Tuesday, February 26, 2013

HP's First Quarter: A Deposit on 2013 Projections

Hewlett-Packard's fiscal first quarter 2013 was a "beat," but only against the company's own Sad Sack  guidance for the quarter: non-GAAP EPS were $0.82 compared to the guidance range  of $0.68-$0.71.  Versus the prior-year period, non-GAAP EPS were $0.82 versus $0.92, a decline of 11 percent.
The non-GAAP pre-tax, operating margin was 7.9% compared to 8.6% in the prior-year period.

A change in the company's segment reporting seemed to chloroform the analysts on the conference call, who took turns asking immaterial and diffuse questions about industry issues like market share and the performance of new printer lines.  For us, the realignment of business units among new segments raises questions and points the way to potential divestitures.

Quarterly revenue of $28.4 billion was down 6% versus the prior-year period and down 4% in constant currency.  Revenue in the Americas was down 3% to $12,8 billion, which seems in line with the October 2012 Analyst Day picture of 2013.  EMEA revenue of $10.3 billion declined by 11 percent and by 9% in constant currency.  Asia-Pacific revenue of $5.2 billion declined by 1 percent both on a reported basis and in constant currency.

The big excitement in the financial press was about cash flow from operations which the company trumpeted as increasing 115% year-over-year, to $2,562 million in the current quarter, compared to $1,193 million in the prior-year period.  At the same time, CEO Whitman repeatedly refused to endorse raising projected full-year 2013 cash flows.  She reined in analysts by characterizing this apparent significant outperformance as a "deposit" on the company's guidance for 2013.

Looking at the statement of cash flows, most of the year-over-year delta comes from a swing in accounts payable and a movement in "Other assets and liabilities."  Unless there is something fundamental going on, this could be simple timing, but it's unclear what's going on in the "Other" category.  Bottom line is that the CFO was encouraging and probably speaks to timing and good cash management.

A bogeyman issue raised in the prior quarter was about a potential $400 million deposit for unpaid tax liabilities in HP's Indian subsidiary.  This wolf turned out to be a sheep.  A $34 million deposit was made in the fiscal first quarter and another $10 million deposit will be made in the second quarter to settle the matter. Perhaps this item was on the balance sheet and accounted for part of the delta in "Other assets and liabilities."

In the quarter, the company returned $511 million to shareholders, comprising $253 million in share repurchases and $258 million in dividends.  19.2 million common shares were repurchased in the quarter at an average price of $13.18.  Finally, some buying for a value-adding return!  We note the CEOs language now describing share repurchases as "offsetting dilution."

We like the balance in the way cash was returned to shareholders in the period.  It is also clear that much of the downsizing and restructuring savings to-date have been reinvested in the business, which is something that we have said is the highest and best use of free cash for shareholders at this juncture.

The new Enterprise Group segment reported revenue of $6,984 million compared to $7,282 million in the prior-year period, a decline of 4.1 percent.  From the recast historical numbers, we know that the $7.3 billion number in the first quarter 2012 contained $2,264 million of Technology Services, which carried a healthy 24.2 percent operating margin compared to an 11.6 percent operating margin for what was called the ESSN segment in 2012.  On the call the CEO mentioned that Technology services reported "strong profitability" in the fiscal first quarter 2013.

This suggests that margin pressures continue in the former ESSN businesses. Overall, the operating margin for the Enterprise Group declined from 18.3 percent in 2012 to 15.5 percent in 2013.  This business clearly is redefining itself as the markets and customers shift their purchasing habits and desired configurations. The CEO mentioned that revenue from converged storage products was up 18 percent year-over-year, including 3PAR products which increased sales 21 percent year-over-year.

Last year, revenue in storage, networking and business critical systems were some $17.2 billion.  The standard server business is under margin pressure, but here too the CEO was optimistic about market share gains in the future.  Sales of standard servers were $12.6 billion in 2012.

Personal Systems revenues declined 7.7 percent year-over-year to $8,204 million in the quarter.  Units sold were down 5 percent and price declined by about 3 percent.  Again, making corporate sales will continue to require personal computing devices, whether in the form of laptops, notebooks, or tablets.  Operating margins declined in this business from 5.2 percent in 2012 to 2.7 percent in 2013.

The CEO clearly rejected any conversation on the call about breaking the company into pieces or divesting large businesses like Personal Systems and Printing.

First quarter sales in Printing were $5,926 million, a decline of 5.3 percent over the prior-year period.  However, operating margins in the Printing business unit increased to 16.1 percent from 12.2 percent, due to a higher mix of supplies versus equipment, as well as higher realizations on ink due to new programs in emerging markets that drove higher volumes, market share and better pricing.  This is certainly encouraging news and speaks of good execution.

The Enterprise Services segment reported revenues of $5,919 million in the quarter, a year-over-decline of
7.1 percent.  The bad news is that the operating margin in this segment fell to a moribund 1.3 percent in 2013 compared to 2.3 percent in the prior-year period.  This segment included $3,701 million in Infrastructure technology outsourcing revenue in 2012's first quarter, which we believe is a commodity business, which is either in a secular low growth phase or at a cyclical low. The rest of this segment is made up of lower margin technology services that amounted to about $2.5 billion in first quarter 2012.  Now this segment is more visible on its own, and its future and fate are more visible for shareholders.

The most interesting comment, in my opinion, was the CEO's reference to resuscitating HP Labs to a primacy of place in the business for pursuit of  big ideas and enriching the patent portfolio.  This is a smart thing to do for a technology company which doesn't want to be left selling legacy products and me-too services.

Software revenue of $5,919 million in the quarter declined by 7.1 percent year-over-year.  One analyst put his finger on the fact that Autonomy revenue was probably down mid-double digits year-over-year, with the core software products growing at mid-single digit rates.  The CEO didn't disavow this estimate, which is logical given the write-downs and the limited scope of Autonomy products ready for production and sale. There were no follow-up questions about Autonomy.

Overall, understanding the CEO's desire to rein in expectations, it was a balanced presentation in the face of confusing comparisons given the short time frame to digest the new segment presentation.  The CEO said specifically, "We still face a long road ahead."  It would have been interesting to hear specifically about why she feels this way, as the road map laid out is becoming clearer.  It is definitely an execution story as 2013 unfolds.

Our proposed playbook looks like it is being run: easing off share buybacks, reinvesting in the business, keeping the portfolio together, pruning it at the margins and stepping up the invention.  An additional important item that would help the CEO would be to bring directors like Marissa Mayer and others on to the board.

