IBM CEO's Email: Lots More in Common With HP

When we compared the quarterly results of HP and IBM exactly one year ago, we noted,

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

In their most recent earnings call, HP CEO Meg Whitman noted the importance of having a team with the right people, in the right place and with the right attitude.  Yesterday, IBM CEO Virginia Rometty announced a reconstitution of the growth markets team at IBM, tasking sales leader Bruno DiLeo  "...to reassemble the team that used to run the growth markets unit, and he will take over responsibility for running the group. Under Mr. Di Leo, IBM's growth markets unit saw a strong run, often generating double-digit revenue growth. The unit was established under Di Leo in 2008 and he ran it until early 2012." 

In passing, I would say that reconstituting a sales team from a few years ago isn't automatically a winning strategy. Five years ago, they may have been the right players in the right place; some of being in the right place at the right time is just LUCK.  They may have been average players entering the business at the inflection of the down cycle, riding the upswing. If they have the right attitude, it has to be that the wind is now in their faces, but they know that they can prevail. Let's hope the move bears fruit. 

Mr. DiLeo's name was mentioned by the IBM CFO in his responses to a question in this week's earnings conference call.  He previewed the culture of performance remarks today when he noted IBM's substantially reduced quarterly incentive payments.  So, really despite the brave face the CFO put on at the beginning of yesterday's conference call, he had to know that it really was a disappointing quarter, with poor execution.

Going back to the 2015 Road Map slides, we see that from the 2010 baseline, the company projects top line revenue growth of about 5%, made up of 2% growth in the core company, excluding divestitures; about 1% from shifting to smaller, but faster growing businesses; and, 2% revenue growth contribution from acquisitions. Now, two years from the End of the Road, revenue growth looks really problematical.  

Bouncing to HP CEO Meg Whitman's continued reference to "GDP like" growth rates, we see that theme in the IBM Road Map projections.  The IBM core businesses are projected to grow at about 3%, composed of 2% organic and a 1% benefit from mix.  Maybe this is the face of our mature technology companies for a while.  Can it be true?

Looking at the at least $20 non-GAAP EPS in $2015, the revenue growth shortfall over the past six quarters compromises both the revenue contribution, but it has a greater effect on the enterprise productivity and on the margin mix contribution.  The contribution from share repurchases in the most recent quarter was a higher contribution than the assumed average from 2010-2015.  That can reverse, to be sure, but the "execution." a.k.a. revenue growth has to turn around. 

The Road Map assumes, on average, 11% a year in constant currency growth contribution from IBM's "growth markets," which means non-North America and developed Europe.  It won't be easy.

Looking back at the whole market this week, it raises a point that appears at the head of this blog post. Technicians used to say that a healthy market "climbs a wall of worry." This far into our so-called, economic recovery, organic revenue growth has been lacking across the board for seasoned, large public companies, no matter what the sector. 

• IBM third quarter revenue of $23.7 billion is down 2% in constant currency;
• Industrial bellwether G.E.'s revenue of $35.7 billion down 1.5%.
• Goldman Sachs reports revenue of $6.7 billion, down 20% yr/yr;
• Wells Fargo revenues decline 3.5%, yr/yr;
• JP Morgan Chase revenues decline 8.1% yr/yr;

There has been some good news as from Google and eBay, but the latter sports a high relative multiple.  The market seems to be trading as a bet on Washington histrionics, but investors' companies seem to be reporting challenging environments across their markets.  European stocks have been touted by lots of money managers and have been bought extensively, despite issues shoved under the rug at the big banks and top line challenges at the larger European non-financial companies.  I don't know what it all means, but it certainly doesn't feel like an environment for hitting new highs, but there it is. 

IBM's 3rd Quarter Report: Issues Outweigh the Financial Engineering

Reading up on IBM's recent history, I was genuinely surprised to see the lack of significant revenue growth since 2008; I know we've had a tech cycle on top of a recession,but still this is Big Blue.  This company likes financial engineering, befitting a company founded by engineers.  According to Forbes, Warren Buffett owns about 6% of IBM, comprising about 19% of the Berkshire equity portfolio.

