Steve Jobs: He Wasn't John The Baptist

With the recent passing of Apple CEO Steve Jobs, the financial press has gone into paroxysms of religious fervor in writing about this refreshing and iconoclastic business leader.  The blogosphere is flooded with Tweets of ecstatic reverie, calling him a "prophet."  Here is the ridiculous, pandering headine from the online Wall Street Journal:

"Steve Jobs turned Eve's apple, the symbol of fallen humankind, into a religious icon for true believers in technology. But can salvation be downloaded?" (Wall Street Journal)

The analogy with the apple in the Genesis story is sophomoric, and more fitting for the Onion than the Journal. "No," he is not a religious icon, and "No" salvation can't be downloaded.  As long as we're entertaining outlandish theories, what if the apple in Apple comes from Magritte's "Son of Man" painting that figures in "The Thomas Crown Affair?" 

A couple of things to note.  In Rakesh Khurana's book on corporate leadership, he notes that the most frequently occurring post-graduate credential among CEO's has been the MBA from the Harvard Business School.  Against that background, the story of Mr. Jobs dropping out of Reed College and taking the path less travelled to corporate leadership of an iconic company is refreshing and worthy of study. 

Talk about a diverse background!  Steve Jobs describes taking a course in calligraphy as giving him the eye and the insight to realize the importance of unique typefaces to the first Mac.  I suspect an interest in Zen informed a lot of his insights.  He helped create, was defeated by, and ultimately remade the culture of Apple, defining it through his unique, personal lens. It gives anyone interested in business a lot to think about, but it's business not messianism. 

The Big Issues for Risk Managers

AON Risk Solutions released its 2011 "Global Risk Management Survey," which covered 960 respondents worldwide, about equally divided between public and private companies.  The Top 10 Risk Issues for the managers were:

1. Economic slow down
2. Regulatory/legislative changes
3. Increasing competition
4. Damage to corporate reputation/brand
5. Business interruption
6. Failure to innovate and loss of customers
7. Failure to attract and manage talent
8. Commodity price risks
9. Technology/system failures
10. Cash flow and liquidity risk

Historically, 5,8,9, and 10  have formed the bulk of the content for a corporate risk management program, and it was probably indistinguishable from the purchase of insurance coverage and from  financial hedging, probably through the treasury function. 

The AON sample companies are 89% from the Americas and Europe.  In total, 31% of the respondents say that they have a position of Chief Risk Officer (CRO), and these tend to be regulated industries, including banks and insurance companies. 69% of the respondents have a dedicated risk management department. 

Interestingly, in Asia the #2 concern of risk managers is the attraction and retention of talent, which falls to #7 in the total survey sample.

Less than 40% of the companies responding to the survey monitor their Total Cost of Risk.  These include, according to AON's framework:

• Risk transfer costs (premiums paid for insurance coverages)
• Risk retention costs (retained risks and claims adjustments costs)
• External costs (brokers, consultants, regulatory compliance)
• Internal costs (personnel and systems)

The AON susrvey concludes that it is for companies with revenues in excess of $1 billion that a dedicated, fully integrated Enterprise-wide Risk Management system begins to make economic sense.  Smaller operations can take a holistic view through good management in the CFO/financial function. 

Much of the literature written for NACD members is written as if  ERM could apply to smaller companies, and it seems clear that this not cost effective. 

One Way Out for the Eurozone?

The capital markets have Eurozone fatigue.  Day after day, hour after hour, we await the same news: an answer is forthcoming from the next meeting of EU finance ministers.  There's a Monty Python sketch in which the characters play around with an innocent question, "How big is it?"  Well pundits at the IMF conference have suggested a rescue/bailout/fiscal equalization fund of 1.4-4.0 TRILLON euros would solve the problem.  There is no answer to "How big?"

A facility of that size is out of the realm of possibility, for a union in which the strongest member has a GDP of 2.5 trillion euros.  Eventually, Germany will have to deal with the reality that its interests diverge not only from the weaker members of the union, but from those of France as well.  Then, Merkel and Sarkozy will no longer be able to pose as figurative, "Brothers in Arms." 

Greece has announced that its austerity measures will not enable it to meet its budget targets in today's WSJ. So, really we are moving, like a slow motion train wreck, towards a default of some kind, semantically within or outside the euro.  We wrote way back in June about the likely fate of the euro and about the attractiveness of Treasuries despite all of our fiscal management issues. 

A country's exchange rate is the most effective market price for adjusting imbalances in merchandise trade and external capital  accounts.  With the euro, Greece or Italy don't  have an exchange rate for the market to devalue until their economises  adjust to a new equilibrium.  Playing with tax and fiscal policies are not primary tools for these adjustments, as Greece is finding out.  Italy is waiting in the wings, and I don't believe that the Berlusconi government would have any inclination to drive itself down a path as Greeece has done. 

Thinking back to the Lehman crisis, one of the justifications for the absurd bailout concocted by Treasury was the fact that nobody could really map out the complete counter party network for Lehman/AIG/Bear Stearns and the other SIFI's, along with the amounts at risk.  Nobody knew how bad it would get and whose hands would get blown off. So we implemented a really bad deal.

