The French army is undermanned, as French conscription for a foreign war is insupportable.  Some of their leaders are brave and courageous, while others are arrogant and foolhardy. 

On the other side, as the war ground on for the Vietnamese, Ho and Giap were increasingly faced with resentment over food shortages, incessant civilian commitment to night time guerilla raids, and to growing middle class disenchantment with the costs of independence. 

Ho's Chinese allies were themselves getting economically overextended and facing questions at home. It was now a true war of attrition, after seven years.

In several key battles, Algerian and North African troops did the hardest and bloodiest fighting and won their objectives.  Of course, later on the Algerians would get the back of the French hand in their own bloody war for independence. 

After the battle of Dien Bien Phu, nine thousand French soldiers, POWs, civilian personnel and deserters were put on a march to camps 300-450 miles away. The marchers were to cover twelve miles a day for more than forty days, during the rainy season, with daily rations of 800 grams of rice. The author rightly focuses on the barbarous behavior the Viet Minh, especially towards the North African soldiers who were harshly treated because of their coming to fight  on the side of colonizers, while they were colonized themselves.  It is a harrowing tale that Logevall tells deftly.
"The soldier is not a man of violence. He carries arms and risks his life for mistakes not of his making. He has the merit of being unflinchingly true to his word to the end, while knowing that he will be forgotten."
               Antoine de SAINT EXUPĖRY
The French could not have fought as long as they did without American aid, especially in armaments and planes.  After the defeat, the allies grumbled at each other for their mutual lack of commitment.  The Eisenhower administration's go slow policy on more direct U.S. engagement was derided by the French.

Ultimately, we substitute ourselves for the French and we write our own history.  Many of the mistakes they made, we replicate, except on a bigger, bloodier and more 'technocratic' scale.  I hadn't realized that we gave the French napalm bombs to use in their war.  I was under the impression that napalm was introduced in our B-52 sorties.

A book on history hasn't left me emotionally spent for decades.  This one did: it is must reading, especially for students of history, culture, foreign policy and military strategy.

© Eapen Chacko

Why Bother With Financial Regulation?

Going into the 2008 financial meltdown, Sarbanes-Oxley was firmly in place, and a public company's CEO and CFO had to individually attest to the existence and effectiveness of a system of internal controls.  Consultants and internal auditors were busy helping management prepare "heat maps" that showed areas of weakness and areas of critical concern. 

Having been through the process myself as a CFO, my staff and I took everything very seriously. When I had to put my signature over my Section 404 attestation, I always took a deep breath thinking about the gravity of the attestation.  Implementation of Section 404 is filled with jargon and buzzwords, some of which have been transmogrified from ISO and TQM. 

Now, as we layer Dodd-Frank and other legislation over Sarbanes, we will add expense, management time, and information overload to the burden of public company shareholders.  Will their investments be any less risky?  Will their ability to analyze the riskiness of their investments be enhanced?  Can a public company shareholder have more confidence that the interests of the management are aligned with theirs?  I hardly think so.

Recently, former Fannie Mae CEO Franklin Raines won a major victory in Federal court when he was awarded summary judgment dismissing a case brought by institutional investors against Fannie Mae, three former executives and the company's the audit firm.  The leading paragraph of  the conclusion reads,
"Sustaining claims for securities fraud requires a showing of scienter-either an intent to deceive or an extreme departure from the standard of ordinary care-for each individual or entity claimed to have committed such fraud. Put simply, the securities fraud laws are not a means for shareholders to recover for all losses, no matter how sizable or sudden. Upon review of all plaintiffs' evidence, this Court concludes that plaintiffs have failed to put forth sufficient evidence from which a reasonable jury could find that Raines had such an intent. A failure to understand, or even negligent behavior,is not the equivalent of the necessary intent to deceive or conscious disregard of obvious risks. Therefore, Raines is entitled to summary judgment on all claims against him"
The Office of Thrift Supervision ("OTS"), one of the several Federal regulators overseeing Fannie Mae comes across as less than competent.  Evidently, Fannie Mae's Controller warned the CEO about some portfolio quality and accounting issues, but the plaintiffs didn't definitively prove that the memo was delivered and that it was definitive.  The Controller and the CFO could still be on the hook, as I understand.

The statement about the securities fraud laws not being a means for loss recovery is a fair statement which underlines the fact that Federal regulations do not, at the end of the day, provide any kind of "insurance" against loss. 

Today, the CEO of IndyMac bank was similarly exonerated in a separate decision. IndyMac, which we have written about at length, was minimally a bank with lax oversight and management, and according to the decision, nothing more. Again, for the public investor, "caveat emptor."  It is the third largest bank failure of the financial crisis era, so far. The OTS figures prominently in one of the very technical reasons for the court decision.  The long-running record of incompetence of this agency led to its being folded, not dissolved, into the OCC.  Federal agencies never go away--they are absorbed and morph into something else. 

The final, almost laughable irony about IndyMac is the sale of the distressed portfolio to a solitary bidding group led by Steve Mnuchin, formerly of Goldman Sachs.  His partners include John Paulson, George Soros and Chris Flowers.  The group has parlayed this portfolio, along with others, into a new, growing and financially stable California bank, OneWest.