Mr. Buffett likes company management, its levered return on equity, and the large return of cash to shareholders through buybacks and dividends. The relatively flattish share price alongside the continuing buybacks allows Berkshire to wind up owning a proportionately larger share of the company over time. In many ways, this is the dream profile for the ultimate value investor.

Going into the call, it struck me that HP, Microsoft, IBM and Cisco, despite the varied regard in which the companies and management are held by investors,  all share the same problems.  They have all built very large, profitable businesses selling hardware, associated middleware, application software, consulting and enterprise management services to large corporate customers.  Now, everyone agrees that what buyers purchase and how they pay for it, will be rapidly changing.  So, the common challenge is to turn these aircraft carriers around on the high seas.  As their legacy businesses decline, they have to manage a transition to an environment that won't require or favor aircraft carrier organizations in the future.  They're all in the same boat, which I guess I didn't realize.

The third quarter 2013 conference call was led by a very fast talking, matter-of-fact CFO who dutifully read the results, which he characterized as representing solid accomplishments.  There were some, but overall this quarterly report, taken in the context of no revenue growth from 2008-2012, should have been a major disappointment to management.  The financial engineering that permeated the GAAP results, on top of of significant non-GAAP adjustments, made for a very low "quality of earnings."

Consolidated revenues of $23.7 billion in the third quarter, declined 2 percent yr/yr on a constant currency ("c.c.") basis.  59% of revenues came from Global Technology Services ($9.5 bn) and Global Business Services ($4.6 bn).  These businesses were the bright spots in the quarter, which we'll see later.  The Systems and Technology group revenues of $3.2 bn declined 16 percent yr/yr, in c.c. More on this later too.

GAAP gross profit was $11, 380 million, but with $102 million in adjustments for acquisitions and $154 million in adjustments for pension plan investment assumptions, transition expenses, and plan terminations, non-GAAP adjusted operating gross profit was $11, 636 million, or a very healthy gross margin rate of 49.1 percent. The rate increased one hundred basis points, yr/yr, due to margin expansion in the services businesses (against easy comparisons) and to a better mix of software sales, due a 2 percent c.c. increase in software and to the double digit decline in hardware sales.

GAAP total operating expenses were $6,567 million in the quarter, but after adjusting for acquisitions and pension expenses, they were reduced to $6,352 million, on a non-GAAP basis.  GAAP pre-tax income of $4,812 million, after acquisition adjustments of $214 million and pension expense adjustments of $257 million, translated to $5,284 million of non-GAAP, pre-tax income.

The GAAP tax rate for the quarter was a financially engineered 16 percent, down 860 basis points over the prior year quarter.  Wow!

Diluted EPS for the third quarter of 2013 were $3.68, on a GAAP basis, compared to $3.33 in the prior-year quarter, on the same basis, an increase of 10.5 percent.  This was characterized as a solid performance, but it was really financial engineering.

The company's supplementary slides had a good reconciliation bridge from last year's third quarter diluted EPS to the 2013 year level: $3.33  was reduced by ($0.14) due to the lack of revenue growth, while margin expansion in the services businesses contributed $0.33 per share yr/yr.  The effect of share repurchases in the quarter added $0.16 per share on a yr/yr basis.  All this yields the current year's $3.68 per share. Note that the tax rate effect wasn't explicitly called out.

54 percent of the yr/yr improvement came from the margin expansion and 5% sales expansion in Global Business Services, while 46% of the yr/yr improvement came from the effect of share repurchases.  One could characterize this as a 'balanced scorecard' between operations and financial balance sheet management, but given the history of recent years and quarters, I don't think this is justified.

Anticipating the forthcoming questions about execution, the CFO mentioned the culture of performance and accountability in IBM; he noted that quarterly incentive payments declined by $177 million (if I heard this right) year-over-year to affirm the comment.  Of course, it's not clear what this means: quarterly bonuses or reduced sales force commissions which would automatically follow from lower sales, or both.  He didn't put the comment out clearly or with much conviction.

