Friday, September 28, 2007

Mr. Smith Goes to Washington…to Lobby for the World’s Largest Unregulated Monopoly


It happens only occasionally: something so beyond the pale of logic and reason that further commentary is barely necessary.

But it does happen, and it happened yesterday: Microsoft, of all companies, sent its General Counsel to the United States Senate to beg the government to stop Google, the world’s most successful internet search company, from buying a small, unrelated banner ad company, for the sake of unfair competition and monopolistic business practices.


How could anyone make this up?

It is a fact. Microsoft—the world’s largest and most successful unregulated monopoly—is asking our government to stop Google from continuing to beat Microsoft in the free marketplace.

Here are Microsoft General Counsel Brad Smith’s own words:

Now, already Google is the dominant company for one of the two main types of online advertising, search online ads. Roughly 70 percent of global spending on searchbased advertising today flows through Google's AdWords service.

Apparently nobody in Redmond informed Mr. Smith that roughly 95% of global spending on desktop computer operating software flows through Microsoft's bank account.


Free of that simple incontrovertible fact, Mr. Smith proceeded to pile one whopper on top of another:

If Google is allowed to proceed with this merger, it will also obtain a dominant gateway position over the other main type of online advertising, nonsearch ads the nonsearch ads that are displayed on Web sites that we visit. Today, Google and DoubleClick are the two largest competitors in this area. And as I hope we will discuss more, they are competitors in this area. And yet combined, Google will account for nearly 80 percent of all spending on nonsearch ads served to third party Web sites.

Once again, nobody in Redmond told Mr. Smith that both Google and DoubleClick became dominant in a free marketplace, with competitive products against bigger, better-funded companies, including Mr. Smith's employer, the World’s Largest Non-Utility Monopoly.

Untethered to the business history of his own company, Mr. Smith wound it all up with a sort of uber-whopper, and I quote:

In short, if Google and DoubleClick are allowed to merge, Google will become the overwhelmingly dominant pipeline for all forms of online advertising.

Now, this merger will almost certainly result in higher profits for the operator of the dominant advertising pipeline, but we believe it will be bad for everyone else. It will be bad for publishers, it will be bad for advertisers and, most importantly, it will be bad for consumers.

In other words, Mr. Smith is suggesting, if the deal goes through, Google would become like Microsoft has been operating for the last twenty years!


I would hope somebody in that Washington Senate chamber recalled the honor roll of companies that Microsoft put out of business by leveraging its own monopoly of the desktop operating system.

If they’ve forgotten, I’d be happy to dig through old trade confirmations from the days when shorting whatever NASDAQ-listed company Microsoft had targeted for destruction was like shooting fish in a barrel.

From memory, they include but are not limited to Lotus, Netscape, Quarterdeck, Software Publishing, and Novell.

Readers with longer memories than mine are free to add to the list.

Whatever happens to the Google/DoubleClick deal, something tells me nobody's going to be making a feel-good movie out of this Mr. Smith's visit to Washington.


Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.




Thursday, September 27, 2007

“Stuff” Rising


Not that I would know this from personal experience, mind you, but Coors—at least in one part of the country—has raised the deposit on their beer kegs from $12 to $30.

The obvious problem for Coors, which followed recent moves by Anheuser Bush, is that low-tech beer kegs are made of high-tech stainless steel, the price of which is flying. Consequently, even hung-over thieves could do the calculation that the $150 replacement cost of an item sitting in their garage was more than ten-times the deposit.

So now the ratio is only five times.

Whether the near-tripling in the deposit charge solves the Mystery of the Disappearing Kegs, time will tell. As percentage price increases go, however, it ranks right up there at the top of the list of price hikes currently excluded from the “Ex-food and energy” calculations of the Federal Reserve Board, who presumably drink more sophisticated elixirs than cold brew anyway.

Still, the fact that prices on all manner of stuff—to use a highly technical economic term—are going up, credit squeeze or not, is no new news to anybody who actually consumes the stuff.

A casual glance at my Bloomberg confirms this:

Wheat Rises to Record as Ukraine Limits Exports,” reads one story in the top news page.