Monday, February 25, 2013

Karzai Endangers Our Troops

Afghan President Karzai's office is reported by the Wall Street Journal as putting out this statement in a press release,
"U.S. Special Forces stationed in Wardak province engage in harassing, annoying, torturing and even murdering innocent people," read a statement from the president's press office."
For all the billions in aid and support we've poured into Afghanistan, not to mention the lives sacrificed and ravaged among our troops, President Obama should send a special envoy to President Karzai to express our profound displeasure with this reckless and inflammatory statement.

Ann Marlowe's blog posts information today from the latest UN report on Afghan civilian casualties,
"For the first year since 2008, civilian casualties are down. Twelve percent down over 2011. At 2,754, civilian deaths in 2012—the equivalent in our population of 300 million would be 27,540—are still horrifyingly high. But contrary to lefty doctrine, 81 percent of the casualties were caused by the insurgents and just 8 percent by foreign and Afghan security forces. Air attacks by our forces caused just 126 deaths in 2012, as opposed to 235 in 2011 and 171 in 2010."
 We should also begin lining up the numbered foreign bank accounts where President Karzai, his family and friends have been expropriating our development funds and freeze the assets immediately. Failing something out of the normal, our draw down in Afghanistan will be hard on the ANA, civilians, and on our troops.

To think of our maintaining elite special forces within Afghanistan after our "pull out" in 2014 is madness.  They will be sitting ducks in a "no win" situation.   Let's not "lead from the back" on this predictable scenario.

My Nominee For HP's Board

An arm of the labor organization "Change to Win" is coordinating a meeting among a few large HP shareholders and a committee of HP directors in front of the annual meeting and elections. We've been talking about this serially disastrous board of directors since 2010.

Looking at the basic composition of this board, it is overweight finance, venture capital, private equity types--people from "the Valley."  It has CEOs with experience in management consulting, specialty chemicals and telecommunications gear.

What's missing?  What about some real, leading edge engineering experience?  Management is charged with building the next generation of products on a shorter cycle than ever before in corporate history.  Someone to interface with the organization in this critical area is missing.  I also don't mean another MBA who has administered an organization, but someone who's been involved in the process personally from the ground up to the highest level.

HP has to sell a lot of value propositions to its customers: servers, software, applications support, security, computing devices, smart phones and consulting services.  What about sales and marketing, with a technical background too?  I think that inviting Marissa Mayer to join HP's board would be a real step forward for the company, employees and its board.  The recent decision to run Android on HP tablets couldn't hurt.  Also, in reading a lot of material recently about Google, Marissa Mayer's name came up often as someone within Google who was savvy, articulate, visionary, hands on, and got things done. She was also in charge of engineers in her job.  She'd be my first choice.

Lynn Turner, with over thirty years in public accounting and a few years as the Chief Accountant for the SEC, writes in today's Wall Street Journal,
"Investor representatives Lynn Turner, a trustee of Colorado Public Employees' Retirement Association, and Michael Garland, who oversees corporate governance for public-employee pension funds for New York City's comptroller, said they hope to hear that H-P is seeking new directors. Even without replacements ready, H-P investors should now "take some of the longer serving directors and throw them overboard," Mr. Turner said."
That's pretty tough talk for an accountant.

Thursday, February 21, 2013

Plus ça change, plus c'est la même chose

Titan CEO Maurice Taylor's refreshing, stream of consciousness letter to the French Minister of Industrial Renewal shines a bright light on unresolved, fundamental weaknesses in the euro currency system.  Labor laws are an impediment to productivity and export competitiveness, but the single currency doesn't allow adjustments for relative cost differentials between, say, France and Germany.

Darren Williams of Alliance Bernstein lays the issues out clearly in a blog post today,

"But France does share some unwelcome characteristics with the periphery. Top of the list is the competitiveness lost since joining the euro in 1999.
This is most noticeable against Germany. According to our calculations, the gap between the actual (irrevocably fixed) exchange rate between Germany and France and the one required to offset the divergence in unit labour costs since the late 1990s now stands at 20%.
The deterioration in France’s relative competitive position is confirmed by the export performance of both countries. During the 1980s and 1990s, both countries’ exports grew broadly in line with their respective export markets. Since then, though, Germany has hugely outperformed its southern neighbour.
In spite of these problems, France has grown at an average annual rate of 1.4% since joining the euro, the same as Germany and the euro area as a whole. How has this been possible?
Part of the answer is that France has run a large and persistent annual budget deficit since joining the euro, equal to 3.7% of gross domestic product (GDP) on average. This compares with 2.1% for Germany and 2.8% for the euro area as a whole."

Unfortunately, no Socialist government, indeed no French government, will be acting on these issues.  Bond market investors are in a position to put meaningful market pressure on through sovereign spreads, but they act more like sheep than supposed "bond market vigilantes." And so it goes.

I'd surmise that Titan CEO Maurice Taylor probably got a congratulatory phone call for his letter from ArcelorMittal CEO Lakshmi Mittal.

Tuesday, February 19, 2013

Warren Romney

We borrowed the Wall Street Journal's headline from an article about the private equity buyout of H.J. Heinz.  Our spokesperson for the popular press narrative on private equity has been Two Face, and he has been wildly popular among readers of two posts.

3G Capital made an impressive turnaround of Burger King, and I'm pretty sure that their plans for Heinz will also bear fruit.  Otherwise, Warren Buffett wouldn't have jumped at the chance of getting in on this deal.

In another story to generate a chuckle, the New York Times writes obliquely about the rehabilitation of Steven Rattner, a private equity investor whose reputation was "sullied" for improperly raising money from a New York State pension fund. For this, he paid fines imposed by Democratic star Governor Andrew Cuomo, who was then wearing the hat of crusading Attorney General.

Then, Mr. Rattner becomes President Obama's auto czar, and steps down because of the pension fund improprieties.  But, the Times writes,
 "And to take the story full circle, the Obama administration, which had eased Mr. Rattner out of his role, appears to have re-embraced him, even using him to campaign for the president last fall."
 A quid pro quo?  A pour boire?  Two Face?

Jake Tapper's "The Outpost" : A Must Read

Jake Tapper graduated from Dartmouth College with an A.B. in History.  This grounding in history and his story telling skills serve the reader well in his meticulously researched, compelling book, "The Outpost." At its core, the book is about scores of brave, disciplined, creative, resourceful, and committed soldiers whose lives were ended or irrevocably changed by their experiences in Afghanistan.  The fulcrum of the story is the creation, defense and ultimate destruction of Combat Outpost Keating in the remote Kamdesh district of Afghanistan.