Regionally, sales in the Americas were $10.3 billion, flat on a c.c. yr/yr.  So, Big Blue or no, the IT spending cycle is stuck in neutral for all the players.  EMEA sales of $7.3 billion were down 2 percent in c.c.  Asia-Pacific sales of $5.5 billion declined 4 percent on a c.c. basis.  Together these regions account for 97% of consolidated revenue.  The BRICs amount for the remaining 3 percent. so for all the commercials about a globally smarter planet, virtually all of IBM's sales really occur in traditional markets, not a bad thing but different from the commercials.

The good questions from analysts centered on the same issues that we noted at the beginning of this post. If I can paraphrase Toni Sacconaghi of Sanford Bernstein, he said something like the following. " I want to step back a bit from the current quarter. IBM has reported negative revenue growth for the past six or seven quarters.  Without the tax rate benefit in the current quarter, this quarter would have been considered a 'miss.' What has changed at IBM, and should we think about IBM in a different way going forward?  Is this a company that reports no growth on the topline and reports less than double digit earnings growth on the bottom line?"  Questions from Goldman Sachs, Stiefel Nicholas, and Barclays were basically around the same point, namely "What does the company model look like in the future? "

For the much heralded "Road Map," the question was how to get from here, about $16 in EPS to $20 in two years.

The CFO's responses, sad to say, generally evaded the core question.  I think that he himself was thinking aloud through the questions, which is amazing, since they are the critical issues that he must have briefed about beforehand.

There was a reflection about IBM's China business that was said to be about 5 percent of IBM's revenue, which is a bit inconsistent with the geographic presentation of sales, but it could be rounding. Of this, forty percent was in hardware which declined precipitously due to the country's slowing of outside procurement as it develops a new five year plan, slated for completion in November 2013.  The CFO opined that once the new plan was published, business should return to normal in the first quarter of 2014.  Talk about rose colored glasses!  Chinese global enterprises like Lenovo, Huawei and others are integral parts of the economic plan since, in some cases the government itself is a large stakeholder.  Their designs, like IBM's are global, and to think that a US company will be able to continue with business as usual under a different Chinese economic worldview may be ill conceived.

An analyst noted that achieving the Road Map's $20 EPS would require 12 percent yr/yr earnings growth in 2014 and 2015.  What is required for this kind of acceleration?  The CFO said that Systems and Technology would have to stabilize its level of profitability compared to 2013.  To achieve this minimalist goal, he said, that the STG would have to successfully introduce new products that are planned for launch. Services should minimally require low single digit growth, although it wasn't clear what these businesses would look like ex-planned divestitures. The cloud businesses, just like HP, will have to grow at double digit rates, but not all of this will be incremental, but it should be more profitable. If I were building a model with what little I know, I would have to do a lot of hand waving to get my desired end product of $20 in earnings.

Somewhere in the end of the question period, the CFO's position changed and he said that the quarter had been challenging or disappointing, I don't recall his exact language.  Finally, this was an honest reaction. Judging from the stock trading down six percent right after the call, others agreed.

With a consolidated debt/capitalization of 64 percent, and a non-financial debt/capitalization of 39%, IBM has a strong balance sheet.  It did not make an egregiously bad large acquisition like HP did with Autonomy. It should be able to plug in several smaller, tuck-in acquisitions to help its cloud efforts.  The four horsemen will be trampling each other in the field to overpay for innovative, niche companies.  Given their lackluster revenue growth and their changing markets, they probably have little choice.

The question of "execution" is referred to often in HP CEO Meg Whitman's remarks.  Clearly, this has been a sore point too for IBM, but their stock of goodwill with the Street has insulated them from more strident choruses.  Their multiple, highly compensated sales forces and distribution channels probably need to be rationalized too over time.  Unfortunately for shareholder most of this will be under the covers.  If the customer is changing, and their budgets and desired ways of using technology are changing, then it follows that corporate go-to-market organizations will have to change with them.

Feds Continue To Pick the Pockets of JPM Shareholders

Going back to JP Morgan's own internal report on the "London Whale," everything is there for an interested party to see. The need to fix the way JPM goes about its businesses was lost in a referendum on CEO Jamie Dimon keeping his Chairman of the Board position. Now as the Feds grab another $11 billion from the shareholders, it is once again open season on a celebrity bank CEO.  This is ridiculous and more befitting a reality television show than talking about the management of one of our largest banks.