Layering more and more regulation on the financial services industry is a waste of money.  The existing labyrinth, if everyone did their jobs, could be than adequate to perform its limited objectives.  No system can reduce risk, guarantee returns, and insure against losses. Our current system is broken, however. Particularly with the legal strategies pursued by the SEC and others, it absolves the main actors of any meaningful accountability and leaves taxpayers holding our moth-eaten bag--again.  

Monday, October 1, 2012

Meg Whitman: It's Not Easy Being Me

HP's media advisers placed a prominent, but curious story in September 29th's New York Times.  It would seem to be timed to October 3rd's Security Analyst Day at HP.  Hopefully, the story will set up some announcements or perspective that will shape a more positive Wall Street view on HP's share price.

The Times writes that Meg Whitman,
"...believes that Wall Street doesn’t quite get it — doesn’t quite see the promise she sees."
I don't know how many times I've heard this quote from incoming CEO's over my years as an analyst.  In most cases, what Wall Street saw was very much closer to future reality than what the CEO saw through rose-colored glasses.  Meg, please drop this line and never repeat it, even if fawning analysts pitch it to you.  The smart investors never got Enron or Tyco either.

A Bernstein analyst/cheerleader is quoted as saying, "This is now the cheapest big stock in the past 25 years."  He must "get it."  How many of the hundreds of other, historically cheap big stocks got cheaper or went to zero?  It's an empty statement.

Institutional portfolio managers are generalists, and even their analysts follow multiple industries.  They need to be educated, in market and financial terms, about where the company is going, how it's getting there, and what's at the end of the rainbow in terms of margins and returns.  The sins of the past and even the challenges of the present aren't that important: investors are buying the future. If the present weren't challenging, Leo A. would still be here. 

Meg Whitman says,

“It (cloud computing) is a shift bigger than anything in our memory,” Ms. Whitman says. “We have to get ahead of the curve.”

This may very well be true.  It does create problems for analysts and investors who are modelling the company's future today.  This statement suggests that an investor who took the local peak margins in HP's business segments, grew revenue forward at a modest single digit rate, and took in restructuring benefits to estimate the future peak margins, might be totally off base.  But, this is exactly the calculation that most investors do to project an upside. 

Some of the current business segments may never achieve their former peak margins precisely because these big shifts will obsolete some of the business offerings and their pricing.  So, HP needs to help investors understand how this will play out.

The other bromide that HP bulls bring forward is the notion of being a "one stop solution" for the corporate IT buyer.  What if the future buyer refuses to spend that way?  What if the buyer demands interoperability of components, "plug and play?"  Software architectures have to be open.  No proprietary systems.  Buy the "best of breed" for every node of the operation.  This would be a "big shift," and it is already taking shape in areas like health care IT. 

HP provided this picture of a self-contained self-contained "cloud pod" of servers, storage and networking.  HP says that 20 units per month are being produced in its Phoenix operations, and each would sell for $20 million.  The advantage, ostensibly, for the corporate buyer would be that it could be deployed sooner than the 18 months needed to build a conventional data center. I'm not sure I get this idea, as shielding these kinds of units from all kinds of attacks would require significant site preparation also.  Again, let's get the context for why this might be important.

The Autonomy question still needs to be answered.  Besides the CEO having a digital dashboard (another hackneyed IT phrase) for Autonomy, is this the platform to take HP into the Big Data future?  Any more writedowns?  Some industry types suggest that their sales penetration pre-acquisition was narrowly focused on areas of Internet security rather than on the broader analytics of Big Data.  Meg, please put some meat on these bones, and be specific.

Saying that HP needs four more years to get "confidence in itself" is a troubling statement.  By that time, hopefully the company should be making some real money, which is the biggest single factor in generating confidence among employees.  Options that are in-the-money are a real tonic for the middle and upper management ranks.  Hopefully, your statement was quoted out of context. 

Why not give some guidance on where the company is going revenue and earnings-wise?  Put all the caveats and risk factors out there.  Have the CFO run this gauntlet: it's not that hard.  Put some kind of floor on the expectations and let them (hopefully) rise from there. 

Meg Whitman also says for the Times, "I am the the first (HP) CEO in a long time who is from the Valley."  This statement sounds a bit delusional.  Having board members or the CEO from a geographical provenance wouldn't seem to be associated with value creation. 

The New York Times writer, Quentin Hardy had some interesting asides in his text, apart from all the feel good material,
  • "Ms. Whitman has plenty of impressive-sounding stats at her fingertips." (they're not really ones you'd write down in your notes)
  • "The fact is, HP isn't what it used to be."
  • "Profit margins at I.B.M. and Apple are several times that of H.P. And H.P.’s share price, at just over $17 on Friday, is about where it was in 1995."
  •  "Instead of standing at the confluence of the phenomenon (mobile, cloud and Big Data), though, H.P. is on the sidelines, with most of the parts but none of the integration to make it a leader. ....H.P. sometimes seems like a place of siloed relics...:
  • "Everyone knows viscerally how fast change can overtake a legacy business — and how hard it is to change."
HP, and its new CEO, needs to meet all these questions head-on and answer them clearly and with numbers which show the contours of the way forward.  No more excuses about the "mess I found." 

Here's hoping for a successful Analyst's Day.