Monday, April 30, 2007

China Raises Reserve Requirements to Fight Growth

The NYT reports that China finds itself in the rather enviable position of fighting to keep its already phenomenal growth rate from becoming excessive. So for the second time in just one month, the People's Bank of China has raised the requirement for how much of the deposits kept in major banks must be held in reserve. And changing the reserve requirements is not the only tool that China has been using to slow growth. China raised interest rates three times in the last year.

The problem China faces is that even with these adjustments, growth is unlikely to slow. China has a $46 billion trade surplus that doubled since just last year. And foreign investors have been pouring money in China's currency as they speculate that the government will have to let the currency strengthen. The stock market has been exploding, rising 130% in 2006 and about 40% so far this year.

Many intelligent people the world over have come to the conclusion that China's rise as a major economic power to rival and even surpass the United States is now a given. In this environment, the huge investments in China are justified, but they have bid down the expected rate of return well below the original potential of the market. The world is facing a level of capital liquidity that is completely unparalleled in history. This liquidity is ultimately a force for good, but a panic could turn this capital influx into an exodus.

The real question that most people are probably asking themselves is: "What's wrong with an economy that grows faster than 10% a year?" The straight answer is that there is nothing magical about growing that quickly that ensures the growth is the result of speculation and not underlying macroeconomic change. But growth of this magnitude has never been sustained before in human history. Economies that have been growing significantly more slowly have been gripped by speculative bubbles that sparked worldwide financial collapse. China treats 10% as the growth rate above which it chooses to be concerned, and with good reason. China's political structure is set up in such a way that continued economic growth is critical to social stability. If the economy stopped growing or even worse began to crash, the Communist Party would face troubles from the countryside that could loosen its grip on power.

Too much growth is actually more likely to cause economic woes for China rather than too little. A speculative bubble popping is the most likely bad scenario and China's steps are a reasonable movement to prevent that. Unfortunately for China, only a slowing world economy is likely to hold back China's export driven growth and outside of the United States, the economies of the world are doing better than they have in years. For once, America's housing bust might do something good for the world economy.

Sunday, April 29, 2007

US Economic Downturn Possible, but Improbable

Reuters reports that the President of San Francisco's Federal Reserve suggested that a downturn in the US that ripples around the world is possible. Of course, she qualified that statement to make it significantly less meaningful than the article suggests. Her analysis appears to consist of noting that the US represents 25% of world production and that the US economy hasn't been doing well recently. She goes on to say that her own opinion is that growth picks up instead of slowing into a recession, but that wouldn't make for exciting headlines.

Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.

The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.

The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.

The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.

Saturday, April 28, 2007

GM Management Takes Pay Cut

Reuters reports that General Motors' CEO, CFO, and product chief have all taken significant pay cuts as GM prepares to negotiate with the United Auto Workers Union. The CEO Rick Wagoner is taking a 25% cut to his base pay rate that means his actual pay will be reduced by over $600,000. Of course, most of his compensation already comes in the form of stock options and outright stock awards.

If this gesture is at all successful at securing the wage concessions that Wagoner will seek in his negotiations with the UAW, his personal payoff looks assured. He suggests that getting "positive operating cash flow is a top priority" - what an understatement. GM has lost $12 billion in the past two years even as it has cut 34,000 workers. That GM has just lost its crown as the world's number one automaker is beside the point - the company is in a death spiral.

GM needs to negotiate massive pay cuts for its remaining workers. Now that GM has cut back on its unprofitable fleet sales, there is significantly less work being done and workers should understand that the ultimate survival of the company is at stake. Of course, if the union agrees to big pay cuts and the company is saved, the preponderance of the benefits will flow to management. Wagoner has demonstrated to presiding over one of the great industrial collapses of the age isn't going to get him fired, so he will still be around to make good on his stock options.

Workers, on the other hand, aren't exactly leaving empty-handed. While the average blue-collar worker at GM isn't rich, he isn't even close to poor either. Looking at a gold-plated pension or six-figure buyout after years of above-market wages, most workers are mourning the end of a relative free ride rather than the end of their economic lives. They haven't made out as well as management, but in a broader perspective it is remarkable that they made out so well. The average GM workers didn't arrive with significant marketable skills and didn't for the most part develop them on the job. To the extent that GM produced better outcomes for everyone associated with the company than they could have achieved anywhere else, workers owe GM a great deal.

The whole pay cut kabuki makes for fascinating brinkmanship, but GM is going to continue hemorrhaging cash until it turns out significantly better products. Toyota is hitting its stride right now, and Detroit looks set for more pain.

Friday, April 27, 2007

US Economic Growth Slows

The IHT reports that the Commerce Department's latest figures show GDP growth slowed to 1.3% in the first quarter. This slow growth is particularly annoying in light of resurgent inflation - which rose at a 4% annual rate. The Fed prefers to consider inflation figures with food and energy costs factored out, so an adjusted 2.2% rate doesn't seem likely to spawn aggressive interest rate moves. Nonetheless, despite their volatility, food and energy prices exact a real cost for the broader economy. Four dollars a gallon for gas seems a remote possibility, but $3 per gallon is much harder on economic activity than $2.25.

The culprit for slower economic growth has been the collapse of residential real estate, which fell by 17% in spite of previous declines of 18.7% and 19.8% the two quarters before. The continuing decline in real estate prices has already made housing more affordable in many of the most expensive markets in the nation, but countless mortgages are going to keep most people's current bills the same.

The weakness in the United States is already being priced into the markets. Worst-case scenarios are being floated that seemed impossible only a year ago. One Bear Stearns analyst has already raised the spectre of stagflation - the horrific combination of sustained slow growth and high inflation.

Still, no new source of a slowdown emerged in the numbers. Analysts have known about weakness in the housing sector for quite some time and energy prices have been significantly higher in the past few years. Exports continued their trend of not following a trend by declining at a 1.2% rate. This compares with an advance of 10.6% the quarter before.

Overall, the numbers suggest that the economy looked a lot like everyone already knew it looked in the broadest outlines and unambiguously weaker than expected from a shorter perspective. These numbers are quite different from last quarter's numbers, so expect a slight upward revision when the next numbers come out. But the general health of the economy is clearly much weaker than many hope for.

Interestingly, corporate profits reported on Wall Street this week don't seem to be closely tracking this slowdown. Maybe Microsoft, Apple, Google, and the others who reported this week are somehow immune, or maybe the revision will be larger than usual next quarter.

Thursday, April 26, 2007

Russia's Consumption Boom

Forbes reports that a combination of factors including a booming energy sector, low income taxes, and continuing government subsidies have resulted in dramatically increased consumption. The real wage has been growing around 10% a year, and per capita consumption has doubled in the last decade. In dollar terms, consumption grew 27% in 2006 and shows no signs of slowing. Imports have grown 30% over the same period.

Russia is still a poor nation by Western standards, but the spending spree is allowing Russians access to goods like televisions that even the poor have come to expect in the United States. One startling revelation is that the cell phone penetration rate is over 100%. This means the average Russian household has more than one cell phone. And at least one anecdotal account suggests that cell phone service is superior to Eastern Europe.