Also rising is the cost of the war in Iraq: “Pentagon Seeks $190 Billion for Iraq in 2008, Most Since Conflict Started,” reads a second headline on the Bloomie.

There’s even bad news for Coors’ own keg costs: “Vale, Rio, BHP May Win a 30 Percent Increase in Iron Ore Prices Next Year,” reads a third headline.

But weep not for Coors and its brethren.

Australian wine and beer giant Foster’s Group is raising prices—and they’re sticking. As Foster’s CEO told Dow Jones recently,

“We put our prices up across the board in August between 4% and 11%....Those prices have stuck and competitors have followed. That’s a pretty good sign.”

Indeed. Stuff rises.



Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Monday, September 24, 2007

Private Equity: What a Business!



One of the all-time greats in the hedge fund business once told me we were in the wrong business.

It happened during the dot-com/telcom bubble deal-a-day phase, when Cisco announced the purchase of yet another three-month old start-up making V-FLOP CYBERWAP nano-modules for the Fiber-to-the-Sun space—or something like that—for several billion dollars.

I don’t recall the company and my guess is Cisco doesn’t either, but since they paid for it with Cisco stock instead of cash, it didn’t really matter except to the poor shlubs who never sold their newly-minted Cisco shares under the delusion that whatever it was that V-FLOP CYBERWAP nano-modules did, they really were worth several billion dollars.

Still, Cisco paid what was, at the time, a ridiculous amount of money for a company with almost no sales and absolutely no earnings—a “company” that was, in fact, not much more than a Venture Capitalist’s dream of a business.

Yet nobody blinked an eye.

In fact, the only question on Wall Street’s mind was who else Cisco might buy for a ridiculous amount of money.

With that in mind, as soon as the announcement hit the tape, I called Tim McCollum, the aforementioned all-time great, for his take on possible answers to that question.

Tim had been one of the original Microsoft analysts on Wall Street, yet unlike most of his peers, he held the distinction of actually providing useful information on that company to hedge fund types like me.

Indeed, Tim had proved so useful to hedge fund types that he’d been lured to our side of the table and he quickly became one of the best analysts I ever knew in this business.

And for that reason Tim was my first call the morning Cisco announced it was paying billions for a V-FLOP CYBERWAP Fiber-to-the-Sun nano-module play, or whatever it was the thing did.

I was looking for public company stocks that would be affected, either positively or negatively, by the news.

“Tim, what does it mean?” I said, while the headlines were scrolling across the tape.

“It means we’re in the wrong business, Jeff. We should be in venture capital”

And Tim was right—at least for another six months or so. Then the Telcom Bubble ended, and all those Fiber-to-the-Sun V-FLOP CYBERWAP nano-module plays, or whatever they were called, became nothing more than accounting ledger write-offs.

Cisco’s own share price went from $77 to $12, and being in the hedge fund business—what with stocks like Cisco going down more frequently than up—once again became a good business to be in, all things considered.

But I think if Tim was here watching the headlines, he’d once again tell me we’re in the wrong business.

Only this time, he’d tell me we should be in Private Equity.

“Surely you jest,” you’re thinking. “After all, private equity deals are blowing up right and left. Blackstone’s IPO was a bust—a complete, utter, embarrassing, highly public bust. And KKR just blew out of the Harman deal.”

And all that is true.

But how many businesses do you know allow the principal of a major transaction to 1) agree to do something, 2) back out of the deal, and 3) ask their bankers to pay the penalties for them?

I am not making that up: after all, that is precisely what KKR—the grandfather of Private Equity—apparently did in the case of Harman Industries, the electronics company that KKR agreed to acquire earlier this year for $120 per share.

To grasp what happened, let’s go back to the halcyon days of April, when KKR and its Private Equity brethren were cutting deals right and left under the assumption that what was happening in the sub-prime housing business would stay in the sub-prime housing business and never affect their own massively leveraged, sub-prime takeover business.