Several American administrations have fostered continuing illusions about Afghanistan. Academics have similarly fallen under the same spell, and they still talk about defining "success" in Afghanistan.
The last paragraph of Tapper's 673 page book sums it up perfectly,
"All that I can tell you with certitude is the the men and women of 3-71 Cav, the 1-91 Cav, 6-4 Cav, and especially 3-61 Cav deserved better.  They are heroes, and they have my appreciation and eternal gratitude.  I wish they had a command structure and a civilian leadership that were always worthy of their efforts." 
The story begins with the sentence, "It was madness."  Somehow, undefined levels of the U.S. military command structure decide that they want to build outposts in the province of Nuristan in order to stem the flow of insurgents crossing over the Pakistan border.  The previous brigade commander in the region didn't think Nuristan was of any strategic value, and nothing was known about the ethnic Nuristanis, who stood removed from even the ethnic power structure in Kabul. The command decision was to place the outpost at the bottom of a bowl, surrounded by 10-12,000 foot mountain peaks.  When the sentry post was designed for the outpost, it didn't have a clear, full view of the outpost itself.

Soldiers described the experience of COP Keating as hunting deer from a deer stand---except that our soldiers were the deer.  Supplying the outpost was problematical, except by helicopter transport and even then the landing pad was dangerous.  "Sir, this is a really bad idea. A. Really. Bad. Idea. Anyone we drop off here is going to die."  (Jacob Whittaker, intelligence analyst to his superior officer in the summer of 2006)  Slowly and inexorably, the small contingent at COP Keating was overrun some five years later. 

The command structure in Vietnam and in Afghanistan proved to be remote, uniformed, capricious, subject to political whims on the part of the General staff, and their ideas were not vetted by senior officers who had some first-hand knowledge of the territory.  The Generals are supported by a foreign policy apparatus which is itself out-of-touch and dominated by NGO-types, State Department lifers and consultants. Thus, the role of Pakistan's ISI in supplying men and materiel, including sheltering them over the winter, was ignored until it was too late.  This command structure learned nothing from our war in Vietnam.  As Tapper says, our soldiers deserve better.

Our celebrity Generals like Petraeus and McChrystal are really politicians, except they wear uniforms rather than suits.  Like egomaniacal CEOs, they eventually believe their own press releases. They are too remote from their troops, and they spend their time using the media and trying to manage a President, his National Security Council, and Senators on Capitol Hill.  Seeing people with acres of medals on their chests makes the American public feel....confident that our conflicts are in good hands.  They are not. 

Even when it became clear that COP Keating should be closed, it remained open for political reasons and for the conclusion of the Afghan Presidential election.  

At some point, the Afghanistan strategy changed over to "counterinsurgency," which meant that our troops were to win hearts and minds over to the notion that an American presence was more in the economic and cultural interest of the local population.  The carrots included local development projects which were approved by the Karzai government in Kabul, like bringing mountain waters down to the villages for cooking and drinking.  Local councils, or shura, would guide and oversee the projects.  This all sounds good and is straight out of the NGO and academic playbooks.  Unfortunately, the real specifics of how counterinsurgency was to be carried out were not obvious.

In the case of Kamdesh certain commanders figured out, through their own awareness, emotional intelligence and moxie, how to make counterinsurgency work.  The stories of Lt. Col. Chris Kolenda, Captain Joey Hutto and 1-91 Cav are inspiring. They were succeeded by Captain Rob Yllescas who created the "Hundred Man Shura," and convinced his superiors that spending money to support this organization would provide returns in goodwill and safety for the locals and our soldiers. Yllescas forged great relationships with the locals. As a result, he was targeted for assassination by Taliban insurgents and their foreign sponsors. Why?  Because the opposition knew if an American soldier was succeeding in breaking down the propaganda walls about American motives and methods in Afghanistan, then the village elders would become effective partners in an alliance against outside Taliban interests.  

After the death of Captain Yllescas, both the Afghan National Army and the shuras were co-opted and compromised by insurgent infiltration.  The Taliban proposals were simple.  "The Americans will be gone soon.  After their departure, when we return we will remember those who cooperated with them and we will exact a price from you and from your families."  The way out for the locals was to look the other way when strangers infiltrated the village and when insurgents took up new positions on the mountainsides.  The book captures the fact that the fifty odd soldiers assigned to the outpost were intuitively aware of these developments.  As much as they tried to ferret out the truth directly from the ANA and the shura, they were inevitably told lies.  

After the collapse of  COP Keating, the Army inevitably called for an investigation in which it totally absolved its own highest leadership, who were not in the terms of reference of the report.  Instead, several soldiers were to be publicly reprimanded for not taking adequate measures to shore up the outpost's defenses as the threats increased.  Never mind that they didn't have the soldiers, material or time to do this, as they were under steadily increasing attacks.  The bureaucracy always moves to cover itself in its Kafkaesque world.  

In 2006, at the beginning of the book, when soldiers are entering villages introducing themselves as working in partnership with the Karzai government in Kabul, the villagers ask, "Who is Karzai?"  Time in the remote provinces of Afghanistan has stood still.  Villagers were unaware of World War II. They had never seen or felt any influence of a central government in Kabul, except around the time of the Presidential election, in which both sides wantonly stuffed ballot boxes.  

Jake Tapper has recently been elevated into the pantheon of emerging media pundits, taking a high position at CNN as Chief Washington correspondent and taking the time slot of the insufferable Wolf Blitzer's Situation Room.  It's good for Mr. Tapper and his professional career, and well deserved.  However, in this situation, it's not likely that he will be able to do the independent, in-depth work produced in this fine book.  

Thursday, February 14, 2013

Warren Buffett Letter to Michael Dell (Imaginary)

Dear Michael,
Since you and I share the privilege of founding businesses which became public companies and leaders in their industries, I am writing to give you some of my thoughts on your proposed buyout deal and about deal-making in general.