Russia's booming, consumption driven economy is a stark contrast to the slowing American consumer and China's tight-fisted legions. Russia is also experiencing comparative political stability. Although Putin's recent decision to require 50% positive news in the media is disturbing from the perspective of political freedom, his administration is wildly popular and the prospect of a revolution seems remote. The average Russian will experience a rapidly growing quality of life over the next few years, even if the price of oil were to fall back significantly.

Russia's improving prospects are reflected in the increasing interest from foreign corporations. Nestle has recently invested half a billion dollars in the country and Coca-Cola spent $600 million for Multon, a juice maker.

While rapidly rising standards of living are always something to be welcomed, Russia's recent growth will not return the nation to its previous stature. As long as the political system remains within the iron grip of Putin, the country will not receive maximal access to global financial markets. Many of the revenue streams that Russia is capitalizing on will not be replicable, either elsewhere or even in Russia ten years from now. Carbon credits derived from the economic collapse of the Soviet Union represent a one-time windfall and economies based on exporting national resources are notoriously given to corruption and free-riding.

An old joke from the end of the Soviet Union suggests that three quarters of the men who died in Russia were drunk - no matter how they died. Russia's rising standard of living is a true blessing, but as long as the deep problems illustrated by this dark humor exist the country will still have a long road to recovery.

Wednesday, April 25, 2007

The Private Equity Boom Continues

The IHT reports that private equity giant Kohlberg Kravis Roberts and an inside investor have outbid their competitors and secured Alliance Boots, Britain's largest drugstore, for $22.2 billion. This enormous price represents a 40% premium on the market price. The largest leveraged buyout ever in Britain, the purchase gives KKR control over 3100 stores.

KKR has been extremely busy this year, having spent $109 billion on three buyouts including $44 billion for TXU, a Texas power utility. Merger mania seems to have hit Wall Street in general and private equity in particular has been constantly in the news.

Analysts predict that the intense bidding over Alliance Boots, which saw KKR raise its bid three times, indicates that other British companies will soon be targeted. Retailers like Carrefour, a titan in Britain, are the subject of speculation.

The question many average investors are asking is: "What prompted this frenzy of activity?" The answer is much more complicated than any one factor, but perhaps the leading reason for the burst of activity is the surge in investment capital being put to aggressive use from major pensions and private universities. There is no global shortage of capital and savvy investors chasing alpha are becoming much more prominent.

Private equity represents the latest fad on Wall Street for creating out-sized returns. Giants like Goldman Sachs are rebuilding their operations around more aggressive use of capital in order to emulate the success of upstarts like KKR.

Private equity seems to have a particular advantage in companies under public scrutiny because executive compensation and other issues don't have to be reported like at most public corporations.

The boom shows no signs of slowing as the careful managers of private equity firms have yet to ridiculously overbid for worthless assets. But the increasing competition for companies like Alliance Boots demonstrates the declining returns that private equity will be able to squeeze out of the market.

Tuesday, April 24, 2007

Las Vegas Hotel Boom, Then Bust?

The NYT reports that Las Vegas is in the midst of an unprecedented building boom among its signature casino hotels. Las Vegas already has more hotel rooms than any other city on the planet. Fifteen of the world's twenty largest hotels are in Las Vegas, and even more remarkably, the presence of so many hotels in such a small area has not hurt occupancy rates. Magnates like Stephen Wynn can still look like financial wizards building hotels in a city with 151,000 rooms because the weekend occupancy rate pushes 95%. And last year, the weekday occupancy rate was just under 90%.

The ability of Las Vegas to fill its hotel rooms at such an astounding rate is a testament to the drawing power of gambling and entertainment. Thanks to the poker boom which has recently swept the country, gambling at casinos has achieved a new, much higher cachet. Advertising your primary product on at least 4 stations on basic cable certainly helps, but Las Vegas isn't just a one-hit wonder.

Las Vegas has packaged itself as a man-made entertainment wonder. Even people who never gamble can find plenty of low-cost, high quality shows both on and off the strip. And for the so-called whales who are willing to bet (and potentially lose) millions of dollars on a roll of the dice, there is no place like Las Vegas.

Tourists in Las Vegas dropped $15 billion last year, but the majority ($9 billion) was spent outside the casinos. And the growth rate is so strong that Las Vegas not only has another 35,000 hotel rooms on the drawing board, but a second airport is planned thirty miles outside of town to handle the immense volumes of people moving through.

Las Vegas has been super-saturated with casinos since the 1950s, but the boom continues. New investors are sparking a gamble on the condominium market as well. The luxury market is loaded with competitors in a way that no other city of the world can beat. It doesn't look like Las Vegas has room for any more growth, but its never a good idea to bet against the house.

Monday, April 23, 2007

Power Deregulation - Fact vs Failure

The AP reports that power deregulation in the 16 states that have enacted reform since the late 1990s has failed to result in lower electric rates for consumers. The piece spends significant time on an anecdotal account about the rising electricity bill of a single woman raising four developmentally challenged children on $1000 a month - with a $450 electric bill.

The absurdity of the evidence doesn't seem to occur Ryan Keith, the author of this blatant hack job. He notes that the rising cost of fuel during this period ensured that electric rates would be bound to rise. And in fact, they have risen precisely in line with the cost of generation.

But the trump card by which the deregulation of the electricity generation industry is declared an unabashed failure? The absence of competition developing outside Texas. Think about that for a minute. The reason deregulation fails to lower electric bills is that the states that enacted "reform" failed to ensure the fundamental root of deregulation - allowing free entry into the industry. Even in Texas, where the airwaves are full of competing rate plans, the rules hardly allow for full and free competition.

So what solution is proposed by deregulation antagonists? Re-regulation or state-owned utilities. Ignoring for the moment the appalling record of public power utilities - the real problem with the rate caps planned under re-regulation is that they ensure that the chronic underinvestment in power generation and transportation infrastructure that plagues America will continue.

Proponents of regulation forget that you cannot get something for nothing. Have we forgotten the electricity outage that turned off the lights for much of the northeastern United States so quickly? Officials might have tried to shift blame to the Canadians, but the truth is that the power grid is running at full capacity and its aging components aren't getting adequate maintenance.

Without competition to stay electric utilities' hands, a cost-plus culture evolves whereby the utility pays whatever it wants to get the job done and just passes the cost on - plus a small profit margin. If there is no incentive to reduce costs, innovation stagnates. Do state-owned utilities advocate peak-time pricing and real-time metering that send signals directly to consumers to reduce their use of power? Of course not, it doesn't create profits and product differentiation is meaningless to a monopolist.

Power deregulation has not been a failure, it's implementation has been. And deregulation hasn't been substantially worse than regulation in any event. The solution is to allow a truly free market, not just crawl back into the comfortable arms of monopoly.

Sunday, April 22, 2007

Reluctant Chinese Consumers

Businessweek reports that the Chinese government is concerned about the fiscal conservatism being demonstrated by its citizens. The Chinese have one of the highest savings rates in the world. Most people are socking away as much as 40% of their income each year. And the trends going forward don't look good. The share of GDP soaked up by private consumption is only 40%. This represents a fall from 48% as recently as 2000. To put this figure in perspective, US consumers spent 8 times as much on consumption goods even though there are only one-fourth as many Americans.

