Tuesday, June 30, 2015

The EU and Greece Share a Cup of Hemlock

Since 2012, we have written about the inevitability of the events the European union are facing today, a Greek sovereign debt default, an exit from the euro currency zone, political chaos at home, and a fundamental failure of the grand European experiment.

To reach this conclusion, no complex economic models are needed.  The design of the system and the notion of divergence, along with the history of relationships within the zone, point the way.

To be sure, along the way, there were many false dawns, as European politicians do what they do best summit meetings and consultations with smiling faces and bowed heads, walking in some countryside.  Hedge fund managers used their tools to call a bottom in bond prices and got involved.

Fast forward to today, and there are no financial markets to impose any discipline on Greece.  Hedge funds have gone home chastened with their losses, and Greek sovereign debt is owed to the IMF and to the ECB, with the biggest chunk being owed to Germany.

For all the Ph.D.s among the Greek expat intelligentsia, for all the worship of game theory and Nash equilibria, Greek politicians have gone beyond brinksmanship to simple economic lunacy.  Asking the EU to wait for a Greek national referendum was irresponsible. Greek government pensioners don't want any changes in the status quo and blame outsiders, like the IMF, for their problems.  A "No" to acceding to further fiscal discipline may be a vote against the EU, but it is also a repudiation of failed Greek political parties.  It does no one any good, except to save face for the Tsipras leadership failure.

For Germany, not how French President Hollande is no longer at the Chancellor's side, as they were inseparable a few years ago, co-leaders of the European experiment, along with the IMF, now led by a French national too.  Chancellor Merkel is now by herself forcing Greece over the cliff.  Of course, she has no real choice.

The Greek alternative to fiscal austerity has been a plan in which, for example, pension payouts were guaranteed, and a plan dependent only on revenue raising through taxes on small businesses, with no more fiscal austerity.  No Ph.D. is needed to see how this plan would turn out.  So, any rational observer has to realize that Greece is no longer serious about reforming its economy to meet substantially higher growth targets.

But, since the Maastricht Treaty is silent about unilateral exits and the mechanics thereof, a Grexit really calls into question the whole value of the euro, the ECB, the ESM, and all the bureaucratic empire that has been created in Brussels.  Which peripheral member would be the next to take bitter medicine?

Although Plato took liberties with the poisoning of Socrates, in terms of describing symptoms and a drawn out death, it probably applies well to Greece and to European Union.  If Greece takes its bitter medicine and defaults, leaving the Eurozone, there will be great economic weeping and gnashing of teeth.  But, Greece will have made Europe pay a price too, finally exposing the emptiness and futility of the eurozone as it has been laid out and administered so far.

Thursday, June 18, 2015

Satya Nadella Shuffles Executives: Microsoft Still Too Ponderous

One of our best read and most forwarded posts was about the accession of Satya Nadella to the Microsoft CEO chair, which really excited us, in the midst of all kinds of Wall Street consternation.
Perceptions about Microsoft among its customers, developers and Wall Street really picked up quickly, and the contrast with the imperial Ballmer Reign was also a refreshing change.

Microsoft continues to be a cash flow behemoth, with untold flexibility to speed up product development and to rebound from its historical behavior of misreading consumer trends and being a clumsy, heavy handed late follower.

But really, the latest executive shuffling is just the traditional reversal, which puts more and more onto the plates of two existing executives.  Here is the relevant quote from the CEO,
"To better align our capabilities and, ultimately, deliver better products and services our customers love at a more rapid pace, I have decided to organize our engineering effort into three groups that work together to deliver on our strategy and ambitions."
Delivering better products and services faster, which work together the way customers want, is something that needs to be achieved now, not ultimately. Making this change doesn't really seem to be demonstrably positive for the important goal.

Microsoft still seems like a big, ponderous organization that is hanging the hat on making the "Windows experience" available across all platforms.  That may be a noble goal, and Windows 10 seems to be generating a lot of excitement among Microsoft store employees, but so many of its features and capabilities, though a move up for Microsoft, will probably be leapfrogged by the far more consumer-aware and organizationally agile Apple.