Here's an excerpt from the Wall Street Journal about my latest monster deal,

Warren Buffet's latest monster deal, to buy H.J. Heinz for $28 billion including debt,HNZ +19.87% comes after the shares had risen in a pretty straight line over four years to an all-time high. And Berkshire HathawayBRKB +1.27% alongside partner 3G Capital of Brazil, added a 20% premium for good measure.The buyers are paying up for an iconic brand and a strong record of expansion—with 30 consecutive quarters of organic revenue growth largely as a result of its growing emerging-markets presence. The deal values Heinz at 13.8 times trailing earnings before interest, tax, depreciation and amortization. Campbell SoupCPB +1.41% by comparison, trades at 10.8 times.
I know that you, like Charlie Munger and I, appreciate the value of a dollar and the joy that comes from doing a sharp deal.   Remember the deal I offered to Goldman Sachs when the financial crisis put them at death's door?  It took me twenty minutes to commit $5 billion of my shareholders' money to a deal!  A ten percent preferred with warrants to purchase Goldman shares at $115 in a five year period. My mentor, Ben Graham, would have been proud: talk about a margin of safety plus!  My shareholders and I will make out like bandits, on a risk-adjusted basis, of course.

But, I also knew that Goldman could and would repay the debt as fast as they could, once the crisis ebbed and they took advantage of their bank charter and the problems among their weaker peers. It's a joy to drive a good deal, but you've got to make the deal suit the constituents and the circumstances.

Look at today's deal.  All the idiots on Wall Street (don't quote me) will say I overpaid.  Let me assure you, Charlie, myself and our Brazilian partners know what the iconic Heinz brand can be worth in a decade under focused, aggressive management with targeted incentives.  If I wanted to buy a bad business on the cheap, I would have bought Campbell's. I bought a great business, alongside great partners, for a fair price.

In retrospect, this deal will be much bigger bonanza for Berkshire shareholders than the quick return we got from Goldman Sachs, no question. With Heinz, we are going to build shareholder value, not pick up gold coins from the Street.

We did our homework as we watched the shares close on their all-time highs.  Paying a twenty percent premium is lower than it could have been, but Heinz shareholders have already had a good ride and my shareholders give Heinz shareholders a nice pourboire via the premium.  Everybody's happy. Everybody wins. Taking the offer is a no-brainer for shareholders and even for those parasitic arbitrageurs. No bad feelings, and no negotiating over another dollar on the offer price.  I don't negotiate in public, period.

Now, to your deal. Your shareholders have had a fairly miserable ride for quite some time. My friends at Southeastern Capital Management, who have also read my mentor Ben Graham's book, bought your stock in the same way that I am buying Heinz.  It's a good franchise that is undervalued for a variety of reasons, but which is in the process of turning itself around, partly due to some of the acquisitions you have made.

The deal you are offering your shareholders is a rubber truncheon kind of deal.  It's opportunistic for sure, and I commend you for that.  Your shareholders (and my friends) at Southeastern, T. Rowe Price and others will be taking a sharp stick in the eye.  So, your deal has winners and losers and creates bad feelings.  Why do it, Michael?

Forget about what your legal eagles and those bankers are telling you.  If you have the conviction and the stomach for turning your company around, craft a deal that is a no-brainer for your shareholders.  Be a mensch.  If you can do what you believe, then the value at the end of the trail will be worth far more than what you need to put on the table now.

I'm going to sign off now, because I need to work on my succession planning.  Talk about boring!  Call me if you want to discuss this.

Best regards,


cc. Eapen Chacko

Sunday, February 10, 2013

Dell Looks At Its Consumer and Small Business Segment

To start, Southeastern Asset Management's letter concludes that a $13.65 per share buyout price for Dell values the bulk of its businesses, including Software and Peripherals, Client, and Services at $1.00 per share.  Without suggesting that this number is sacred, the founders and analysts at SAM don't throw around numbers without any foundation.

On January 8, 2013, Phil Bryant, who is VP and GM of Dell's North American Consumer and Small Business organizations gave an interview at the J.P. Morgan Tech Summit at the Consumer Electronics Show, probably the premier industry venue for these businesses.  To close the loop on a few posts, here are selected bullet points from Mr. Bryant's comments:

  • The Consumer and Small Business segments are focused on mid and high band systems, at $700-$800 price points. 
    • these price points are profitable segments where there is "still a lot of head room overall."
  • Dell's strengths in these businesses and opportunities to increase profits in next 12-18 months
    • to a basic sale, Dell gets high attachment rates for services, software and peripherals.
      • I would add that Dell's customer service organization has become very active monitoring consumer questions and concerns via social media.  Customer service reps identify themselves when they research and answer specific product spec and performance issues, even on their partner sites like Best Buy.  
  • In the small office and professional practice space Dell generates "really good ASPs," and it has a "strong desktop business" with "good share position" and "good profitability," which he will continue to drive. 
  • The tablet business is still evolving, but they have two offerings in the market place.  They are working on additional convertible form factors.  As touch screens continue to penetrate the user bases, notebooks and tablets will converge.  
  • Enterprise solutions services and the software business comprise "well over a third of our revenue and over 50% of our gross margin," according to David Mehok, VP of Investor Relations.  It is something that "a lot of people don't realize."  (Without knowing his definition of terms exactly, it's hard to recreate his number.  However, using the revenue by product charts at the end of the SAM letter, it appears his revenue comment is in the ball park.) The gross margin comment is interesting.
    • These businesses have gained "significant share over the last few quarters."
  • Comments about "Bring Your Own Device," or 'consumerization' of IT.
    • As this trend continues, security is the key concern for enterprise IT executives.  Dell's security acquisitions are playing a key role in their solutions offering.
      • Quest for identity and access management.
      • SonicWall for firewall and Virtual Private Networks.  
      • Credant, acquired about a month before, is already being incorporated into Latitude product lines for endpoint security.  
  • Server Business
    • Great penetration from 12th generation servers. 
    • Networking business grew 40% y-o-y in the last quarter.
    • Strong services businesses despite some margin pressure on the hardware side. 
  • Lots of opportunity to reduce general and administrative expenses.
  • Some will be reinvested in raising research and development above the current 2% of revenues.
  • About the relevance of the PC/Computing Device business from David Mehok: "you always lead a corporate sale with PCs."  He is a sixteen year veteran of Dell.  
Do all these businesses taken together, with these trends, sound like a portfolio worth $1.00 per share?  Does being public preclude investing in research and cutting expenses?  I don't think so. 

Saturday, February 9, 2013

Dell's Buyout: Ill Conceived and Poorly Priced

Reading this quote from a Dell spokesperson made me think some more about the Dell transaction,
“Based on that work, the board concluded that the proposed all-cash transaction is in the best interests of stockholders,” said the spokesman, David Frink. “The transaction offers an attractive and immediate premium for stockholders and shifts the risks facing the business to the buyer group.”
Going back in the recent press, Dell and its journalistic allies have been peddling a story.  Wall Street, with its fixations on quarterly results, has made it impossible to transform Dell into the innovative, disruptive competitor it was when Michael Dell sold computers out of his dorm room and car's trunk. The only answer is for Silver Lake Partners, a collection of banks, Microsoft, and Michael Dell to put shareholders out of their misery and buy the company.