It might seem to some observers that saving a lot of money is really a good thing. And it certainly can be. The US savings rate has been hovering near zero and in fact gone negative for several years now. The problem is that only so much investment can be done at reasonable levels of profitability at any given time. In real terms, this means that every additional dollar saved goes into a slightly worse investment, because all the best investments get taken first. The cost of saving such a high percentage of income is ultimately personal privation. Foreign businesses have been trying to crack the China market for decades with little success. One reason is that the Chinese are simply much more price conscious than other consumers. By only purchasing a few, very low cost goods, the Chinese limit the marketplace by not rewarding manufacturers for catering to them.

The eternally optimistic in the world economic community envision a day when a great Chinese middle class finally starts spending and touches off a tremendous global bull market. And while continued economic growth on the level of 10% per annum makes such an eventuality much more likely, the sad truth is that a day like that is still far off in the future. For all the good press that China has been able to get in the media, the Chinese middle class only includes about 25 million people. Out of a total population well over 1 billion, it is clear that such a small minority is unlikely to move global markets anytime soon.

The real tragedy of weak Chinese consumer spending is that the quality of life of the average person in China is much lower than it could be. Most urban residents don't own cars and despite the best efforts of automakers, that won't be changing soon either.

The Chinese economic miracle is a wondrous thing, but it could certainly be a much more wonderful thing if it benefited the workers who have made it happen.

Saturday, April 21, 2007

The Hypocrisy of Islamic Debt

The IHT reports that Malayan Banking's first bond offer that complies with Islamic principles was a huge success. $300 million in securities were sold, but interested parties offered to buy as much as $2.4 billion.

Bonds are big business and the Islamic world is a traditionally under served market. And its not because rich Middle Eastern oil magnates haven't been offered the finest financial products conceivable. The reason is that Islam rather specifically forbids charging interest. A true believer in Islam is never going to buy any financial asset based on charging interest, but that didn't stop Malayan Banking.

The Islamic debt sold by Malayan Banking is based on a carefully created fiction. A borrower creates a separate holding company that issues securities to investors and rents the assets to the borrower. The rental income is paid instead of interest. At the end of the contract, the borrower buys back the assets at a guaranteed price and the principal is returned to investors.

An important point about Islamic debt is that it requires the complicity of prominent religious figures who must check to see the whole deal doesn't violate Islam. Why would someone who has dedicated their life to a religion bless a deal that is so blatantly against the basic precepts of that religion? Giant kickbacks. Pay the imam enough money to build a bunch of new mosques and he'll sign off on anything.

Of course, beyond the religious liberalism being demonstrated by Islamic, the whole region is likely to benefit enormously from the practice. Companies that have access to more capital are capable of expanding much faster than companies that have to rely solely on organic growth. Investors throughout the Islamic world have accepted returns that are significantly less than they could have attained because of deference to Islam.

True believers in Islam should be appalled by Islamic debt, but everyone else should be happy that the Islamic world has finally decided to enjoy the benefits of modern capital markets.

Friday, April 20, 2007

Eastern Europe's Cheap Labor Disappearing

Speigel Online reports that Eastern Europe's dramatic economic boom is starting to drive calls for higher wages that would make the region uncompetitive with other "low wage countries". Most Americans would probably point to Singapore and Mexico as places where exactly the same phenomenon has already occurred and advise Eastern Europeans to enjoy their higher wages.

Growth in median hourly earnings has been tremendous since 2002. The Czechs have 45% higher wages, the Hungarians have 70% higher wages, and the Latvians have 168% higher wages. Obviously these trends cannot continue forever, but the average worker in Eastern Europe has witnessed a great increase in earnings and overall quality of life. Indeed, considering that entry into the European Union caused a migration of many of these countries best workers to higher paying jobs in France, England, and the Nordic countries, this broad-based rise is all the more impressive.

One of Eastern Europe's best selling points has been its highly educated workforce. If labor productivity continues to grow, the possibility for organic growth in living standards seems much higher for the region than the rest of the world in general.

Spiegel Online considers autoworkers at a Skoda plant that are demanding wages that approach those of Volkswagen in Germany. Skoda can certainly afford the 12% wage increase that the workers are proposing for now, but consider that Volkswagen workers are some of the highest paid in the world. One plant in Germany reduced the work week from 35 hours per week to only 32 in order to maintain wages that approach $70 per hour.

Not bad work if you can get it.

Paid Links and Gaming Google

Due to Google's stranglehold on the online advertising market, businesses absolutely must get a top 10 ranking for their relevant keywords if they are to generate substantial traffic to their websites. And the payoff to a top 10 ranking just keeps getting bigger as more and more people come to rely on Google.

One way to get a higher ranking from Google is to develop your site naturally. Unfortunately, this may take years and if a business is in a competitive industry there is no way to be sure it will ever happen. This is due to Google's practice of tracking the number of inbound links to websites. If a site lacks lots of people linking back to it, it won't rise in the search engines.

One way to overcome this hurdle is to pay bloggers to consider a website. Bloggerwave is a Danish company that connects advertisers with bloggers in order to maximize their search engine rankings. Bloggerwave allows a business owner to overcome the formerly tedious process of getting listed in search engines and move straight to addressing the needs of customers.

Thursday, April 19, 2007

Russia's Floating Nuclear Power Plants

Reuters reports that Russia has begun construction of the world's first floating nuclear power plant. The idea is to create a 70 megawatt nuclear reactor that literally floats in the ocean as it produces power and desalinates seawater.

Russian officials are already talking about the potential for export. They say their idea is a good way to power much of the third world without spreading nuclear knowledge.

Anti-Nuclear forces are alarmed. If Russia turns nuclear power into a commodity like commercial airplanes, the potential for accidents like Chernobyl dramatically increases. The notion of a floating reactor is exceedingly alarming in particular. The spectre of a nuclear power plant being hit by an iceberg or capsizing in a fierce storm has been totally unknown until now.

The environmental record of nuclear reactors at sea is surprisingly good. The United States and Russia both employed fleets of nuclear powered submarines without incident. In fact, the Russian sub Kursk suffered an explosion and sank without causing appreciable damage to its reactor. Specialists suggest that the reactor could have been immediately restarted after the disaster.

Nuclear powered icebreakers have also been forging northern sea lanes for years without iceberg troubles.

But the Russian government is likely to move ahead anyway. Look for heavily government influenced companies like Gazprom to be peddling floating nuclear power stations to India and other countries within just a few years.

Challenging Google and Finding a Business Niche

Google has achieved such total dominance in the general online search market that businesses everywhere should seriously consider ways to reduce their reliance on the behemoth. It may be cost-effective to advertise solely through Google, but ultimately giving up control over everyone's Internet presence to one company is a recipe for disaster.

One company that has stepped forward to offer businesses a reasonable alternative is masterseek. Masterseek specializes in connecting businesses with other businesses, to leverage new supply chain connections and consider investment opportunities.