If the culture of Microsoft is ever going to change it has to be at the layers below the EVPs and deep into the structure of the organization.  I still wonder how this can be done, and how long it will take.

Tuesday, June 16, 2015

Greek Default Without Leaving the Euro? The Wrong Question.

The Wall Street Journal online header asks this question, which John Cochrane of Chicago Booth and many others have answered, "Most definitely, yes."

However, it is the wrong question to ask. For Greece, its political leaders and the electorate have to decide about the rising costs and declining benefits of staying in the eurozone, including the never spoken about effective loss of national sovereignty and damage to the Greek democracy of being beholden to the ECB, ESM, and the IMF, all faceless bureaucrats with other agendas and different cost-benefit ratios.

Greece has lots of economic problems, one of which is the relatively small size of its export sector which has also been hurt by its growing, self-inflicted loss of manufacturing competitiveness, as pointed out in the financial press.  If Greeks are ever to turn their economy into something other than an object of derision and pity, they need to take charge of it, apart from a non-stop, weekly crisis in the world view.

Yes, that pathway will be messy and their will be prices to be paid.  However, the current situation, even with sovereign debt holders taking a haircut, won't end the problems of a "transfer union" that is the euro today.

The EU needs to look at itself, a Greek settlement with significant investor haircuts and write downs, even without a Grexit calls into question the value of the currency union in its current design.

It is not just Greece that faces a day of reckoning.

Uber Plans to Master Delivery? It Hasn't Yet Mastered Its Core Business.

The $50 billion implied valuation of Uber must have everyone scrambling to come up with a new twist on the story while putting their brains on the sideline. 

According to the Wall Street Journal, " Investors are counting on Uber to upend the delivery business much as it has for taxis.." 

The first problem is that Amazon, a public investor darling which has actually proven that it can upend and dominate traditional businesses, starting with books, has targeted rapid delivery with drones. Amazon, unlike Uber, has figured out that it's not worth using a service like this to deliver burritos.  As an investor, I wouldn't feel comfortable putting in capital to take on Amazon.

The next problem is again a limiting factor in Uber's phantasmagorical world of network effects: curb space.  In cities, like San Francisco or New York, there is no curb space, period.  Now, the Uber driver has to leave his car to pick up the burrito, during which time it may be ticketed or worse, and then do the same thing at the destination end to bring the merchandise to the customer. Spoilage and dissatisfaction, including cancelled orders, are another headache, cited in the article.

Assume that Uber wakes up and realizes there is no value-added in delivering low tickets.  Doing this kind of work isn't additive to the core business of driving customers, rather it detracts from it and really raises the stress levels and lowers the returns for its already taxed drivers.  

Even early investor, relentless cheerleader and company director Bill Gurley has trouble choking out this story.  Witness this quote, "Bill Gurley, a partner at venture-capital firm Benchmark in San Francisco and director at Uber, says he has never seen a financial projection for Uber which includes revenue from deliveries. “This company is growing faster than any company I think there’s ever been in Silicon Valley, and that’s on the core product offering,” Mr. Gurley says.

In other words, if this puffery turns out to be nothing, we don't need it to justify the valuation; never mind that other early investors are being mouthpieces now.  Signs of a market top? 

Monday, June 15, 2015

Starr CEO Greenberg Wins Against the Lawless and Discriminating Feds

The Federal Claims Court today ruled in favor of Starr International Company, the largest shareholder of AIG, against the Federal government's treatment of AIG during the "Lehman Weekend" and its unprecedented, claimed illegal extraction of equity in exchange for an $85 billion rescue loan.  No damages were awarded, and though that outcome seems inconceivable, Judge Wheeler's logic had some very weak merit.