Let's try to put some things in context.

Over the past five years, eyeballing raw charts from Schwab, JP Morgan's stock is up about 30%, which looks slightly better than Wells Fargo's rise of about 23%.  The big losers are Bank of America (-40%) and Citigroup (-70%).  Here's what Andew Ross Sorkin wrote in the print edition of the New York Times,

"When I called Dennis Kelleher, president of Better Markets, a nonprofit Wall Street watchdog (he was playing golf when I reached him), he put it this way: "By any objective measure, Jamie Dimon should be fired. The compliance failures are egregious and systemic."   

What objective measures are those?  Everyone of the big four banks are digging out from under the mortgage mess, and if WFC is now considered a darling of the sector, JPM's performance has been on a par or better.  This is a ridiculous suggestion, and shareholders see it differently.

However, the age old question about having a global investment bank together with a global commercial bank and a global asset manager is an appropriate question to ask.  Not necessarily because of "systemic risk," since nobody can really define what this means, but because the cultures of these businesses are distinctly different and they are operationally impossible to manage effectively together.  [on the issue of not being able to define systemic risk, see NBER  working paper 185 (2012) from Nobel Laureate economist Lars Peter Hansen].   The London Whale report makes it clear that layers of executives and multiple complex regulatory schemes cannot inoculate shareholders from outsize trading losses.  It's happened in the past, from the beginning of mortgage backed asset trading, and it will happen again in some market.

What's to be done?  Split up commercial banking and investment banking, at a minimum.  However, the Volcker Rule is eons from implementation, so this is tilting at windmills.  It is interesting to note that Warren Buffett likes commercial banking and asset management, and he owns both these businesses through his investment in Wells Fargo.  He also likes global investment banking because of his investment in Goldman Sachs.  He could have bought a financial supermarket through Citigroup, Bank of America, or JP Morgan Chase, but he didn't.  Instead, he bought what he regarded as best in breed for each business in the public market.  JP Morgan's board should think about this, after all there's always something to be learned from Mr. Buffett's investment behavior.



For JP Morgan shareholders, they should think about a few things:

• Strengthening the board and making it more than a rubber stamp.  Bring some people in to help in the real areas of weakness, like risk management. Comments about the board's failure to monitor their own systems of internal control and to align compensations structures with governance are right on the money.  What's in place for a company of this size and complexity has been shown to be woefully inadequate. 
• Think about the continuing legal settlements and the implications for future liability.  $11 billion for acquired mortgages in a shotgun acquisition at the behest of the Feds themselves?  How could the board have signed off on this?   Bank of America CEO Brian Moynihan seems to have a better handle on managing this issue than does JP Morgan; have a board member give him a call and compare notes. 
• Look at the whole mortgage business itself.  The originate-to-distribute model and the structure of MBS deals needs to be reset.  Wells Fargo seems to be tuning down its mortgage engine.  The servicers effectively hung their clients out to dry and have escaped unfazed.  Does the board understand how this business operates?  
• Assign a team from the CFO's office to help the board manage the legal bills.  An $8 billion quarterly bill?  I used a blended bill rate of $1,000 an hour, assumed minimal sleep for all, and the number of people involved in a quarter is nonsensical.  Next time, admit nothing, put up no resistance, and offer to pay $8 billion on the spot; you're $3 billion to the better and the Feds are better off, since their costs are largely fixed. 
• Pick a lead director to interact with the CEO on a weekly basis.  This is to make sure that he has someone to talk to besides his self-interested lieutenants, who clearly let him down during the trading crisis.
• Think about a different corporate structure, portfolio and business model for JPM.  Value is being destroyed on a large scale with the current model. 

HP Analyst Day 2013: Sober Optimism

HP's 2013 Analyst Day 2013 disappointed the worst skeptics, including those who boldly called for the stock to move to the mid-teens. Hopefully, that analyst's research director is asking some tough questions about the analyst methodology and model.  It was a solid presentation that raised as many questions as it answered. The management team's presentations were well drilled, and everyone hewed to the CEO's key themes.