This company is not even trying to replace Google, but by moving a specific type of highly valuable searches away from Google a company could meaningfully reduce its reliance on Google.

Wednesday, April 18, 2007

Dollar at Record Lows, Europe Unconcerned

Reuters reports that the dollar has fallen to a 26-year low against the British pound sterling and is nearing the lowest levels against the euro in 2 years. The abrupt change in exchange rates has been driven by concerns about slowing US growth and the spectre of lower interest rates at home compared with higher rates abroad.

The Euro zone has been receiving much more cheerleading from the press of late. The New York Times and others have recently remarked on the resurgent strength of Germany - where unemployment may fall below 9% if the current strength continues. A recent article even went so far as to observe that Chinese entrepreneurs are forsaking America for Europe. Unfortunately, as even the most ebullient euro-boosters must note, Germany's recent spate of economic growth has been driven by wild successes in niche markets. Sensors for lasers and satellite parts for Boeing are certainly growth opportunities, but Germany as a whole and certainly no other large economy can base its growth on niche manufacturing.

The manufacturing lobby in the United States has been arguing hard for a sharply reduced currency to boost exports, but now that it has finally arrived they are strangely silent. Even in the face of such favorable economic conditions, no one seriously expects all those outsourced jobs to miraculously return.

Economists will tell anyone who listens that in the long run, fluctuations in the value of currency between widely held, freely traded alternatives are irrelevant to growth rates and have a neutral effect on the economy. But as journalists are so fond of quoting Keynes, "In the long run we are all dead".

Tuesday, April 17, 2007

DiscountClick - Search Engine Optimization for Online Business

Operating a web-based business in today's fast-paced world requires the ability to get noticed. Google has taken such complete control over the Internet that more than 60% of all the searches conducted today are run through their service. The implication for business owners is clear - get noticed as the first or second result on Google or get run out of business.

DiscountClick offers specialized search engine optimization tools and promotion for as little as $50 per month. Compared with the cost of being listed in the yellow pages, DiscountClick is a profound value proposition.

Marketing doesn't happen overnight, but in as little as 2 weeks DiscountClick can dramatically increase the ranking of any website. Google's dominance of the search engine market only means that businesses can't afford to wait to get noticed.

Advantage Processors - Full Service Credit Card Processing

Credit cards are the lifeblood of the modern economy. Most people don't even bother to carry around cash or checks any more. But merchants are understandably unhappy with the high costs associated with taking customers' credit cards.

Advantage Processors has developed the close business relationships necessary to secure its customers with the very lowest rates for processing credit cards. The business is poised for dramatic growth going forward because online merchants with a high risk of fraud are increasingly coming to represent a larger share of the global economy.

Customer service in the credit card processing business is absolutely vital. If a customer's account is rejected, they frequently feel a strong sense of personal affront. Only a dedicated business like Advantage Processors can help to resolve any issues quickly to avoid hurt feelings.

Blogvertise and the Paid Blogging Movement

Blogvertise is the latest and greatest company to offer aspiring bloggers across the Internet the opportunity to make a quick buck in exchange for advertising a few products. The Internet as a whole has largely been subsidized by advertising and this is the latest modality whereby advertisers are able to engage highly lucrative potential customers.

One twist that separates Blogvertise from competitors like PayPerPost is that tasks are assigned so there is no sense of the magnitude of the total pool of opportunities. Like most such systems, advertisers are understandably more interested in higher profile blogs.

Marketing will certainly never be the same now that companies like Blogvertise have provided advertisers with the unique ability to really connect with potential customers.

AARP - Your New HMO

The NYT reports that the nation's preeminent lobby for older Americans is going to offer its services as HMO to Medicare recipients and people as young as 50. Other Medicare watchdog groups are highly concerned by the tremendous conflicts of interest that this new arrangement will create when it is offered next year.

Yet in many ways, AARP has been a commercial enterprise for years. AARP's positions to date have not been noticeably impacted by their life insurance activities, for example. Democrats in Washington seem to welcome AARP's expansion, and Republicans could seek to curry AARP's favor as they try to privatize Social Security and Medicare.

The real test will be AARP's stance on privatization. If AARP suddenly changes its mind on this important issue, then the organization has in all probability been co-opted.

Of course, AARP may already be turning into one of the evil corporations it has railed against for years. AARP has already warned that it is "not economically feasible" to extend coverage to everyone. Maybe someone's wires got crossed, but isn't that precisely the problem that AARP has attacked traditional HMOs for?

AARP might end up offering better coverage than average. They plan to be serving more than 7 million more people by 2014.

Better take your vitamins.

Monday, April 16, 2007

Google Turns Evil

The IHT reports that Google has purchased DoubleClick, quite possibly the most evil company in the history of the Internet (yes, it's worse than Microsoft). Google won what was apparently a bidding war with Microsoft over leverage in the Internet advertising business.
Google spent $3.1 billion in cold, hard cash for DoubleClick, significantly more than the $1.65 billion it spent on Youtube.

DoubleClick is a very valuable company to anyone who wants to know what you've been doing on the Internet. Advertisers are obviously interested, but so are privacy activists. DoubleClick is probably responsible for 1/2 of the spyware currently on the Internet. Basically, the company's business model is built around tracking what users do on the Internet, largely without their knowledge.

Most realists recognized that Google couldn't remain forever the perfect company, able to mix phenomenal products with high margins and social goodness. But this acquisition, literally beating Microsoft at its own game, just signals the extent to which Google has changed. One of the great criticisms of Microsoft is that it doesn't develop anything in house, but rather acquires smaller, more innovative companies and milks their products for revenue. Google is at least still paying lip service to its core competency by concentrating on advertising, but the writing is on the wall.

An intriguing side note is that private equity has infiltrated another giant deal. The connection this time is a San Francisco private equity firm Hellman & Friedman, which bought DoubleClick for $1.1 billion in 2005. Not a bad return for such a short investment. Watch for other private equity firms to develop companies with the express purpose of selling them to Google for a big profit. As long as Google retains control over the Internet through its search dominance, Google will have lots of cash from advertising to invest in other businesses.

Ironically, in much the same way that Microsoft used its dominance on the desktop to crush Netscape, Google is poised to use its search dominance to muscle into other areas.

Friday, April 13, 2007

Chavez Nationalizes Venezuela's Oil - And Impoverishes His People

The Associated Press reports that Hugo Chavez has announced that the state oil company of Venezuela, PDVSA, will take control of 4 heavy oil projects in the Orinoco River region at gunpoint. He actually is sending the army to ensure that the transnational oil giants who have invested $17 billion in the projects will hand over control quietly.

The problem with Chavez's continued nationalization of Venezuela's oil industry is that political considerations have translated into a real inability to access Venezuela's oil resources at all. At many of the facilities that have been controlled by the government production has actually been falling. The proximate cause of this inability to pump oil is a general lack of preventative maintenance.

Chavez has used his political control over the PDVSA to change the way it conducts business. As recently as just a few years ago, the company was managed like any other oil company and simply paid out its profits directly into government coffers. But Chavez has tried to leverage popular support by using company funds directly for philanthropy. In short, money that might have gone for maintaining machinery has been spent on public handouts.