Likewise, the structure of the EU and the obligations of its members were built without contemplating the alternatives we're now facing, namely an exit from the euro.  However, if one member exits, the utility of the entire common currency mechanism is mortally wounded as an economic construct. I'm not sure anyone really knows how the default//exit scenario would play out in practice.  Markets need to adjust and move one, but that means a paralyzed Europe has to come to terms with the failure of the notion of their common currency union. 

It doesn't matter how many times the finance ministers meet and where they meet, there may only be "One Way Out."

"Ain't but one way out, baby,
  Lord, I just can't go out that door.
  Ain't but one way out baby,
  Lord, I just can't go out that door.
  'Cause there's a man down there,
  Might be your man, I just don't know."
 
  (Holland/Dozier/Holland) EMI

HP Hires Goldman: The Best Defense Is a Good Offense

HP's embattled board hired Goldman Sachs to assist it with anti-takeover defenses in wake of its unparalleled streak of value destroying activities. In a very limited sense, the board does have a duty to be prepared for the appearance of an activist investor, and so the move could be regarded as a good defense.  They have certainly hired the best to help them, but that's as far as it goes.

We wrote in our last post, "Without some fresh air in the board room, it's hard to see how HP becomes anything other than a value trap."  I really believe that the company won't be able to move forward and realize its potential without changing the way it does business both in the market and in the board room.  Putting a poison pill into place, for example, is a knee jerk, mindless alternative usually associated with companies whose fundamental options for creating value are limited.  A pill would also deter some high quality, traditional institutional investors, which are just the sort of investors the company needs now. 

The best defense can be a good offense.  In this case, the good offense would focus on fundamentals, such as definitively changing the company culture, changing the way an alternatively meddling and disengaged board works, rationalizing the company's strategy and portfolio, resetting the business model to focus on customers, raising the hurdles for returns and use of assets, and communicating in an entirely different way with stakeholders.  This is the only place where the company board and management should be focused, and not on trying to head off an activist investor.  HP is big enough that there are few activist investors who would be able to acquire a big enough stake and risk dead money while a turnaround takes place; it could happen, but it will take time, and in that time, the board and management should roll up their sleeves and focus on fixing the culture and the business model.

Hearkening back to my analyst days and thinking about Fluor's decision to put off buying HP computers for its global organization, I decided to talk to some tech repair people about what they thought of HP computers.  Several years ago, I noticed that a lot of tech savvy users carried HP laptops, in preference to Dell and IBM/Lenovo.  The latter manufacturers were classified as "junk," referring to everything from design, to component quality, to assembly and finishing.

Today, the situation seems to have reversed itself in my survey.  HP laptops and desktops were the ones marked "avoid," or "junk."  Meanwhile, Dell and Lenovo have become highly regarded for volume purchasers.  One repair tech was kind enough to take me on a tour of a desktop's guts that he had repaired.  It was a gaggle of cables, some of which were harnessed and some not.  He tried to harness a big clump of cables in the interest of allowing better air flow and accessibility for service.  Slots were poorly designed for boards and cards, which then resulted in poor fit and more heat.  The HP units look like someone built them in their garage.  Talk about fundamentals! 

If this business is to stay within the corporate portfolio, then it needs to be an industry leader, and not an object of ridicule.  This kind of turnaround requires hard work, as opposed to a press release about hiring Goldman Sachs.  Let's hope that HP gets down to business soon. 

HP Sum of Parts Valuation Is No Guide

Analysts who claim that a "sum of parts" valuation of HP at $37 per share justifies a "buy" are whistling in the wind, putting forward numbers without a reasonable basis.  Projections for sales, earnings and cash flow are all contingent on a capable management team, a motivated organization in tune with the strategic plan, and on a board that is itself of one mind and supportive of management and the plan.

As far as I can see, none of these things are in place at HP.  The new CEO comes from a consumer focused company into a technology company trying to refocus on the enterprise business, as different as night and day. She will be learning on the job. Who knows what the management team will look like after defections and reshuffling?  An organization that leaks information so consistently, thereby hurting their own share price is dysfunctional and clearly not motivated to focus on the business.

The sales teams are having their heads handed to them by customers demanding answers, and they have none because the former CEO was so absurdly out of touch. How can they maintain and grow their sales relationships? Sell the PC business: yes or no?  The new CEO has to study the issue, although she was a board member that supposedly signed off on that decision.  What if she comes to a different conclusion upon further reflection? The Autonomy deal can't be broken without major financial damage and loss of focus working on court actions.  How will that deal add value?

The same board is in place, with the same unhealthy dynamics and deeply flawed visions.  Board chair Lane's public flip flops on former CEO Apotheker don't give any comfort about temperament or judgment, and there's the continuing question about how much his position as Oracle's #2 is an asset to HP or a liability.  Oracle's poke in the eye to HP by hiring Mark Hurd was great PR grandstanding.

This kind of strategic, communications and governance debacle at HP is usually reserved for micro cap companies or for companies that are quasi-public, i.e. controlled by a family, an entity, or by an uber CEO.  For a company of HP's size, this should generate years of business and law school case studies.