First, the CEO quoted a statistic about the amount of information that mankind created since the primordial ooze until 2000, which I frankly don't remember; today, that amount of raw data is produced in one year. This theme was echoed by other executives, including by George Khadifa who heads HP's Software businesses. The context here would be that corporations need to store, protect, analyze and extract value from data mountains that are running on IT infrastructures patched together from the sixties through the eighties.

Within this lies the second theme, namely that IT is being reinvented in its mission, strategic importance, and in the way customers use it, pay for it, and in the way they select partners.  Again, the "new IT" theme was consistently echoed by all the executive presenters.  This all seems eminently plausible.

Meg Whitman's Presentation

In this five year turnaround, the first year was spent diagnosing the patient and building the foundation for the turnaround. After that, her focus was on fixing and rebuilding the company, especially the executive team. She characterized a good team as having the "right people in the right places with the right attitudes."  That's an interesting triad, but it doesn't mention the right incentives, which are especially important in a large, sprawling organization like HP.  The good news is that the CEO said that the current group of executives are a team, for the first time, and it is made up of the right players.  That is no mean accomplishment and would seem to bode well for the future.

Meg Whitman said that FCF of $7 billion through nine months of FY13 and net debt reduction of $8 billion both exceeded the guidance ranges provided at the Analyst Day one year ago.  The management team had done all they could to achieve the corporate financial goals, and to exceed some; she was happy with the performance, but she was now looking forward into the back half of the turnaround.

The CEO repeatedly talked about sales forces and their interactions with their customers.  She has formed her opinions from, among other things, personally meeting with 1,000 major customers of HP,  Overall the sales teams lacked focus, metrics, and the technology infrastructure to sell effectively to their corporate customers and partners.  Increasing the quality of HP's interactions with its customers was overall the number one goal for everyone in the corporate leadership down through the next level of executive client-facing management.

She told a story about being with a top tier corporate IT buyer who said that she told her HP leader about some IT problems for which she was seeking a solution.  The HP account leader said that she would go back to corporate and get some ideas.  Before HP responded, the customer told the CEO that she had already received emails from two competitors asking to set up meetings with their senior technical people to talk about solutions.  It was a small story, but it seemed to speak volumes about the inertia and bureaucracy within HP.

Execution, particularly in sales, both growing within accounts, and quickening new product introductions will be critical to fulfilling the shareholder value part of the turnaround.

The other big, recurring theme echoed by all the executives was that HP's future was going to built around four areas: Cloud, Security, Big Data, and Mobility.  She felt that by offering devices, infrastructure, software and services HP was one of the very few players that could provide the new IT buyer with the whole spectrum of products, tools and services to help their businesses.

The CEO reviewed the major businesses. Enterprise Services, a $17.5 billion business (based on nine months, YTD), accounts for 21% of the YTD revenues but only 5% of the non-GAAP operating income. Whitman cited the inconsistent leadership, strategy, lack of EDS integration, and inadequate internal systems as the biggest reasons for its historically poor performance.  This business needs some portfolio pruning, in my opinion, but the CEO said that there would be no major restructurings in fiscal 2014.  The segment's non-GAAP operating margin was said to be at the high end of the outlook given at last year's meeting, but that doesn't change the fact that this is an albatross that needs to take flight.  It clearly has the CEO's attention.

Whitman cited a pretty extensive list of new leadership within Enterprise Services, including executive promoted from within and new hires from Bain, Accenture, Microsoft, and Elastic Intelligence/BMC.  The leadership group has pretty easy comps to have a strong 2014, let's hope that they get there.

Turning to the Enterprise Group, the CEO noted this is the group that this groups focus is to exploit the industry trend and customer need to build and support a converged infrastructure driven by servers which are increasing dramatically in power, with smaller profiles and lower power consumption.  The Enterprise Group comes to the customer with products like the Moonshot server line, 3PAR storage solutions, networking, security, and data center management tools. Instead of selling a grab bag of discrete products, HP has reset their offerings into a platform called HAVEn for analytics.  The two different capabilities are provided by Vertica for structured data and by Autonomy for unstructured data.  For the nine months of the current fiscal year, Enterprise Group revenues are about $20 billion, with non-GAAP operating income of $2.8 billion.  Enterprise Services, at some point after the ship is righted and the portfolio pruned, should probably be integrated into the Enterprise Group.