The following is excerpted from the KKR press release trumpeting the Harman deal:

HARMAN INTERNATIONAL INDUSTRIES TO BE ACQUIRED BY KKR AND GS CAPITAL PARTNERS


Harman Stockholders Can Elect to Receive $120 Per Share In Cash or Shares in Post-Transaction Company

Transaction Valued at Approximately $8 Billion

Henry R. Kravis, Co-Founding Member of KKR, said, “Harman is one of the world’s outstanding providers of audio equipment and infotainment systems with an unparalleled portfolio of legendary brands and strong customer relationships. Since founding Harman more than 50 years ago, Dr. Sidney Harman has brought exceptional vision to the company and we are proud to work with him and the management team to continue building the value of their company.”

—Press Release, April 26, 2007

Now it just so happens that on the very same day of that takeover announcement, Harman conducted an earnings call for Wall Street’s Finest—the third quarter of the company’s fiscal year.

And on that call, the plain-spoken Dr. Harman did not shy away from discussing the downs as well as the ups of running a large-scale supplier of high-end electronics systems to the automobile industry, as follows:

To reach our [earnings] target of $4.35 [per share], we will need a strong fourth quarter…. At our midyear earnings call, I stated we hoped to achieve that target despite the expectation that R&D costs would exceed plan by $30 million.

Our analysis of R&D continues unchanged, but I am less certain that we will be able to absorb it all. It is too early to know with certainty…

—Sidney Harman, CEO Harman Industries, April 26, 2007


Unlike most CEOs who prefer to accentuate the positive, Dr. Harman made no bones about the challenges faced by his company:

Permit me to offer a perspective going forward. Ours is a very healthy business, as we have a special place in both the automotive OEM and the professional sides of our work. But we have no conceit that this is a walk in the park. There are challenges as there are opportunities throughout the markets and throughout the technologies with which we work.

There is no guarantee where new, vigorous competition may or may not arise. But my judgment today is that our role in that firmament remains unique. We are the strongest player in that space and our job is to stay there.

—Sidney Harman, CEO Harman Industries, April 26, 2007



All of that is public information, and was presumably available to Mr. Kravis and his deal-makers who had voluntarily agreed to buy Harman’s less-than-certain $4.35 per share of earnings for the absolutely certain price of $120 per share—a multiple of 28-times earnings for what is essentially an OEM supplier to the automobile industry.

Indeed, so happy was Mr. Kravis in the afterglow of the Harman deal that he could not contain his delight with the state of the world a couple of weeks later, when he made headlines with the following statement:

“The private equity world is in its golden era right now…the stars are aligned.”

—Henry Kravis, Banking Conference, May 2007


As market-topping headline go, Mr. Kravis’ “Golden Era” headline will likely go down in business history right alongside economist Irving Fisher’s famous “Permanently Higher Plateau” whopper about stock prices, made just days before The Crash of 1929.

Indeed, even as Kravis spoke the words “Golden Era,” what was happening in sub-prime had already begun spreading quickly and widely, and by late last week the Wall Street Journal was reporting the Harman buyout was in trouble:

Amid a credit crunch and lackluster financial results from Harman, Mr. Kravis and other investors in the deal have soured on the transaction, say people familiar with the matter…. Should KKR and Goldman choose to break the deal, they would have to pay a $225 million termination fee….

—“Harman's Suitors Sour on Buyout,” Wall Street Journal, September 21, 2007

Now, you might think that someone of Mr. Kravis’ stature in the Private Equity business would recognize a bad decision when he saw it, honor his commitments and move on.

But no, the Journal reported: KKR not only wanted to break the Harman deal, but they apparently wanted help from the bankers in paying the termination fee:


KKR has solicited some of the lending banks to help pay part of that fee, said one person familiar with the matter, but the banks have resisted the effort.

—“Harman's Suitors Sour on Buyout,” Wall Street Journal, September 21, 2007

Which is why I say Tim, who unfortunately—for he was not just a great stock picker but a great human being—did not live to see the Housing Bubble, the China Bubble or the Private Equity Bubble of 2007, would no doubt be telling me we are indeed in the wrong business.