Value investors looking at HP won't get an extra reward for being early, because so many of the risks are unknown at this time.  Technicals and noise trading should dominate the stock in the near term, Time is the friend of a new, fundamental investor looking at this stock.

AIG Enterprise Risk Management: Tougher Than It Sounds

             Photo credit: Philip Montgomery for the Wall Street Journal, Online Edition


AIG has a new "risk czar," Peter Hancock, an economist by training I'm happy to see, who heads up the Chartis unit charged with doing "enterprise risk management."  I have yet so to meet a public company director who can describe in concrete terms what this means for their company, and especially so for financial companies.

One of the operational problems generally, and especially for financial companies, is that risk is generated in silos.  An example of a large silo would be proprietary trading, and a sub-silo might be what's called Delta-1, where the latest rogue trader has surfaced at UBS.  Every profit center will have its own system of reporting, especially for the purposes of calculating bonuses and incentive compensation.  Lots of magic takes place when financials are rolled up for the purposes of external reporting.

Since risk is being generated in large numbers of relevant silos, how can a person at one desk look at a chart, report, or dashboard and monitor risk on an enterprise-wide basis?  I don't believe its possible for an investment bank, which is why we've had rogue traders since way in the early days of MBS trading in 1987.  Howard Rubin generated $377 million in losses which were not discovered until he left Merrill Lynch, and somebody found the unreported trade confirms in his locked desk drawer; he was banned from the industry for nine months and eventually joined Bear Stearns.  Joe Jett was another prominent "profit center" for Kidder Peabody who created some fictional profits of $350 million and paid himself a $9 million bonus before being discovered.  A Japanese trader for Royal Dutch Shell lost $1 billion in unauthorized commodity trading.  Nick Leeson was a recent example who lost $1 billion for Barings, and apparently Kweku Adoboli of UBS has hired Lesson's attorney to defend him in his court action. Sounds like a prudent move for the trader.

The point is that rogue traders are nothing new, and the ones in the news are really a subset of those who are out there and undiscovered, or who had big exposures that reversed themselves before they were found out.
Bonuses, like those that Joe Jett generated for himself, are done in the profit centers themselves and on a basis that is too fast for any effective risk management, except well after the fact.

Managers in the profit silos will complain to risk czars that rigorous systems of oversight and reporting will negatively impact their ability to recruit superstar trading talent.  Guess which side is going to win this argument?  Not somebody like the man in the picture above.

Now AIG is supposedly a simpler business than before, with the demise of their specialty financial businesses.  If this is true, and it has gone back to its traditional  insurance and reinsurance businesses, then it might be possible that a risk management system could be devised and operative.  I can't conceive of how this can be done for a traditional global investment bank.

Dodd-Frank does not give any degree of comfort. Banks will have to divest their prop trading desks, but the problem is that nobody can agree on what constitutes a prop trading desk.  Witness the confused discussion on whether or not Adoboli's Delta 1 desk constituted a prop trading operation, or one that worked on behalf of UBS clients!  The more things change, the more they remain the same.

Best Buy Gets Yellow Tagged

Best Buy shares have gone on a yellow tag sale, as their price has fallen 32% year-to-date.  There is some good news for shareholders, namely in the current maturity cycle for their stores and without any significant plans to expand retail footage, the stores are throwing off cash.  Sales growth, however, is another story.

I've followed this stock from its early days when it was forecast by Wall Street to expire under pressure from the now defunct Circuit City.  I made money for my customers several times during the stock's short cycles.  However, in recent years, it has me scratching my head.

I can't answer one basic question: "Why would I get in a car and drive into a Best Buy?"  Music, which was a great traffic draw and a source of impulse purchases, has come and gone because of the revolution in how music is sold and enjoyed.  The appliance section, despite all the corporate best intentions, still seems out of place in the store and uninviting.  Sears is still the top of mind destination store for the top brands and Kenmore.

The service experience, which has had its ups and downs, is on a down cycle.  In some stores, the only person who ever says anything to the customer is the security person at the door who says, "Goodbye."

Televisions have been commoditized and subject to everyday discounts and sales by players from Target and Costco to Office Depot and Kmart/Sears.  The Magnolia store-within-the store usually looks like tumbleweeds are going through it.  Computers are about as exciting as toasters.

Some retailer used to have an interesting tag line, "What do you want to do?"  Maybe that's the pitch for Best Buy.  Solve the customer's problem by packaging the best-in-class product and service options for, say a mid size flat screen TV with good sound that can double as a computer screen for my son's Xbox and streaming NetFlix.  Perhaps the store could even guarantee the "lowest price" on the bundle, which of course will never be put to the test.  Throw in some freebies from smaller vendor-partners looking for exposure.

The problem is two-fold: no compelling reason to go the store, and an unmemorable customer experience when you go.  Lots of stores are struggling with the first aspect, and Apple's retail stores have mastered the customer experience part.  Until these problems are worked out, the same-store sales decline, absent significant new technology introductions, will continue.