Talking about the competitive landscape, Whitman noted the growing population of single technology startups, along with the well known established players.  Partners like Microsoft and Intel are now competitors both on devices, servers and services.  Although she "likes" the assets at HP, she again mentioned the word "execution," which she said will determine HP's degree of success in monetizing those assets. She again reiterated the point that revenue opportunities were being missed at existing large accounts and with partners.  Some of the customer feedback she received is that HP isn't attentive to the customer's thinking and slow to respond.

The response has been to arm the sales organizations with better tools, including Salesforce and Workday. Company-wide, everyone has a Top 40 pairing of opportunities by country, a Top 30 desired innovations for 2014, and a Top 15 growth markets in IT.  All prospecting and market development work, whatever the business segment, will work of the same playbook, and these are expected to have the most financial impact on the CFOs goals.

George Khadifa's presentation on Software was a lot more sober and a little less energetic than the one he did upon joining last year.  It is about a $4 billion on an annual basis this fiscal year. IT operations management is about 39% of the Software segment, applications delivery management about 22%, Autonomy about 23%, Security about 15%, while Vertica is about 1%. 51% of their business is built around software that supports and maintains IT infrastructure: it is recurring revenue. He characterized HP as a large SaaS player, noting that their business is larger than those of Workday and Splunk.

It sounds as if he is quite excited by Vertica, but it is tiny.  It seems that Khadifa has his arms around Autonomy, in terms of getting them to focus their sales and product development efforts around fitting into the HAVEn platform instead of selling the next personal innovation of an engineer.  Khadifa talked more like a corporate insider this time, and he seemed a bit weary from all the infighting and pruning he probably has to do to get this business as a real growth engine, given its relatively small size.  I assume that Khadifa continues to report to the CEO as was announced at last year's Analyst Day.

I continue to believe that Meg Whitman needs more support around her if she isn't going to burn out on this turnaround.  With the repeated reference to execution and the mediocre performance of sales teams, that's too much micro work to land on the CEO's desk, especially if she continues to interact with customers, partners, investors and the board.  A stronger board could provide some counsel and support here, notwithstanding the two new members who are good for the long-term direction.

Overall, she describes HP as growing at GDP rates.  Assuming little inflation, that could be 2-3%.  Lest you think that's pessimistic, she also made repeated references to a balancing act of managing declining or stagnant business lines while feeding and investing in in the future growth drivers.  That is very difficult for the managers of these empires to carry out, unless they think like a CFO or CEO.  So again, if this lands on the CEO's desk, this balancing act of portfolio unwinding and growing is not easy at this scale, espcecially with the business segments being more inter-connected than discrete.  

The research and development budget will be about $3 billion next year.  There will be lots of back office upgrading of systems to manage the diverse portfolio, and these kinds of expenditures were cut off during the Hurd tenure.

Getting back to the GDP-like growth concept for the HP top line, the CEO said that this should be consistent with a 7-9% operating margin and an ROIC of 15-25%.  With limited information and not a lot of effort, it's hard to see how one gets there with the current portfolio.

According to the slides from the CFO's presentation, Printing and the Enterprise Group together comprised  45% of the YTD revenue of $83.2 billion, and 77% of the non-GAAP operating profits.  Enterprise Services and Personal Systems together, account for 49% of revenue and a paltry 14% of operating profit. Software is very profitable but only about 3% of revenue.

The CFO noted that the reduction in force announced over a year ago was stated as being from 29,000 employees plus or minus 15%; the final RIF will be at the upper end of the range.  To date, 22,000 employees have left the company, worldwide.  2014 earnings will get an incremental $1.1 billion of benefit compared to fiscal 2013.

FCF for 2014 is projected at $6-6.5 billion, down from the nine-month pace of the current fiscal year.Earnings per share were projected in the $3.55-$3.75 range.