Wall Street investment banks J.P. Morgan and Evercore partners advised the board about strategic alternatives, but it isn't clear what other alternatives were seriously vetted and why they were ruled out. An unnamed, "leading consulting company" was also involved.  It all sounds as if the concerns were to give the patina of independence to the board from Michael Dell's self-interest in the privatization transaction.

Bank financing will be provided by Bank of America Merrill Lynch, Barclay's, Credit Suisse and RBC.  Of course, all of these banks have investment research arms with equity analysts who cover Dell.  But wait, aren't these banks precisely "Wall Street" which is putting on the debilitating psychological pressure for short-term results?  Never mind, but their Wall Street investment banking colleagues are much more understanding and will generate superior returns between fees and extending credit.

Dell's shares were as high as $41.75 some years back, and were hovering around $16 before taking the recent down trend in 2012.  It really seems incredibly opportunistic to cite an "attractive premium" over a share price which itself has been talked down by the "frustration with short-term pressures" narrative.

Southeastern Asset Management's 8.5% stake was not accumulated for a short term trade.  Since they run relatively concentrated portfolios, they also carry out their due diligence within Dell's industry over a long period of time.  Dell was a significant holding in the Partners Fund at the end of 2011 and again at the end of 2012.  Their risk-adjusted, required return on such an investment is built on a relatively long holding period. They would be concerned about understanding quarters that seemed disappointing, but if the stock traded down short-term, this kind of investor often adds to a position.

If one such long-term, fundamental investor has come on board, then it is up to Dell's Investor Relations effort to go out and recruit more owners like this.  These fundamental investors are out there looking for good ideas.

So, the whole notion of Wall Street pressure requiring an privatization is ridiculous.  Dell hasn't been a momentum stock for over a decade.  It hasn't been a growth stock either.  If it is being priced as a value stock, when in fact it has the potential for re-accelerating growth, then that is a very attractive situation for a number of fundamental investment styles.

At the current price levels, other things equal, the expected return on Dell is higher than it was when it was in the mid-twenties, for example.  So the whole notion of some arbitrary premium to an arbitrary baseline price is as meaningful as a trading pattern on a technical stock chart.

The whole notion of "shifting risks to the buying group" should raise a red flag.  There is less risk at $13, and a higher expected return than in recent memory.  As SAM points out, since Michael Dell returned as CEO in 2007, the company has spent $7.58 per share for acquisitions, which have not been written down.  Dell's CFO claims that these acquisitions to-date June 2012 have generated a 15% IRR.  SAM credits the value at the historical cost, which is understated according to management's own claims.

Strategically, these acquisitions have, among other things, doubled services as a percent of revenues to 12% from FY05 to FY11, and this percentage is said to increase to 18-22% of revenues by FY15.  Services carry an operating margin of more than 20%, based on 1Q FY12 actuals.

The transformation of the revenue mix is well underway.  Dell's established niche in SMB (small to medium sized businesses) is strong across all the business lines.  The retail consumer business, according to SAM's presentation, is 30% of a $33.7 billion business, which is balanced between SMB, public sector, and large enterprises.  The overall operating margin is in excess of 5%, diluted by what's been happening in personal computing. This trend should reverse, as products converge between tablets and laptops.

Kroger is one of the largest global food retailers, with sales in excess of $90 billion.  When I covered their stock as a retail analyst, the Street was sure that entire world was going to buy its food from Wal-Mart supercenters and that Kroger would be hemmed in by Albertson's.  After rebuffing an effort by KKR to take it private, the company did a leveraged recapitalization, which included a large special dividend, funded by debt, and a public stub for shareholders who wanted to retain an equity interest.  After valuing all the pieces, I recommended the stub, and my institutional investors did exceptionally well when the company turned itself around.

Such a transaction could have worked for Dell, as SAM points out in its letter.  It would have been a fair deal for existing shareholders.  Based on the board procedures adopted, this would appear to be off the table now.  The question is "Why?"

Unfortunately, Wall Street sell side research is totally off the reservation now. Credit Suisse analysts, for example, are restricted because the investment bank will arrange some of the debt financing for the current management's proposed deal.  Their writing does nothing more than rubber stamp the proposed premia implied by the $13.65 price.

Dell's own executive presentations at investment conferences as recent as 2012 tell very optimistic stories about what has been accomplished and about what's to come.  To force shareholders to cash out now has no basis in any economic reality.  It is, however, a terrific power play by management and Silver Lake Partners.

Friday, February 8, 2013

Southeastern Asset Takes Its Dell Investment Seriously

Southeastern Asset Management, which is the largest outside shareholder of Dell, has written a letter to Dell's Board of Directors opposing the proposed transaction to take the company private.  Unlike some other professional shareholder activists, SAM isn't proposing any self-serving transformation of the company or cosmetic sale of some business.

Instead their letter makes simple, but astute arguments, using some of the company's own statements, to show that the proposed buyout price is larceny in broad daylight.

If Dell's board hasn't thrown in the towel figuring everything is a go, they should wake up and do their job, as the letter asks them to do.

I've read shareholder letters and commentaries from SAM for decades.  As far as their own mutual fund shareholders go, they treat them well by providing a consistent investment process, with moderate expenses, and diligent oversight of the portfolios. Best of all, the fund management "eat their own cooking."  That is, they all have significant portions of their wealth tied up in their own funds.  So, when they call Dell on the carpet for management ennui in not wanting to deal with their public shareholders any more, it is exemplary shareholder activism.

Hopefully, other long-term shareholders will wake up from their slumber and take an hard look at this transaction.

Fed Governor Stein on Credit Market Overheating

Jeremy Stein, a member of the Board of Governors of the Federal Reserve System, made some remarks at the St. Louis Fed Research Symposium.  His talk was titled,  "Overheating in Credit Markets." 

One of the subsidiary themes in Stein's paper was hedge fund performance.  As of June 2010, the Ivy League university endowments had forty percent of combined assets in non-traditional ("alternative") investments, versus about two percent in the global investment industry portfolio.

A raw performance comparison between hedge fund indexes and the Standard and Poors 500 equity index over 59 quarters ending Q3:2010, shows hedge funds returning 9.2 percent per annum versus 7.5 percent per annum for the 500 index, with hedge funds having lower volatility and higher Sharpe ratios.