Venezuela is an oil powerhouse. If you count heavy oil, instead of just the lighter sweeter oil preferred by oil companies for its easier processing, Venezuela has more oil than Saudi Arabia. Venezuela isn't going to become as poor as its Latin American neighbors anytime soon. But this represents a real tragedy in terms of missed opportunities.

Oil wealth doesn't have to be the developmental curse that it has been in Africa and Venezuela, but it does require careful management. Hugo Chavez hasn't been up to the job and unfortunately for the Venezuelan people this means many more men, women, and children will live and die in needless poverty.

The Rise of China - Sooner than You Think

Businessweek reports that tax revenues in China are up 25.5% in the first quarter. The rising revenues are due to a combination of sharply higher profits as the economy continues to grow at about 10% per annum and a crackdown on tax evasion by Chinese officials.

China is using its rapidly growing revenue stream to fund big increases in spending across the board. Western military planners are concerned about big increases in Chinese military spending, but China is also spending big bucks on social spending to ease the yawning gap between urban and rural livelihoods.

By some measures, China is already a larger force in the global economy than the United States. But China's institutions and global standing have yet to make a commiserate rise. China's leadership attempts to hide behind the rhetoric of a "peaceful rise". The real truth remains that the Communist Party apparatus is ill-equipped to maintain its iron hold on a rapidly changing nation.

Most people in China today are just getting their first taste of real material progress. As long as powerful economic growth continues, the government will be able to keep a firm grip on its people. But growth at this pace has consequences beyond rising standards of living. The toll of rapid industrialization and mass consumer culture on China's environment and social stability will be immense.

It's a good thing that China is rising, indeed to suggest otherwise is to justify the continued impoverishment of more than a billion people. Let's just hope that China can manage the figurative minefield that awaits its citizens.

Thursday, April 12, 2007

Hedge Fund Billionaires and "Light Regulation"

The IHT reports that Fed chairman Ben Bernanke supports "light regulation" of hedge funds because they deal with sophisticated investors and don't demand government bailouts. This is particularly timely because foreign governments, especially Germany have been to increase pressure of hedge funds for greater transparency.

The United States however, has a history of not regulating hedge funds. Even the collapse of Long-Term Capital Management in 1998 did not cause a rush to regulation. Just last September, Amaranth Advisors lost $6.6 billion in the natural gas market.

This caught my eye because Trader Daily just published its list of the highest earning traders. The top guys are all hedge fund folks, so it is to be expected that they would be rolling in the dough. But the top 5 traders made over $1 billion each. Yes, that's right, billion with a capital 'B'. And the number one spot was held by a Houston hedge fund manager who made about $2 billion betting exactly opposite Amaranth.

It looks like hedge funds are the place to be for managers looking to make a quick buck, but it is unclear if they are going to destabilize the economy. At the end of the day, if traders think oil is going to go to $500 a barrel and buy up all the available contracts, they will only hurt themselves. Oil isn't going to end up that high, and six months later the hedge fund guys will be out on the street.

Regulators need to watch companies that think they can juice their returns by investing in the exotic derivatives and other financial incentives offered by hedge funds. As long as hedge funds are just investing "Mad Money", speculation isn't a bad thing. Just make sure that your pension doesn't do something stupid and invest in the guys who used to work for Amaranth.

Please Revive the Doha Round!

Voice of America reports that negotiators from the US, the EU, Brazil, and India are meeting today to try to revive the trade talks that broke down last July.

Too much optimism is probably misplaced at this point because the political considerations surrounding agricultural subsidies that derailed talks before are unchanged. The only real changes at this point are the US-South Korean free trade agreement and months of castigating editorials belaboring the shortsightedness of the Bush administration.

Everyone not party to the US-South Korean free trade agreement is probably concerned about trade distortions that could steal their market share in two of the world's largest economies. This might concern far-sighted economists, but most politicians will probably remain oblivious.

The real unknown then is what impact months of editorials in many of the world's finest newspapers has had on the political will of the folks pulling the negotiators' strings. It is conceivable that Europe is sufficiently concerned about the US going it alone with bilateral trade agreements to sign on to an agreeable treaty. But not terribly likely.

Indeed, the real hope for success at a revived Doha Round lies with Brazil and India. If they reduce their expectations of reduced subsidies from the West, any deal becomes much more workable. Essentially giving in would be political suicide, but that doesn't mean it won't happen. It just probably won't happen.

Wednesday, April 11, 2007

Continued World Productivity Rate Growth Questionable? Please!

The Financial Times reports that worldwide economic growth is unlikely to maintain the momentum that has allowed it to grow at the "highest sustained rate since the early 1970s". Productivity in the United States at least has been driven by increased returns to almost all sectors of the economy as a result of information technology. This technological growth is actually preferable to the one-time growth that occurred in the 1970s due to the entry of women into the labor force because it is likely to continue, even if at a diminished rate, after the initial spurt of growth.

The IMF thinks lack of progress on multilateral trade liberalization, the costs of addressing global warming, and aging populations will all weigh down growth. Which while absolutely true, completely misses the point.

Economic growth in the United States is coming almost entirely from the service sector. The material well being of most Americans is unlikely to increase dramatically in terms of the amount of stuff, but it continues to advance in terms of the quality of the goods we own. Back in 2001, Apple was still primarily a computer company and everyone still listened to Cd's. Now 100 million Ipods later, people have negligibly more music devices, but their new music options are light-years ahead.

GDP, while still immensely important to economic analysts, is an anachronism. Our most basic economic statistic was developed to determine the United States' capacity to improve its industrial production for WWII. But now that the Cold War is over, the best measure of our well-being is not how many computers we produce, but how much number crunching they are capable of doing. Economists have trouble quantifying how much better televisions have gotten since plasma and LCD screens, but nothing is capable of measuring the improvement in our lives caused by something completely new - our ability to seamlessly communicate information over the Internet at almost no cost.

Right now the Internet's market capitalization is closely tied to the porn industry and advertisers. But just like television is mostly about what happens between commercials, the Internet is so much more than a new way to sell diapers.

The service economy is most perfectly leveraged over the Internet. One guy in his basement can create a great new piece of software and instantly send it out to millions of people across the globe. And if his video editing skills are any good, he could change the course of history by affecting the ongoing presidential campaign.

The world is unlikely to continue to grow in the same way that it grew in the past, but no serious person is going to be willing to go back once they experience a qualitatively better economy.

Japan looks to Kazakhstan for Uranium Supply

The IHT reports that Japan is trying to purchase stakes in uranium mines in Kazakhstan and Russia in order to protect itself from surging uranium prices driven by higher Chinese energy demand. In contrast to the United States, Japan already derives 30% of its power from nuclear energy. But a plan to curb carbon dioxide emissions has Japan planning to increase its reliance on atomic energy to approximately 40%.

Uranium prices are currently at a record $113 a pound, and even without an increase in demand, prices are likely to rise further due to problems with mines in Australia and Canada. A global effort to address greenhouse gas emissions will only exacerbate an annoying supply bottleneck.