 It is a clean, well written opinion, in which the text's many pithy sentences speak for themselves:

  • "This sizable loan would keep AIG afloat and avoid bankruptcy, but the punitive terms of the loan were unprecedented and triggered this lawsuit." 
  • "Operating as a monopolistic lender of last resort, the Board of Governors imposed a 12 percent interest rate on AIG, much higher than the 3.25 to 3.5 percent interest rates offered to other troubled financial institutions such as Citibank and Morgan Stanley. Moreover, the Board of Governors imposed a draconian requirement to take 79.9 percent equity ownership in AIG as a condition of the loan. Although it is common in corporate lending for a borrower to post its assets as collateral for a loan, here, the 79.9 percent equity taking of AIG ownership was much different. More than just collateral, the Government would retain its ownership interest in AIG even after AIG had repaid the loan. 
  • The weight of the evidence demonstrates that the Government treated AIG much more harshly than other institutions in need of financial assistance. In September 2008, AIG’s international insurance subsidiaries were thriving and profitable, but its Financial Products Division experienced a severe liquidity shortage due to the collapse of the housing market. Other major institutions, such as Morgan Stanley, Goldman Sachs, and Bank of America, encountered similar liquidity shortages. Thus, while the Government publicly singled out AIG as the poster child for causing the September 2008 economic crisis (Paulson, Tr. 1254-55), the evidence supports a conclusion that AIG actually was less responsible for the crisis than other major institutions.
Though the opinion doesn't recount the discussion, the mere association of an $85 billion loan facility to fund a relatively small Financial Products Division with an 80% stake in a holding company with extremely profitable insurance businesses defies logic; surely other arrangements for collateral pledges could have been made had the Feds decided not to put the gun to AIG's head.  

  • The Government did not demand shareholder equity, high interest rates, or voting control of any entity except AIG. Indeed, with the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75-year history of Section 13(3) of the Federal Reserve Act
The government is cited by Judge Wheeler as carefully orchestrating the taking of equity, installation of management, and overrunning of the company by its favored consultants without requiring a shareholder vote, and to maximize the benefit to AIG Financial Products Division counterparties, the taxpaying public and to the U.S. Treasury.  

On the fundamental issue of illegal extraction of value from AIG shareholders, the court found,
  • "Having considered the entire record, the Court finds in Starr’s favor on the illegal exaction claim. With the approval of the Board of Governors, the Federal Reserve Bank of New York had the authority to serve as a lender of last resort under Section 13(3) of the Federal Reserve Act in a time of “unusual and exigent circumstances,” 12 U.S.C. § 343 (2006), and to establish an interest rate “fixed with a view of accommodating commerce and business,” 12 U.S.C. § 357. However, Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consideration for the loan. Although the Bank may exercise “all powers specifically granted by the provisions of this chapter and such incidental powers as shall be necessary to carry on the business of banking within the limitations prescribed by this chapter,” 12 U.S.C. § 341, this language does not authorize the taking of equity."
Oops.  While the smart folks at the Fed and the Treasury were working hard to save us from a thirties style depression (a red herring), they did manage to violate a fundamental statute of the Federal Reserve Act in the process.  However, when an enemy with unlimited time, funds and access to the court of public opinion comes gunning for you, surrender might be the lesser of two bad alternatives, and so the AIG board capitulated based on that logic. 

  • In the end, the Achilles’ heel of Starr’s case is that, if not for the Government’s intervention, AIG would have filed for bankruptcy. In a bankruptcy proceeding, AIG’s shareholders would most likely have lost 100 percent of their stock value.
The last sentence threw me because I thought surely that the extremely profitable insurance businesses would have provided some real residual value to shareholders. However, state regulators which are charged with protecting policy holders at all costs, would have brought assets which supported those policies into their ambit through existing state insurance regulations, as well as through other protections.  

In some ways, Starr and Mr. Greenberg are to be congratulated for using their slingshot against our own rapacious, selective prosecuting, and plundering financial regulatory Goliath.  Goliath has almost finished plundering the financial services sector for cash, and as it continues to selectively apply its novel legal theories to its enemies, perhaps other victims may stop and say "Basta!"  Let's see how Met Life does.  