Where else can you ask your bankers to help pay mutually-agreed-upon, clearly spelled out penalties, for your mistakes?

Not in my small corner of Wall Street.

And certainly not on Main Street.

I’d like to see Joe Shmo, who took his mortgage broker’s advice and signed on the dotted line for a no doc, interest-only sub-prime mortgage on his tract house in Sacramento, California, go to the bank that owns the loan and ask them to help pay the cost of refinancing his mortgage to something affordable.

They’d laugh him out of the room.

As, you would hope, the bankers did to Henry.


Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Thursday, September 20, 2007

Fed Chairman Flunks Final Jeopardy!



Okay, it’s time for ‘Final Jeopardy’ and the category is…The Economy.

The answer is:

Something that argon, helium, fabric softener, Cheerios, potash, wheat, soybean, waste collection, packaging, spot iron ore and air fares all have in common.

What is the question?

We’ll let the Jeopardy! theme song play in the background while you ponder your response.

Meanwhile, as host of this particular show, we offer the following hint.

The answer we are looking for should be easy for those readers attending this week’s Bank of America conference in San Francisco, during which companies ranging from Procter & Gamble to Waste Management discussed most of these items.

Doesn’t help?

Yikes! The ‘Final Jeopardy’ theme song is moving into that slightly higher register which lets you know we’re getting near the end of the line and you better start writing something.

So let us provide one more clue:

There is one individual who undoubtedly was not in attendance at the BofA conference: Federal Reserve Chairman Ben Bernanke, who, according to his own press release, just cut interest rates not to help out damaged hedge funds and sub-prime mortgage speculators but to avert the “potential” for an economic slow-down in an environment where only “some” inflation risk remains.

Emphasis on the “some.”

Does that help? I thought so.

Okay, the theme song is ending with those final, syncopated notes and that goofy trampoline sound: drop your pens!

Let’s see what you answered.

If you answered “What is ‘price increases’?” you’d be right.

And if you wrote “9%” in the case of fabric softeners, and “25%” in the case of low-volume customers of Waste Management, you’d get an extra hefty congratulations from me, your host.

But you wouldn’t be Fed Chairman, that’s for sure.


Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Wednesday, September 19, 2007

Absolute Mess



Absolute Capital Yield Strategies Fund – Built to last through credit cycles

—Headline of Absolute Capital statement, July 18, 2007

Florian Homm, the co-founder of Absolute Capital Management Holdings Ltd., has quit the U.K-.listed hedge fund after a boardroom clash over how best to boost fund performance and compensate staff during the credit turmoil, sending its share price plunging 70% at yesterday's close.


—Wall Street Journal, September 19, 2007


You will not read about the current turmoil at Absolute Capital (“The Structured Credit Specialists”) on that firm’s web site.

No, the latest entry in the Absolute Capital “Newsroom” is dated way back on August 27th, a lifetime in the fast moving world of credit derivatives.

It was an “update” on the Yield Strategies Fund, which had been “temporarily” closed—i.e. no withdrawals—on July 25th, and it reads, in part, as follows:

Since our last update of late July, we have seen some stabilisation as well as some opportunities emerge. The structured credit market, however, remains illiquid with few secondary transactions being completed and almost no primary issues being priced. What started as a subprime credit event has now spread and impacted just about all forms of credit investments. The result has been a broad-based repricing of credit risk.

Since July, there have been many hedge funds, traditional fund management firms and banks disclosing subprime related losses and/or who have suffered from negative mark-to-market losses across the wider credit markets. In many of these cases problems have been exacerbated by “forced selling” as a result of high levels of leverage and financing terms being withdrawn by banks, something that Absolute Capital has been able to avoid due to its distinct investment strategy…

However “distinct” that investment strategy may be, Absolute Capital has not been “able to avoid” the internal power struggle now making its way to the front pages of the Wall Street Journal, as quoted above and elaborated on as follows:

Mr. Homm, who set up Absolute Capital Management in 2002 with co-founder Sean Ewing and was also co-chief investment officer, is thought to be the most high-profile hedge-fund executive in Europe to leave his post since the credit crunch spread from the U.S. to Europe this summer….