As a practical matter, uranium production will never run up against the natural limits that face fossil fuels both because there is plenty in the ground and because uranium is so energy dense. But uranium mines have been floundering for decades because they simply weren't terribly profitable investments if no one in the richest country on earth wanted to buy any.

Now that companies like TXU are considering expanding nuclear power again within the United States, the prospect for higher margins for uranium mines looks good. Take a look at this chart from The UxC Consulting Company, LLC:

Restructuring at Citigroup - 17000 jobs lost

The Globe and Mail reports that Citigroup may fire 5 percent of its workforce - about 17000 people. This is significantly less than earlier reports that warned of as many as 45000 jobs lost.

Citigroup is not exactly a money-losing business. Earnings per share have been steadily, if slowly, growing. The CEO Charles Prince is under pressure from Citigroup's largest shareholder, a Saudi prince, to match the performance of Bank of America and JPMorgan Chase & Co.

Citigroup plans to save about $2 billion per year after its restructuring, but it doesn't plan to rest on its laurels. The company just acquired Taiwan's Bank of Overseas Chinese for more than $400 million and is in talks to buy hedge fund Old Lane LP in order to expand their alternative-investments group. This profitable new area of business would include private equity and real estate.

Is this a sluggish, old money giant trying to slim its way to new economy success? Of course, but just because the strategy closely resembles a cliche doesn't mean it won't work. Citigroup can afford to pay a premium to hire the world's best management. The current leadership doesn't have a strong track record of recent success, but that actually makes immediate success easier to attain due to lower thresholds for growth rates.

Citigroup hasn't been a great investment for the last few years, and no matter how effective the restructuring turns out to be, the company probably won't lead the market higher in the next few years either. But Citigroup isn't going to even come close to losing money either. It can be difficult to leverage the stable, unsexy cash flows of the past into new revenue streams, but that's a whole lot easier than leveraging red ink into growth.

Private Equity: NOT A Risk to Financial Stability

Forbes reported that the IMF has warned investors to pay attention to "areas of risk which could cause a disorderly correction in financial markets". First came a discussion of the carry trade in the Japanese yen that could have occurred at any time in the past decade with precisely the same arguments and exactly the same amount of evidence - none. Financial analysts at the IMF have noted the potential trouble emanating from Japan's ultra-low interest rates, but they aren't paying attention to the fact that the Japanese are also aware of the situation and are highly unlikely to wreck the global financial system since that would immediately destroy their own export dependent economy as well.

The new area of risk that the IMF wants investors to watch is private equity. The problem is that every time a buyout occurs, the acquired firm takes on a great deal of debt that could make the business more vulnerable to a downturn. While it is certainly true that taking on debt up to your eyeballs is a risky financial strategy, the greater reality is that not leveraging your business is itself a decision to hold back and retain your flexibility to ignore the needs of your customers. All businesses are going to end up taking on lots of debt before they go belly up, simply because they can. If companies already have a significant debt load, they can't slowly fade away over the course of decades. While it might be more psychologically satisfying to give everyone years and years to get used to the fact that a given company isn't producing any value, the economy is better off when resources flow to their most efficient uses.

At any rate, the geniuses behind private equity are constrained in their ability to take on excessive debt both by their bankers, who rightly fear default, and their own profit motive, because a failed company is never in the interest of its owner.

If this is the new risk facing the world economy, the next few years should witness some impressive growth.

Tuesday, April 10, 2007

Are More Nuclear Power Plants in Our Future?

CNN reports that TXU, a utility company acquired by two private equity firms earlier this year, is working to build the largest nuclear power plants in the country. Something big must be under way in Texas, because the Wall Street Journal suggests that at least three other utilities are considering building nuclear power plants in Texas.

No new nuclear power plants have been built in the United States in decades, but TXU has apparently been consulting with Mitsubishi Heavy Industries of Japan who would build the reactors, so there might actually be fire at the bottom of all this smoke.

The global warming debate has cast nuclear power into a sudden environmentally friendly light. If people are really more worried about global warming than nuclear accidents or terrorism, then the country might follow the French model which derives the vast majority of electrical power from nuclear energy.

The more capitalistic angle on this renewed interest in nuclear power questions what impact private equity has had on TXU's priorities. If private equity's ability to focus on long-term profits has allowed TXU to finally act on long simmering plans, this could have major repercussions for the economy as a whole. In a world where private equity is capable of even considering spending $50 billion for Dow Chemical, no public company is safe.

Greater willingness to take on spectacular risks will undoubtedly result in higher eventual payoffs for everyone in society, but the financial disasters will be larger too. Society just needs to make sure that the risks remain purely financial and not allow private business to avoid appropriate technological safeguards.

Is A Benevolent Duopoly about to End?

The NYT reports that Advanced Micro Devices plans major cuts in hiring after a surprise revenue forecast more than $400 million below it's own January numbers. This crisis is potentially life-threatening for AMD because of its cutthroat competition with much larger rival Intel.

Consumers have been the big winners over the last few years as both Intel and AMD have suffered shrinking profit margins and simultaneously increased the pace of innovation. But the semiconductor market could easily be one of a handful of markets that is most efficiently served by a monopoly. The problem with semiconductors is that the cutting edge facilities required to manufacture computer chips in the quantities necessary for the mass consumer market seem to have grown unbelievably expensive. In ten years, it might cost $10 billion for just one fabrication facility that in 1990 might have cost only $100 million. This incredible change in the order of magnitude of costs means that only a handful of companies worldwide can afford to build these facilities. If costs continue to rise, it may only be efficient for one company to invest in these massive undertakings.

The consumer electronics world is much richer because of the competition between Intel and AMD. It is always possible that AMD's planned chip code-named "Barcelona" will be a sufficient challenger to beat back Intel's current champ the "Core 2 Duo". But Intel already has two successor chips of its own lined up and AMD's cost-cutting won't help it keep up with the intellectual arms race.

Before AMD, Intel turned out improved products more infrequently and charged higher prices. If Intel succeeds in driving AMD out of competition for microchips, all consumers will be at least slightly worse off.

Will the World's Most Valuable Company be a Wholly Owned Subsidiary of The Kremlin?

General Electric and Exxon Mobil are likely to fend off any hostile bids out of Russia, but according to the IHT, Gazprom plans to be worth more than $1 trillion within a decade. It might seem unlikely for one Russian company to exceed the size of Russia's entire economy for 2006, but Gazprom has the inside track to success.

When Putin took power just a few short years ago, Gazprom was worth only $25 billion and suffered from severe mismanagement. The management of the company didn't get any better, and may in fact have gotten worse due to political meddling in company affairs. But the company achieved a market value of $250 billion because Putin's government essentially outlawed doing business with anyone else in Russia. Shell and other big oil companies played ball because they let the potential of Russia's massive energy reserves blind them, and Gazprom prospered.

It's probably no longer possible to strong arm the West into any more favorable terms of trade, at least over the short term. But Gazprom still has significant room to grow. Gazprom's proven oil reserves in the ground are valued by financial markets at about $5.50 a barrel. In contrast, Exxon Mobil's reserves in the ground are valued at around $20 a barrel. The reason for the big difference is that investors fear the Kremlin will just seize the 50% of the company it does not already own.