Ivy League university endowment funds, led by Harvard and Yale, pioneered large portfolio allocations to alternative investments (hedge funds, private equity, and real estate).  Dave Swensen of Yale became the public face for popularizing the use of alternative investments.

As of June 2010, Ivy endowment funds had 40 % of their combines assets allocated to alternative investments, whereas global institutional portfolios has only about 2% allocated to these investments.

According to a March 2011, Prequin survey cited by PwC, public pension plans had increased their allocations to hedge funds from 3.6% at the end of 2007 to 6.6% at the beginning of 2011.

So, what's not to like about hedge funds?  The current consensus among financial planners is that every investor needs to have exposure to alternative investments, particularly hedge funds, in their portfolio.  Morningstar even rates long/short equity funds among their mutual fund universe, although this category had a tough 2012.  Unfortunately, hedge funds are truly "black boxes," which should always be viewed with skepticism.

A 2007 paper by John Griffin (University of Texas at Austin) and Jin Xu ( Zebra Capital Management) looked at whether or not hedge fund managers were smarter equity managers than their traditional portfolio manager counterparts.  Hedge funds, they found, tended to deal in smaller, more opaque equities.  According to the multifactor APT models, small caps are an equity sector that has historically provided excess return.  Hedge fund managers also had higher turnover than mutual fund managers.  Because these smaller cap, more opaque equities often trade by appointment, this had to mean the hedge fund managers made extensive use of derivatives.  Their key finding was rather surprising.

"Decomposing returns into three components, we find that hedge funds are better than mutual funds at stock picking by only 1.32 percent per year on a value-weighted basis, and this result is insignificant on an equal-weighted basis or with price-to-sales benchmarks. Hedge funds exhibit no ability to time sectors or pick better stock styles. Surprisingly, we find no evidence of consistent differential ability between hedge funds. Overall, our study raises serious questions about the perceived superior skill of hedge fund managers."
So, why would investor agree to pay a 2/20 (2% per annum management fees; and 20% of portfolio profits) for an investment strategy which, when measured appropriately, may not add value?

According to the New York Times,
"In September 2012, the average hedge fund still charged 1.6 percent annually in management fees and collected 18.7 percent of any gains, according to data provider Preqin. Through November of that year, the average global hedge fund investor earned just 2.6 percent, according to the HFRX global index maintained by Hedge Fund Research. In 2011, investors lost nearly 9 percent. The average annual return from 2009 to 2012, supposedly recovery years following the losses of more than 20 percent in 2008, was a measly 3 percent."
Behavioral economists would say (1) investors are greedy; (2) individual investors, and even public pension funds, are forced to reach for returns in a low return environment precipitated by Fed policy; (3) investors are easily seduced by the black box, APT argument that free lunches of excess returns available to smart managers, and (4) since the fee and trading cost structures are opaque, it is nigh impossible to get an estimate of the true value added by hedge fund managers above their risk-adjusted cost of capital.

Now, in 2012 Governor Stein references papers by Jurek and Stafford who present some interesting data that seeks to decompose hedge fund outperformance.  Overall, they find that hedge funds as a category are not market neutral, which is one of the features their brokers and sales people trumpet when funds are sold to institutions.

Jurek and Stafford find that they can mimic hedge fund performance with a replicating portfolio of cash and a short position in single equity index put options.  In a recovering market uptrend, a manager could easily outperform the SandP by inexpensively replicating the index and by selling out-of-the-money put options on the index; these would expire out-of-the money and the manager would earn the option writing premia, assuring outperformance.

In both severe and mild market declines, the authors show that their replicating portfolio generates the same non-market neutral performance displayed by hedge funds over their research period.

The authors results appear in Table V in the appendix to the 2012 SSRN paper linked here.  The sample period is 1996-2010, and the gross return to hedge funds is the Hedge Fund Research Institute Composite Index plus an estimated average annual fee of 350 basis points, equating to a gross return of 13.1% per annum.  The risk-free rate is 3.14%, and the required risk premium is the mean, annualized excess return attributable to the put writing strategy, which is 9.79%.  The total hedge fund alpha in this model, accounting for a required return/cost of capital is 17 basis points.

Remember that we have progressed from the 2007 paper which showed that hedge fund managers don't have any demonstrable advantage in stock picking or market timing acumen compared to their mutual fund peers.  Yet they appeared  to outperform traditional equity or balanced fund investment strategies.  Now, when the sources of their excess return are decomposed and an attribution is made for their "cost of capital" then their alpha is essentially zero, according to the 2012 research cited by Fed Governor Stein.

So, of course, investors are now rushing like lemmings into hedge funds.

Governor Stein notes that the 2012 historic new high inflows into high yield mutual funds and new issue spread compression suggest an overheating in the high yield market. He, however, stops short of calling it a bubble, because of some historical precedents for the spread behavior.

I thought that the hedge fund material, buried in some references was at least as interesting as the discussion of high yield and leveraged loans. As opposed to financial industry economists, academia and the Fed seem to be producing the most interesting, and disinterested, research.  A reader has to dig for it, though.

Wednesday, February 6, 2013

Breaking Up HP: A Bad Idea Rears Its Head Again

Back in October 2012, with HP's stock price testing the 52 week lows, we made two points:

  1. HP's customers are telling the company that separating computing hardware and printing from the rest of the company was not something desirable from their point of view, and
  2. The company's lengthy analyst day presentation and the multi-year turnaround make little sense if the company were contemplating the classic Wall Street breakup.
Today, based on one report from Quartz Media, recycled by the Wall Street Journal, the idea that the HP board is reconsidering the breakup has resurfaced.  

One of the fundamental arguments for declaring the end of the PC era is the "tablet."  Have you ever watched what people do with their iPads?  They take low quality videos of their child's band concerts or soccer games.  They look up useless information on Google and search for restaurant reviews, or check NBA box scores.  These are certainly not "value added" activities.  

There are certainly interesting and useful apps for specific tasks, like running a virtual sound board for a concert band.  However, to say that corporate users will all migrate to tablets is a bit premature. Before that happens, the tablets themselves will have to become more powerful.  And, at the end of the day, users who want to work on data analysis will need more than touch screen typing.  If they want to collaborate across geographies on a new prototype in a software application, it won't be done on an iPad. 