Mr. Homm pledged not to start another fund or compete with Absolute Capital. He did raise the prospect of continuing his activist stance regarding Absolute Capital, Europe's eighth-busiest activist shareholder since 2000 based on research by London Business School published by Financial News last month.

That a hedge fund of Absolute’s size and “high profile” is suffering inner turmoil on the heels of “temporarily” halting withdrawals is not surprising.

What should be more surprising—and distressing to those who have invested their hard-earned money in the Absolute Capital family of funds—is the minimalist news flow available on the Absolute web site.

Herewith a list of all 2007 entries in the Absolute "Newsroom." Note especially the extremely brief time span bridging the announcement that the Yield Strategies Funds were “Built to last through credit cycles” and the closing of those funds.

Like, a week:

March 19 Yield Strategies Fund: Update on US sub-prime mortgage market

April 16 Moody’s upgrades PINS Series 2005-1 rating to Aa2

May 9 Absolute Capital launches New Zealand dollar version of successful Yield Strategies Fund

June 6 Structured Credit Investor: Interview with portfolio manager Campbell Smyth

June 12 Yield Strategies Fund investor update: Volatility continues in sub-prime mortgages

June 28 Yield Strategies Fund investor update: Market impact on our Funds

July 18 Absolute Capital Yield Strategies Funds – Built to last through credit cycles

July 25 Yield Strategies Funds – Questions and answers

July 25 Absolute Capital temporarily closes its Yield Strategies Funds to protect investors

August 28 Yield Strategies Fund – August 2007 update



I am absolutely not making this up.



Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Monday, September 17, 2007

The Least Helpful Research Call You Will See Today



While nearly every business day brings at least one unhelpful research “call”—an analyst upgrading or downgrading a stock long after the news behind the call has already been reflected in the stock price, much the way Wall Street economists have begun to fret over weak housing sales, weak retail sales, and weak employment trends long after all three became obvious to anybody with a pair of eyes and a subscription to the Wall Street Journal—some days one call stands out particularly starkly even in a bleak landscape.

Today that call must belong to the Merrill Lynch analyst who has chosen to downgrade Northern Rock, the U.K. version of Bailey’s Building & Loan—that is, a bank suffering an actual run on deposits, and whose problems were front-page news last week—from a “Buy” to a “Neutral.”


The price on the report? Down two-thirds from its 52-week high.

Nobody can make this up.




Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Friday, September 14, 2007

Captain Renault on Wall Street



Captain Renault: I’m shocked, shocked to find that gambling is going on here!

Croupier: Your winnings, sir.

Captain Renault: Oh, thank you very much…. Everybody out at once!

—Casablanca



It appears that Wall Street’s so-called economists are shocked—shocked!—to discover that retail sales in America declined last month.

These are the same folks, you may recall, who were shocked—shocked!—just last week to discover that payrolls in America had likewise declined last month.

And were shocked—shocked!—at the recent collapse in housing starts...and were shocked—shocked!— at...well, the list is too long even for the virtual world, including as it does
not just the sub-prime bubble and the sub-prime collapse, but also the fact that the sub-prime rot was not contained inside the realm of sub-prime assets, as virtually every Captain Renault on Wall Street maintained it would be, but has spread throughout the world, from Spain to the UK to Asia.

What gives here?

Do these experts not read the papers? Listen to earnings calls? Visit companies? Talk to their neighbors? See the “Open House” signs that sprout up around town on weekends?

Or is it just that, like Captain Renault, they’re part of a system that always seems to find the horse has left the barn and disappeared across the back forty before it decides to firmly close and lock the door?

After all, like Renault, who is shocked—shocked!—at the gambling yet takes his cut before shutting down the joint and leaving the other winners holding the bag, they're still going to get paid, even while the poor shlubs who relied on their sage advice take a write-off.

.

What’s next...Entertainment Tonight is shocked—shocked!—when Britney Spears loses her record contract?


Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Monday, September 10, 2007

Meet the New Boss…



Sometimes in the realm of individuals or companies making things up, it just so happens that no additional commentary is needed to highlight the inherent making-it-upness of the issue in question.

So read and enjoy these excerpts, with emphasis added, from the Sunday New York Times’ front-page business story, “Can Michael Dell Refocus His Namesake?” They tell the whole story, I think...



ON a recent afternoon at his company’s headquarters here, Michael S. Dell is seated in a spacious conference room named Dobie Hall — in honor of the University of Texas dormitory where, in 1984, he started the computer giant that bears his name.

He boasts that Dell Inc. has just reported quarterly profits that exceeded Wall Street projections. It’s an encouraging sign, he says, that the company — buffeted by high-profile production problems and accounting shenanigans — is finally regaining momentum.

Over the last few years, Dell, once the gold standard among PC makers, has simply overlooked major growth trends in personal computing. It missed significant shifts in notebook computer sales and the consumer market as a whole, lagged competitors in international sales, and lost the profit edge that it enjoyed from its superior procurement-and-supply network. Hewlett-Packard having overcome its own woes, passed Dell last year as the largest seller of PCs worldwide.

Dell’s ills also extend beyond the nuts-and-bolts of making and marketing PCs. After a yearlong internal investigation, Dell conceded last month that some managers had falsified quarterly results to meet sales targets from 2003 to 2006….

“The company was too focused on the short term, and the balance of priorities was way too leaning toward things that deliver short-term results — that was the major root cause,” explains Mr. Dell, dressed for the Texas summer in a short-sleeved polo shirt and jeans.


Same as the old boss?



Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Wednesday, September 05, 2007

China's Newest Export: Inflation


Ben Bernanke, the Fed Chairman currently living the nightmare of the Alan Greenspan's free-money daydream, has publicly downplayed the immense benefits reaped by the American Consumer from China's deflationary manufacturing arbitrage, as we quoted in "Fed Big Flunks Eco 101" back on March 7, 2007:

Globalization hasn't had a significant impact on reducing inflation in the U.S. and may have raised it, Federal Reserve Chairman Ben Bernanke said.

—Wall Street Journal


Now, Mr. Bernanke may have been a great economist before succeeding Alan Greespan to the head of that class of academic thinkers, but he clearly never shopped at a Wal-Mart, or a Costco, or even a Safeway, for that matter, during the 1990s, when prices across America were falling thanks to the China arbitrage.

Indeed, if he had just wandered into a Best Buy now and then he would have seen what every retail CEO in America knew first-hand: stuff made in China cost a lot less than stuff made anywhere else, and those retail CEOs were pushing every one of their vendors to get with the program.

But not Mr. Bernanke.

Still, he did make it to the top of the economic pile. And, as the saying goes, even a stopped watch is right twice a day. So it looks like Mr. Bernanke's views on China's inflationary impact might, finally, be right.

While it is no secret that labor costs, and environmental costs, and energy costs are rising, along with the cost of just about everything else China needs to feed the manufacturing beast that now supplies American with 8 out of 10 everything, according to government statistics I just made up, the magnitude of the overall cost increase is certainly a shock to at least one major retailer of Chinese-sourced goods.

Like, 50% shocking.

I am not making that up: word out of one significant retailer is that some of the China-sourced merchandise they were expecting to cost, for example, $10 a unit prior to packaging, shipping, handling and mark-ups, is coming in at $15 a unit.

Now, after checking with other companies that also source in China, 50% gap-ups is not the norm.

But 10% is not unheard of, making companies work extra hard on packaging and distribution costs to get the entire impact down to a more manageable 5% or so.

Which, last I heard, was more than double Mr. Bernanke's inflationary "comfort level."

But, then again, since according to Mr. Bernanke's view of economic history, China never helped us when it came to inflation, then perhaps China will never hurt us.

It's a win-win all around!



Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Monday, September 03, 2007

Mr. Willoughby Shoots the Messenger



June 25, 2007


That makes [State Street] a far different sort of bank than, say, Citigroup…which has struggled to get its multi-faceted global financial supermarket in synch.