If Putin and his eventual successor convince financial markets that Russia won't nationalize the company, it would be a trivial accomplishment for Gazprom to become the world's most valuable company. And even if Putin just outright nationalizes the company, it would still be true that the underlying assets represent the most valuable company on earth.

All those "No More Blood for Oil" folks should take a good long look at Russia. Exxon Mobil is hardly the most innocent company in America, but Gazprom makes America's oil lobby look like a bunch of sissies.

Sunday, April 8, 2007

Are Labor Unions going Extinct?

The NYT reports that the National Labor Relations Board charged that Starbucks, everyone's favorite coffee joint, broke the law 30 times as it tried to discourage union activity at four locations in Manhattan. But the story is not about an evil corporation taking advantage of hapless workers. Rather, the focus of attention is the overwhelming anti-union sentiment at private businesses in general and do-gooder concerns like Starbucks and Whole Foods in particular. Anecdotal evidence seems to suggest that "accusations of union-busting and poor pay" simply don't matter in one of the most liberal cities in America.

Business owners aren't just expressing a mild preference for fewer unions. Whole Foods' CEO John Mackey is extremely hostile to unionization. He has gone so far as to say that unions are "highly unethical and self-interested".

Why is a socially conscious leader like Mackey getting away with being so down on unions? The easy answer is that most people are opposed to unions these days. The last twenty years have witnessed a collapse in organized labor. And if government workers are excluded from calculations, less than 8% of employees belong to a union.

The article credits the trend toward political activism via conspicuous consumption that has brought us such wonders as the Prius and compact fluorescent light bulbs. And while this cultural movement no doubt has some impact, other factors seem more significant. The trend toward the service sector at the broad expense of manufacturing, fewer government restrictions on anti-union efforts, increased competition from abroad, and better market institutions all seem more likely to negatively influence unions more.

But unions will likely be fixtures in certain sectors of the economy for many years to come. For example, Hollywood, grocery stores, and professional sports are all likely to remain highly unionized for the foreseeable future.

The real question mark is the fate of unionized automakers. In a very real sense, the Big Three automakers are tied to unions in a manner their foreign competitors will never be. If GM, Ford, and Chrysler continue to crash and burn while Toyota and the other Asian automakers grow without significant union presence, it could spell the end of unions in their most high-profile instantiation.

Today, things don't look good for the unions.

Saturday, April 7, 2007

Why do Billionaires want employees to own their company stock?

The Detroit News reports the next chapter in the growing trend toward employee stock ownership programs. Kirk Kerkorian wants the United Auto Workers union to share in the "risks and rewards" of his proposed $4.5 billion buyout of Chrysler. And he's not the only one connected with the bidding for Chrysler that thinks that might be a good idea. The union president Ron Gettelfinger says other parties, probably private equity giants Cerberus and Blackstone, have approached him about an ownership role for the union.

But why would a billionaire like Kerkorian and the smart guys behind private equity want to share the risks (and return) of ownership? The short answer is that they want employees to buy into the change in ownership and they think they can use clever contracts to keep employees from really enjoying the benefits of ownership.

The best current example of this Machiavellian management is Samuel Zell's recent purchase of Tribune Co. His complicated scheme for controlling an $8.2 billion company will cost him only $315 million. How does he pull this off? I refer to the Chicago Tribune's own explanation:

The new company structure depends on the creation of what's known as an S Corp. ESOP, which is essentially a sole-proprietorship encased within an ESOP trust. The attractiveness of the structure, according to one source, is that it eliminates most of the corporate taxes Tribune would otherwise pay, which boosts the cash flow and allows the company to support a heavier debt load. If the structure had been in place in 2006, for instance, Tribune would have been able to avoid paying $348 million in taxes.

For the first 10 years of an S Corp. ESOP, the trade-off is that the company has to pay capital-gains taxes on asset sales. That could explain why Zell has said he has no intention of breaking up the company, since most of the company's long-held assets would generate big capital gains. After 10 years, however, the company can sell assets without paying capital gains. So, at that point, the glue holding the company together might not be so strong.

Zell will initially invest $315 million in the deal, which will close in several steps. In the first step, the ESOP will buy $250 million worth of newly issued Tribune common stock. Zell will invest $225 million and receive a note from the company. He will also pay $90 million for a warrant that can be converted into about 40 percent of the company if Zell pays $500 million.

Meanwhile, the company will stage a tender offer for approximately 126 million shares at $34 a share. It will borrow $7 billion at the same time, using $4.2 billion to pay for the tender and $2.8 billion to refinance existing debt. Then, in a final step that will take place if or when various government approvals can be secured, Tribune will merge with the ESOP and convert into an S corporation and will borrow another $4.2 billion to buy the rest of the shares at $34 a share.

When the deal is complete, the ESOP will hold all of Tribune's then-outstanding stock, with Zell holding a subordinated note for $225 million and the warrant entitling him to acquire 40 percent of the common stock for $500 million. In effect, the ownership split will be 60 percent employees, 40 percent Zell.

In effect, Zell hasn't even paid $315 million because at least initially $225 million of his investment will take the form of a loan that would be privileged in any bankruptcy proceedings before all shareholders. But how are the company's employees going to pay for their stock ownership program you ask?

Their 401k program will be gutted in exchange for the opportunity to buy shares in a business with decidedly poor long-term prospects. And the icing on the cake is that no employees can sell their newly purchased stock for ten years!

Zell might be getting into the newspaper business, but he's already demonstrated his mastery at taking a major corporation's workers to the cleaners.

Friday, April 6, 2007

Zell takes on Google

The Washington Post reports that Samuel Zell, the billionaire in the process of purchasing Tribune Co., doesn't think news outlets can afford to continue to give away their content online to companies like Google. His opinions carry significant weight because the Tribune Co. owns such important newspapers as the Chicago Tribune and the Los Angeles Times in addition to other properties like the Chicago Cubs.

Zell is upset because while the average consumer of news is increasingly getting their information online, his personal slice of cyberspace is not making any money. His concern regarding internet revenues is important to the newspaper business because the crown jewels of the news world, the Chicago Tribune and particularly the Los Angeles Times, are actually losing circulation. This overall trend has been going on for at least the past decade and seems to be accelerating.

Zell's comments regarding Google aren't really even specific to the newspaper industry. Search engines like Google essentially freeload off the content that everyone else on the internet generates. If all sectors of the economy defended their intellectual property with the vigor of book publishers, Google's business model would implode. In a real sense, Google receives a significant subsidy from all the content they index.

Zell obviously wants a larger share of the advertising revenues derived from viewers of his newspapers. The outcome of his push for compensation could have implications for the rest of the internet. Content is king, but also largely free. If a spat over the distribution of advertising revenues gets too intense, content providers may move in the direction of a subscription-only model. And that would be a shame, because information just wants to be free.

Kerkorian Takes on Chrysler

Forbes reports that things are really heating up at the Chrysler firesale. Billionaire investor Kirk Kerkorian has offered $4.5 billion for Chrysler. This is significantly less than DaimlerChrysler's hopes of $8 billion but the mere presence of another bidder may force Cerberus and Blackstone to significantly raise their own bids.