So the the stock appears to be selling at 6-7x its forward, adjusted EPS level, which is certainly distressed.  The company could just continue to do what it said, and it could show significant gains from multiple expansion alone.  A distressed P/E for tech companies at similar turning points would have been 10-11x.

The consensus which seems to have been a great guide for contrary action on this stock, is Neutral or Hold. I do wonder about the continuing focus on returning 50% or better of the FCF to shareholders through dividends and buy backs. Now that it's clear HP is not a distressed investment, why continue to act as if it's in liquidation?  If there are investments to be made in 64% of the revenue that can be fed by businesses that generate 36% of the operating profit and are stagnant, why not invest what's needed to get out of the gate faster?  Make the shareholder cash return a true residual.  Invest in your growth, unless you really don't have clear projects or you don't believe in them.  It may be splitting hairs, but I think not.

Whether one believes it or not, it is easier to understand what this company is doing and where it's trying to go than it is for that giant ball of yarn in Redmond.  Congrats to HP for trying to be transparent without being blustery or self-congratulatory, like people in blue shirts at Microsoft.

The IMF Pulls the Rug from Under the Greek Government

I thought that it would take longer than a day after yesterday's post for the IMF to show its fecklessness as a global economic institution, but here it is from the Wall Street Journal. 

The Greek government, based on a projection from those clueless prognosticators at the IMF, will only hit a 2014 primary budget surplus of 1.1% of GDP compared to the 1.5% contained in the terms of the first bailout.  40 basis points projected difference and the Greek government and people will be thrown to the wolves and not receive a next round of funds from the troika, which in turn will freeze any other creditors from acting also.  Meanwhile "negotiations" with the troika over how to solve this problem will begin in the next few weeks.  

The Greek government has done more than any the French or U.S. governments have ever done: the Greeks have actually cut wages and spending and decreased the primary deficit in the here and now, not at some future time.  Addressing the collapse in tax revenue collections and longer term issues of economic and administrative reform haven't gone as well as could be hoped, but surely none of the core EU countries can point to the Greeks and say, "Let's show you how we slashed our central government budget and reformed our economies in two years."  

The Greeks are being very circumspect in their statements, but their frustration is very clear in the short quotes reported in the Journal. 

“The Greek government does not comment on reports from international organizations like the International Monetary Fund,” it said, adding that it refrained from commenting “even when this organization (the IMF) accepted [it made] wrong assumptions and wrong estimates in the drafting of the first Economic Policy Program for our country.”  Let's remember that the Managing Director of the IMF admitted they "had no clue" that economic fundamentals in Greece would deteriorate so quickly after the first bailout.

Yet, the Greek government committed itself to the austerity program and suggests that it might consider more measures, even with likelihood that the IMF's 2014 forecasts for the EU will prove to be too optimistic.  

What this set of announcements does is to raise the specter of another Franco-German confrontation about solutions to the Greek debt crisis, casting the Germans again as the bad actors for not agreeing to have their taxpayers contribute to the "solution." Here we go again. 

Revisiting the Euro and the Grexit

Less than a year ago, we expressed our doubts about the scenarios for Greek austerity.   We said, "It's hard to see a scenario continuing where the Greek government keeps wearing sackcloth and ashes, begging for more relief.  They can never achieve the 4.5% GDP target even in 2016.  What is the point of this two year long multinational charade?"

Now we know that the Directors at the International Monetary Fund, when they implemented the Greek bailout in May 2010 knew that it was a charade, based on minutes of meetings viewed by the New York Times.  According to the Times, one-third of the forty voting Directors worried about the "immense risks" of the bailout, and the consensus was that it would not be feasible without demanding concessions from the creditors.  This demand was never put on the table.  Why?

French banks, like BNP and SocGen, and German banks like DB and Commerzbank were among the largest private creditors to Greece and didn't want to take the balance sheet hits at a time when capital adequacy and the need for bigger equity cushions might be demanded of the banks.