Friday, June 12, 2015

Twitter's Blue Bird Has the Blues

I confess that I have a Twitter account, at the suggestion of a tech industry CEO/founder friend who said it is essential to life on earth, but I also confess to not using it at all. I acknowledge that without Twitter, mainstream and cable news shows would almost certainly have less to talk about and therefore less broadcast time during which they can generate ad revenue.  They owe Twitter a debt of thanks.

I really enjoyed Twitter co-founder Biz Stone's book, "Things A Little Bird Told Me," which is about startups, a personal odyssey, the founding and internal culture of Twitter, and about his ultimate separation.  I really don't like business books, but this one rang true for me and was a fun read.

I remember from Stone's book that he was really the co-founder who interacted with the Twitter user base who, he says, effectively told the company how they wanted to use a new feature the company introduced.  There was such a community among the users, Stone, and the rest of the executive team that in the midst of one of Twitter's frequent outages, some users sent pizzas to the development team and Stone whom they all knew were pulling all-nighters to get things up and running.  When the delivery of the pizzas went momentarily unacknowledged, a big user Tweeted, "Didn't you get the pizzas?"  Such was the level of community among the corporation and the user community.

Stone goes to great lengths to say how much the 140 character limit, an inadvertent limitation caused by the early technology base, forced people to edit themselves and to be creative in how they did this.
Fast forward to today, and things seem different and exactly the same.  Instead of listening and watching how the user community deploys a new tool or feature, the corporation now uses the traditional A/B testing methodology used by direct marketers and catalogers since time immemorial.

The small, understaffed startup described in Stone's book now looks like a very bureaucratic, overstaffed, top heavy organization. It superficially seems like Google, but it seems more sclerotic.  It competes with Facebook for investors hearts, but it doesn't seem to have Facebook's culture.

Finally, executive infighting and the clash of personalities among co-founders has been going on since Biz Stone's early days.  This is exactly what the company doesn't need.

As the Wall Street Journal points out, the company seems afraid to incur the wrath of their high volume users, i.e. those who have trouble editing themselves; now the company is doing away with the 140 character limit which will encourage the fill the news feeds with endless oceans of boring and self-indulgent text.  But alienating these folks might be fine, if the company can find features and capabilities that will generate a large stream of new, active users.

This all feels so familiar, but Twitter had better rid itself of its worst cultural and organizational  practices before it becomes yesterdays news.

Thursday, June 11, 2015

Mickey Drexler's Outdated Playbook

Having been a retailing industry analyst on the equity side, I came across Mickey Drexler many times in my travels.  I know that I have visited many hundreds of stores all round the United States, looking at my companies, their competitors and emerging concepts.  I had a passion for what these businesses were doing, and the best place to learn is on the ground.  As Sam Zemerray's motto goes in "The Fish that Ate the Whale,"  "Go See for Yourself."

In Drexler's old modus operandi he and his family traveled on road trips during which he visited every store under his management umbrella, talking to store managers, coaching employees on how to restock the floor and keep displays clean, and generally introducing them to what otherwise is the remote, hierarchical, hands off management style of the typical chain.  I can speak to this from experience.

In fact, the Wall Street Journal's story on Mr. Drexler from 2010 calls him a "retail therapist," which is a clever moniker for the grinding, time intensive, heavy personal engagement style described above.  Of course, this style can't be sustained for many, many years and ultimately employees become inured to repeated CEO visits.

Subsequent to the huge success of the GAP, Mr. Drexler as CEO began a series of discussions with investors about taking the company private.  His behavior as CEO wouldn't win any corporate governance awards, to say the least.

Many fast growing retail concepts from the bygone era of the nineties floundered as their concepts stagnated, as they failed to stay ahead of emerging competition and changes in consumer demographics, income and tastes.  Abercrombie & Fitch, The Gap, and J. Crew are among the big ones.  The trends which launched these companies continued and even drew more customers into their ambits, e.g. adventure travel, classic but functional clothing and accessories, crossover between outdoor suppliers like REI and fashion, and completely new purveyors of fashion and function, like Nike and Under Armour.