Tablets will evolve and converge towards something farther away from an iPad and closer to a notebook.  Look at some of the reviews for the Microsoft Surface Pro with Windows 8. The hybrid of the future shouldn't require a hard disk drive, as storage should be on something like Sky Drive; applications can also reside on the Web, being accessed in a SaaS mode, again doing away with a drive.  Business users won't require a DVD drive.  

Whatever this device looks like in the future, a company that has a long history with a corporate client in delivering devices and software, will have a decided sales advantage.  It will also have a global supply chain in place, and it will also have be able to redeploy cash flows to develop these future products.  

The Enterprise Business, which would be left over after HP ostensibly got rid of PCs and Printers, would face its own challenges from declining hardware margins for servers.  As HP software grows, the margin rates could stabilize before eventually turning north.  For now, the HP software business is too small, and it needs time to grow.  Again, all of this can happen by reallocating cash flows from within the large leviathan. 

Paying down debt and restoring the credit rating should be a high priority, and share repurchases should move to the bottom of the list. A split of the company with the current structure would not be considered a "bondholder friendly" action.  Research and truly new product development expenditures have to be carried out efficiently and with a sense of urgency.  

The sales organizations will hold the key to putting a face on the company's strategy with customers. 

Walt Kelly's Pogo said it best.

Historically this has been the case for HP management and its board of directors.  Let's hope things have really changed.  

Au Revoir Alcatel-Lucent?

 Alcatel-Lucent came to our attention in July 2012,
"Finally, a good former institutional customer sponsors a successful international equity mutual fund, and looking over their holdings, I noticed Alcatel-Lucent, S.A., owned in the Sponsored ADR form.  I haven't looked at this company since Carly Fiorina was working her magic at Lucent in 1999.  You don't have to be an electrical engineer to understand these businesses, although much of the foggy commentary about these companies, like Juniper Networks, is replete with capitalized acronyms.  I read the press release and was a bit distraught.  I then went to the company's website and listened to the conference call.  Wow!  This was truly a dismal performance, and the cash flows in the quarter were awful, especially given the reduced outlook for 2012, a large debt load, upcoming rollovers, and loss of revenues as the company leaves behind "legacy" technology and moves to "new platforms."  I went back to my fund's annual report, and they've taken a forty percent hit from last December to date.  Value investors may not get it right very time, but they probably can demonstrate their thesis with some numbers.  I may have to call my fund and find out."
Now tonight's Wall Street Journal online updates the story, and it's not encouraging.  My fund clearly missed on this investment, and a large, reactionary employment downsizing isn't at all encouraging. Technology gear for the guts of networks is a commodity business, and the evolution of companies like Huawei has hastened this shift.

Investors will hear echoes of this theme as proprietary servers start moving down this road too.  Historical margins for companies like Dell and HP in servers may prove to be artifacts too.

Tuesday, February 5, 2013

Smoking E-Mails and More From Standard and Poors

Journalists from the New York Times report today that Federal prosecutors have subpoenaed 20 million pages of emails from Standard and Poors in relation to Federal investigations about the company's ratings of structured finance vehicles.  That sounds like prosecutorial over-reaching, but that's the climate of our political environment, I guess.

Just as in every Wall Street crisis, there are smoking emails, and the Times reports these two:

“Rating agencies continue to create an even bigger monster — the C.D.O. market,” one S.& P. employee wrote in an internal e-mail in December 2006. “Let’s hope we are all wealthy and retired by the time this house of card falters.”
Another S.& P. employee wrote in an instant message the next April, reproduced in the complaint: “We rate every deal. It could be structured by cows and we would rate it.”
 The original 2010 Senate hearings on the credit ratings issue feature a high level cast of characters from the rating agencies.  A student or reader who wants a laugh, or a headache, can listen to the audio.  Like most hearings on the Hill, they are not enlightening.

One expert's testimony, I found today, was enlightening and educational for me.  He is Dr. Arturo Cifuentes, a Professor of Industrial Engineering who also earned his M.B.A. in Finance at NYU's Stern School of Business.  When Dr. Cifuentes testified in 2008 and again in 2010, he was Managing Director in the Structured Finance Department of R.W. Pressprich and Company in New York.  He also writes with a sharp sense of humor.

In relation to my post from yesterday, Cifuentes told the Senate Banking Committee in 2008,

 "A study should be conducted by an independent internationally-recognized statistical consulting organization (there are well-established mathematical methods to conduct this type of analysis) to see if the ratings have been “independent.”  Take, for example, all the CDO ratings given in a specific time period by Moody’s and S&P (to the same transactions) and compare them to see if they are “statistically different” or not.  This is a much needed exercise"
The point I was making yesterday is that this exercise is the first, objective "smell test" which would show if in fact the global financial system had three independent credit rating agencies or not.  Professor John Coffee  concluded the evidence shows a "race to the bottom" as the three agencies competed for market share and for large consulting fees.  They had nothing to gain by giving appropriately lower ratings to CDO's, since this would automatically exclude them from being considered for an investment bank's business.  Issuers needed AAA ratings from two agencies in order to go forward marketing to their institutional investors, who had to be rating driven by their charters.

If was very clear, as Cifuentes points out, that once these CDO's were trading in the secondary market, buyers and sellers looked right through the published ratings and priced the paper appropriately.  He cites the example of two CDO's issued in March-April 2007, both rated (BBB/Baa).  One was trading at LIBOR +1000 and the other at LIBOR+120.  Cifuentes says this situation is "unheard of."

The much more technical paper by Cifuentes and Katsaros convincingly demonstrates a problem facing rating agency analysts and investment bank analysts.  As we said before, the performance of the CDO depends on the credit risk behavior of the underlying pool of assets.  The analyst has to determine the probability of default, for which market proxies like CDS spreads are available.  In addition, there are ratings and fundamental analyses of assets which can provide guidance.  The big problem is how to estimate the default correlation, for which there should be relatively few events from which to make an estimate.  Then, as Cifuentes points out, the default correlations proved to be time-dependent, which is not a usual model assumption.

Rating agency analysts turned to a specific model to solve their problems, the One-Factor Gaussian Copula, which allowed a modeler to use asset correlations as proxies for the unknown default correlation.  Using this model derives implied default correlation values that are tranche-dependent, something that should not happen.  Just to give the punch line from their interesting paper,

"To sum up: the one-factor Gaussian copula method is a flawed technique to
model something that does not exist -- two very good reasons to move on
and leave all this correlation/copula nonsense behind.  Future efforts should
be focused on estimating default probabilities better.  Period.  End of story."
I believe that when one thinks about the flawed model and how it propagated itself through all the rating agencies, it explains something about the behavior of the investment banks.  Their analysts and quants are, like it or not, of a much higher caliber than those of the rating agencies.  I would guess that they knew relying on the Gaussian copula was fine for generating the AAA rating the banks needed to move the paper into the market, but they also knew that a rating based on this flawed model was unjustified.  Thus, it's no surprise that investment banks like Goldman shorted CDO's in the secondary market. Just a thought.