So, Dominique Strauss-Kahn opined, according to the Times, that there was "no doubt" that the Greek bailout would succeed.  He was not available for comment. Christine Lagarde, the IMF's Managing Director since 2011, had her eyes on that prize and needed to have a public success, even if was doomed to fail. When asked about the failure today she notes, "We had no clue that the overall economic situation was going to deteriorate as fast as it did."  It's nice to admit that you were clueless, but it's also hard to believe.

The Greek GDP has contracted by 20% since 2007, according to the Economist.  The austerity programs took the primary budget deficit (w/o interest payments) from 10.5% of GDP in 2009 to 1% of GDP in 2012. The revival of the economy can't come from the consumer sector, as the Greek unemployment rate of 27.2% is the highest in Europe.  Exports can't make up the difference, nor can increased direct private investment because of an antiquated Greek legal system that doesn't offer adequate protections.  The Greek bureaucratic logjams in the ports has been relieved, but it's still not on a par with those of the core countries.

As reported in the Wall Street Journal, Citigroup's economic forecasts for Greece are disheartening, and on another planet from those of the IMF, the ECB and the EC.  Citigroup sees the Greek GDP contracting by 11.8% in 2014.  They may be directionally correct, but let's hope that they are being too pessimistic.  There will be political blood in the streets under this scenario.

What are some of the reality bytes from all this?

• The European monetary system still has fundamental design and execution flaws that make it unstable in most environments;
• It offers peripheral members few real benefits except access to easy credit; 
• Unless the peripheral countries undertake real economic reforms, the austerity medicine may make the patient better, if it hasn't killed him first;
• French, European and Italian banks need to take their medicine and acknowledge the diminished economic values of sovereign debt on their balance sheets;
• The continuing struggle for EU power between France and Germany is very analogous to the struggle between our two sides in Congress.  Despite all the nice rhetoric and the ECB posturing, their divergent interests still limit the effectiveness of the monetary union. 

Checking In With Tech's Four Horsemen: HP

Let's recap in broad strokes how we got were we are.  Meg Whitman takes over as CEO, gets a brief honeymoon.  She eventually produces not only a clear, new strategic plan and resets expectations for a multiyear horizon.  From the fourth quarter of 2012 until recently, the stock goes on a tear from $12ish to $27ish, before pulling back testing the $20 support level.

The initial guidance strategy, depending on your viewpoint, was to take investor expectations to the sub-basement.  Another way of looking at it would be to say that management told it "like it was."  A multi-year turnaround.  Lots of industry and macro headwinds.  Lack of innovation and commitment to deliver new products.  Sales organization problems.  Executives in the wrong spots on the roster.  And so on, and so on.

The promised staff reductions came quickly, and the ramp up of this program caught some skeptical analysts by surprise.  Along with some one-time factors, good tax planning, and cash flow management, debt was paid down faster than expected and the share repurchases continued.  What was not to like about this?

We believe that the dysfunctional culture within HP and the organizational discouragement precipitated by the reigns of the imperial and imperious Mark Hurd and the clueless Leo Apotheker have gained traction and buy-in within the rank-and-file.  The new board members, given their stature and experience would certainly not have come on ship if they didn't fully vet the longevity and outcome of the turnaround.

So, here we are, but where is that?  The consensus view of analysts for the Analyst Day outlook revisions are that the company, which has already cautioned about no 2014 revenue growth, will revise this outlook down sharply, for both the revenue and earnings lines.  In other words, "No Expectations."

Targets have been lowered, and some analysts have projected a price decline to the mid-teens, post the revised outlook.

In the meantime, the company seems to have introduced both Windows and Android tablet lines aimed at the corporate accounts.  So, their stated intention of being the best, platform-agnostic supplier of hardware, software and services to global corporate accounts seems well underway.  That's pretty encouraging.

As we've said before, there is still some significant portfolio optimization to be done, e.g. on corporate technology services.  Lowering expectations would give good cover to announce this now, but I'm not sure that it's on the radar at the moment.  Not a big deal.

Given that Dell has shot itself in the thigh with its acrimonious deal that couldn't have given its customers or employees much comfort, HP's visibility with corporate accounts should continue to increase.  That's good.

So, we definitely go into Analyst Day, with "No Expectations," which is okay, and we return to the Stones for a closing serenade,