The personal drama of Chrysler's crackup and subsequent firesale is really heightened by the addition of Kerkorian. His investment company lost a lawsuit against DaimlerChrysler in 2000 based on his assertion that management duped investors into supporting the merger with Daimler Benz. According to the article, he still has an appeal pending that seems to put the due-diligence probe that typically occurs after a bid of this magnitude underwater before it gets off the ground.

Kerkorian is enormously interested in American carmakers. He invested in General Motors and tried to convince management to form some sort of combination with Nissan and Renault in order to jumpstart growth. He made his personal fortune in other areas - gambling and plastics - but if Kerkorian succeeds in his titanic investments in automakers, he could remake the industrial landscape of America.

Kerkorian is a brilliant investor, but this investment strategy just doesn't look promising. Chrysler is hemoraging cash and marketshare at frightening rates. The company needs a fundamentally different strategy if it is to get more customers into its cars. Ultimately, the increased financial leverage applied under almost any conceivable acquisition of Chrysler may only increase the risk of catastrophic collapse. Lenders with billions of dollars in loans coming due will simply not tolerate continued losses, and the way for any American carmaker to achieve even modest profits is still unclear.

Thursday, April 5, 2007

Detroit Collapsing - Sign of Broader Troubles or an Isolated Problem?

The IHT reports that Detroit is in serious economic trouble. The article starts with an anecdotal account of a man who can't sell his home that creates the false impression of a connection with the subprime mortgage debacle. Subprime mortgage woes are in the news, but this sort of shoddy journalism creates hysteria where it isn't warranted by the facts.

As the article goes on to note, Detroit led the nation in foreclosures last year because the auto industry put more than 350,000 people out of work in the state with the highest unemployment rate in the nation.

Things look bad in Michigan right now. Home prices have fallen more than 5 percent in the last three years, while the rest of the nation's real estate has been on a tear. And it's not just the little guy who is suffering. Ford is axing 30% of its executives as it struggles to compete with Toyota.

But it would be wrong to interpret things as too terrible. The reporter filing her assignment from Detroit plays up the risk of default by even prime mortgages. The facts don't really back her up. The percentage of prime loans overdue by 3 or more months is a tiny 0.67%.

It must be terribly difficult for an entire region of the country to go through such a gut-wrenching decline, but Detroit is managing about as well as could possibly be expected. If 350,000 people lost their jobs in almost any other industry, the impact would be much worse. The very same unions that the Big Three automakers blame for strangling their profit margins are ensuring that most workers are getting extremely generous buyouts. It's not even that uncommon for middle-aged autoworkers with few transferable skills to receive six-figure checks to compensate them for their lost jobs.

The situation in Detroit is tragic, but a system that is allowing frugal blue-collar workers to essentially retire in their early 50s is hardly sticking it to the working man. It must be hard to have to completely start over at such a late stage in life, but at least they aren't being tossed out in the street empty handed.

Wednesday, April 4, 2007

Is a Chrysler Buyout in the Cards?

Bloomberg reports that at least two serious bids have been made for DaimlerChrysler AG's Chrysler unit. One of the bids is from Canada's largest auto-parts supplier and the other is a joint bid by private equity giants Blackstone Group LP and Centerbridge Capital Partners LLC.

Nobody close to the deal is saying what the likely price will be, but $6 billion is a number that has been tossed around by analysts. That's a lot of money considering Chrysler lost $1.5 billion last year. Its market share is also in freefall, dropping to 12.9 percent.

The real story here seems to be that the nine-year-old merger between DaimlerBenz AG and Chrysler Corp has been an unmitigated failure. The Germans were unable to take a struggling Chrysler back to its former glory, in spite of the fact that in most regards Chrysler has been the most vigorous of the Big Three Detroit automakers. This failure is particularly galling in view of the concommittent rise of Toyota. None of the Detroit automakers has been able to avoid enormous losses and even most foreign automakers like Honda are really just treading water. Only Toyota has moved to significantly increase its marketshare while remaining profitable.

The global auto industry is definitely a growth business worldwide over the next few decades. None of the Detroit automakers looks particularly well leveraged to take advantage of the rise of a new consumer class around the world. American management has failed spectacularly to lead the way and our German friends likewise appear stumped. Canada's largest auto-parts supplier looks to be doubling down and maybe that's their only hope to keep their jobs, but if I were one of those private equity concerns I'd rather invest in the only auto company worldwide with proven leadership - Toyota.

Tuesday, April 3, 2007

Private Equity Strikes Again!

According to the IHT, one of the largest private equity firms in the world has just signed a deal to buy First Data, the credit card payment processor, for over $25 billion. First Data has been a money machine for years, growing along with the credit card industry to become a true behemoth.

But while the underlying business at First Data is clearly sound, overpaying for a great company can still result in poor returns. The private equity firm KKR will pay a 26 percent premium to the market value of the company and assume over $3 billion in debt. That works out to 27 times estimated earnings per share.

You don't even need to resort to back of the envelope calculations to see that such a large premium is only justified by impressive future growth. It's certainly possible that growth like that is going to happen, and only a fool would bet on the company actually shrinking, but it takes good management to maximize growth and First Data looks like its about to lose its leadership.

Henry Duques, the chief executive of First Data, is 63 and looking for a way to get out. He's already tried this in the past - he turned the company over once before in 2002, but now he's back in control because his first hand-picked successor couldn't cut it.

I don't think buying First Data is a bad decision by any means, but KKR is going to need to demonstrate impressive management over a business that hasn't really done that on it's own in order to make this investment a winner.

KKR has access to lots of cheap debt right now, and I'll bet that makes all of KKR's calculations look much more tractible, but at the end of the day the underlying business needs to perform. Credit cards aren't going to leave our society tomorrow, but if Dave Ramsey has his way, their impressive growth will stall.

Monday, April 2, 2007

US - South Korea Free Trade Agreement

The NYT reports that negotiators in Seoul squeezed through "the world's largest bilateral free trade agreement" before President Bush's fasttrack negotiating authority expired. Most free traders are mildly optimistic, but they'd certainly prefer that the deal was rendered unnecessary due to the success of the Doha round at the WTO.

The primacy of multilateral trade agreements over bilateral treaties always struck me as fairly straightforward. Yet political considerations have pushed the Bush administration into making quite explicit the contention that bilateral agreements are enough. I was actually surprised at the generally thin literature on this issue, but this article rather definitively decides the issue in favor of multilateral trade agreements.

The real question now is one of how to proceed from here. With the rather spectacular death of the Doha round, not even the smallest progress toward multilateral negotiation seems possible. Some progress on lowered trade barriers is obviously better than none, but distortions will creep into the system. The current bilateral trade regime is based on the "wheel and spoke" model, but invariably the "spokes" of trade are unbalanced and even overlapping. Real human costs are observable every time the international trade regime is upended by a new set of rules. The current adjustment makes the world richer on balance, but unfortunately future changes will be more painful because of the political failures of the Doha round.

Truly free trade, despite almost universal acceptance in principle, still eludes us. Maybe next time we'll finally get it right.