It really is a shame that five years after these problems were clearly identified, essentially nothing has happened to hold the culprits and their enablers accountable for a crisis whose after-effects still permeate our economy and our financial system. Politicians of both parties and our regulators are squarely to blame.

Monday, February 4, 2013

Standard and Poors Takes Some Punches

The earliest and best exposition of the role of the rating agencies in the mortgage debacle dates back to 2009. I posted a blog entry about Professor John Coffee's analysis of the drama and its bad actors. Here's the relevant excerpt:

This begins Act II of the tragedy in Professor Coffee's presentation. The investment banks bought loans because they knew that they could securitize them on a global basis if they could get "investment grade" ratings from two of the critical gatekeepers, names the rating agencies SandP and Moody's. Two ratings were needed for investor acceptance. So why did the gatekeepers fail to do their jobs?
When Moody's and SandP were focused on corporate bond issuance, no one client accounted for more than 1% of their business. When structured finance overtook corporate bond issuance, their business mix changed dramatically. In 2006, for example, 56% of Moody's revenues came from the top investment banks for structured finance product ratings. In addition, now the rating agencies generated consulting revenues from the same investment banks, counseling them on how to design a marketable structure. This concentrated their business and reduced their independence.
An additional wrinkle came with the acquisition of Fitch, and the new French owner's decision to grow its market share. Now, instead of a duopoly, you had three firms competing for the two ratings that had to accompany every "investment grade" deal. Professor Coffee had a dramatic slide that showed significant grade inflation for both investment-grade and below-investment grade securities
Standard and Poors' argument that its ratings were not motivated by "commercial considerations" seems to a weak one, although the issue of proving that the ratings were made in "bad faith" will be difficult for the government, unless there are a load of "smoking e-mails."

In 2012, we wrote about the Australian judge who wrote that investors could sue Standard and Poors for assigning AAA ratings to a CPDO structured finance vehicle.

Like judging the performance of the audit firms, the argument has to stay on technical and process grounds.

  • What models did Standard and Poors use to evaluate the performance of the mortgage pool underlying the structured finance vehicle?
  • Did SandP rigorously analyze a sample of underlying types of mortgage loans in the pool, especially the higher risk loans? 
  • Did their modeling, analytical process, and historical experience with these products provide a reasonable basis for their AAA rating?
  • Was the high percentage of AAA deals and the absence of split ratings among the three competitors a reasonable statistical outcome?  
Standard and Poors predictably argues that (1) Their opinions are just opinions, like me opining on the Oscar-winning movies; as such they are protected by free speech.  They are not to be relied on for investment decisions.  
(2) Their opinions were not motivated by commercial considerations.

The rating agency contention that it was being held accountable for not foreseeing the credit meltdown is a red herring and nonsensical. 

The Justice Department has to be pushing for a settlement, since they probably can't win at trial. SandP would be foolish to admit to any wrongdoing, because none of the other bad actors in the mortgage meltdown--from IndyMac,Countrywide to Bank of America, to Fannie Mae, Angelo Mozillo and Franklin Raines-- have done so.  

If Standard and Poors gets harpooned for a few billion dollars, then Moody's and Fitch would also probably be caught in the nets of Justice.  Let's see if some cosmetic accountability is better than none. 

Markets Continue Their Economic Disconnect

It's always nice to look at a daily portfolio update and see the equities portion of a portfolio going up, but I've never found it comforting when I can't put a finger on why.

Unfortunately most of the economic talking heads commentaries are just political propaganda in a poor disguise.  Paul Krugman: enough said.

Jeffries Economic Forecasting group, headed up by Ward McCarthy, has consistently tracked the fundamentally weak numbers from the labor market.  The divergence between payrolls data and the establishment survey has always been a statistical feature for analysts to deal with, but the current divergence is striking.

As JEF notes in their current bulletin, the establishment survey shows that since the recovery's start in the first quarter of 2010 , the private sector has added 6.11 million jobs, with public sector jobs shrinking net by 610 thousand, for a net jobs addition of 5.5 million.  This sounds good, but the household survey is less encouraging.

The bottom line is that 8,786,000 jobs were lost during the horrific financial downturn, and 3,297,000 more jobs have to be added before the economy gets back to where it was pre-crisis, never mind employing new or returning labor force entrants.  Movements in the unemployment rate, as the authors point out, are dominated by changes in the participation rate, which is down to 63.6% versus 66% at the start of the recession.

What about the rising equity markets, you say?  Surely, they are discounting higher expected streams of corporate profits from a stealth, but improving recovery.  Look at the housing sector.

David Rosenberg, the Chief Economic Strategist for Canadian firm Gluskin Sheff has an illuminating current presentation, which could be called "bearish" in this ebullient market.  I found an older version of it, with the same essence, on Business Insider. This particular slide shows the sharp upticks in the U.S. stock market have coincided with the announcements of  QE1, QE2, and Operation Twist.  The search for fundamental economic underpinning goes on.

Meanwhile, the distortions for business decision making caused by the unconventional monetary policy continue apace.  Jeffries notes the "insatiable" investor demand for yield: Mohawk Industries priced a ten year offering at a paltry 30 basis points over Treasuries.  Mohawk is a split-rated (Ba1/BBB-) issuer with a cyclical business exposed to residential construction and remodeling.  But, the "good news" about housing is old news and surely should have been discounted.  Mohawk is not a strong issuer, which is what a 30 basis point spread would seem to suggest, but this is a desperate investor market.

The Jeffries team also notes the weak bidding for Treasuries, apart from the Fed. As they say, "...both the price action and customer flow at the long end are troubling...The long end is effectively being propped up by Fed purchases."  No good fundamentals here either.

Finally, remember those corporate coffers filled with cash to invest in business expansion?  Large chunks went to special dividends and irrational share buybacks.  Today, we're told that the distorted yield curve from the Fed's policies is forcing corporations like Ford to spend $5 billion for this year's contribution to its corporate pension funds.

As we begin the week, let's hope that the markets re-equilibrate.  In so doing, perhaps they can send a signal to Washington--including the Fed--that feel good asset markets are not a drug of choice for a sputtering economy.