All of these concepts missed the boat completely, and now Mr. Drexler has his hands all over every aspect of retail operations, including merchandising, which is where he started his career at low end department store Abraham and Strauss.  Making the success of J. Crew rely on one executive, no matter how much pixie dust he spread in the past, is foolish.

Apparel production, sales and merchandising are both commoditizing and breaking into finer and finer niches, in store and online, all the time. The field isn't just shifting, it's like trying to have an office on a water bed.

Even hot teen chains emerge and burn out faster than ever before.  I fear this playbook is badly outdated.

Sunday, June 7, 2015

Engineers Are Often Too Smart for Our Own Good

Google's venture into what are now called "autonomous cars" seems yet another example of engineers being, in their own minds, smarter than everyone else.  What problem are these really smart, Googly folks addressing?

There are so many ways to make driving safer for everyone on the road, using technologies about which so much is already known.  A meaningful example would be the issue of glare from the headlights of oncoming cars on two-way, high speed turnpikes without medians.  Tall crossover sport utility vehicles with lights hitting the corneas of most drivers in low-profile sedans is a problem I struggle with, and I see lots of drivers experiencing hesitation, momentary loss of perspective, and just plain visual fatigue.  Semi headlights on trucks are just as bad.

In earlier times, headlights used to be aimed, and annual inspections used to check that lights were aimed at the road a fixed distance ahead.  With the advent of sealed beams, there is no such thing as alignment of the lights; if the car has a certain profile, the light unit is installed and the beam goes Hera knows only where.

How about a form of smarter glass, either in windshields or in optical glass that consumers could buy at their optical store?  This isn't a multi-billion dollar fix, and its an innovation from which many kinds of innovative companies might profit.

Instead, we have a solution in search of a problem.  Lowering highway fatalities?  Lowering insurance rates?  The easier solution would be to get the 25% of motorists who are uninsured off the road, thereby reducing rates for everybody who is insured.  No research and development expense required.

Google's CEO responded to questions about this giant boondoggle by saying that companies had to invest in technologies for the "next generation."  Why not work on food replicators to end hunger?  It works on "Star Trek: Next Generation," after all.

Corporate entities are not particularly adept at making huge investments out of their main areas of expertise and developing next generation products.  Engineers are even worse than marketers and futurologists at predicting cross-generational technology, particularly in the consumer area, like cars.

Look at the Edsel.  One of the great innovative features of that car, which I saw in our neighbor's vehicle was the push button transmission, a series of large buttons with definitive clicks in a panel that resembled what one might see unlocking a bank vault.  Great concept, and seemingly much easier than a stick and even a steering wheel mounted shifter.  There were a few problems, the first being that it didn't work.  Fast forward to today, and the desire to have automatics with a feel of a stick is what people want: push buttons were something that auto engineers wanted, but the public never have.

Google should start paying dividends with their monumental free cash flow, instead of indulging their founders in corporate whimsy.

Saturday, June 6, 2015

T-Mobile and the Dish Network: Please Let It Happen!

The corporate merger dance can be a protracted one, with partners eyeing each other and making inviting gestures, before suddenly leaving the dance with another partner; or, it can be a case of eyeing each other and suddenly the suitor aggressively carries off the apple of his eye.

T-Mobile badly needs a merger partner, and more than that it BADLY needs spectrum, more towers and better service for its growing, but often poorly served customers.  Dish Network needs a merger partner, although their mercurial CEO isn't sure what he wants to merge and what industry he wants to dominate, e.g. wireless, home entertainment or content.  It has plenty of spectrum that is essentially sitting around like excess cash, it makes shareholders antsy.

Regulators, for some unknown reason want four strong wireless companies.  Right now the former Bell stepchildren, Verizon and ATT are the giants, and Sprint and T-Mobile the runts of the litter. Absorbing T-Mobile would give them a much stronger third player, and it would satisfy the long-held desire of Deutsche Telekom to divest its investment.

As a long-suffering T-Mobile customer, I am hopeful, but listening to the T-Mobile CFO talk about a potential deal or "partnership," I wonder if anything will come of this.  Watching for my text of the deal being done!