—Jack Willoughby, Barron’s


September 3, 2007

The fear -- some of it no doubt fanned by hedge funds -- is that these [State Street] conduits' portfolios, full of credit-card, auto, and mortgage loans the bank uses as collateral for selling commercial paper to investors, have undisclosed losses. If spooked buyers were to balk at buying more commercial paper, State Street might have to provide some funding. Obviously, $29 billion is a big exposure relative to the bank's total capital of $113 billion.

—Jack Willoughby, Barron’s


State Street has a problem.

It seems the bank, which over the years carefully built the best securities processing franchise going, has also accumulated $29 billion worth of off-balance sheet credit exposure to four special investment vehicles known as “conduits.”

“Conduits” is, I think, an excellent term for such financial structures, since what flows through them can be the financial equivalent of anything ranging from spring water to raw sewage.

In the case of certain “conduits” established by a pair of German banks—IKG Deutshe Industriebank and Sachsen—the financial effluent was, as it turned out, a lot like sewage, and would have brought the banks down but for their ignominious rescues.

As for State Street, precisely what is flowing through its “conduits” is not clear except to State Street, which says the assets include credit card debt, auto loans and NOT sub-prime mortgages—all properly priced and liquid as can be.

Mr. Market is not so sure.

After all, $29 billion worth of headline credit exposure to the four measly conduits is a much larger number than State Street’s own shareholder’s equity of just under $8 billion—making those very shareholders understandably nervous.

Furthermore, sentiment towards the company—grandly touted by Barron’s Jack Willoughby as “a far different sort of bank” just weeks before its “conduits” exposure knocked the legs out from under the stock—has not been helped by the fact that one of State Street’s many investment funds was, apparently, so chock full of sub-prime something that it lost enough money in early August to make headlines in the Boston Globe.

Which brings us to Mr. Willoughby's messenger-shooting.

The recent conduit-related decline in State Street’s stock triggered a defensive “Follow-Up” column from Barron’s this weekend, in which Willoughby, as quoted at the top, placed blame for State Street’s problems squarely on the shoulders of where it belongs…the management team that elected to accumulate $29 billion worth of credit exposure to off-balance sheet financing vehicles in the first place.

Actually, I am making that up.


He blames hedge funds, in part. I am not making that up:

The fear -- some of it no doubt fanned by hedge funds [emphasis added]-- is that these conduits' portfolios, full of credit-card, auto, and mortgage loans the bank uses as collateral for selling commercial paper to investors, have undisclosed losses.

Why a Barron’s reporter should take am at the hedge fund messenger, rather than the P.R. flak who presumably pitched him the State Street story in the first place, is beyond me.

Hedge funds had nothing to do with establishing State Street’s off-balance sheet “conduits,” or loading them with credit card debt, or mortgage debt, or auto loan debt.

Nor did any “hedge fund” that I know of encourage State Street’s Limited Duration Bond Fund to lose enough money in early August to make a story out of it in the Boston Globe.

In fact, I can’t think of anything at all that “hedge funds” have had to do with State Street except use their excellent back-office services, and, perhaps, short the stock.

Perhaps if Mr. Willoughby had called one of those “hedge funds” savvy enough to have shorted State Street when he was preparing his original puff piece, he might have seen what was coming and toned down his glowing company love-fest, which called State Street “a different kind of bank” and contained such cringe-making quotes as this, from State Street’s CEO:

“Revenue growth will separate the men from the boys.”

In fact, had Mr. Willoughby spoken to a hedge fund manager or two about the company’s ballooning exposure to off-balance sheet “conduits” rather than relying, as he apparently did, on the good graces of the company’s own P.R. flaks to make the CEO available for carefully scripted interviews, he might even have given Barron’s readers a useful heads up, instead of cringe-making observations such as this one:

Such a well-informed streak of independence is refreshing in a CEO, even if it doesn't always make him popular.

Of course, defending a one-sided, rose-colored bit of reporting is easier to do if one blames the messenger without re-examining the original premise of the piece in the first place.

However, if he had indeed chosen the harder way, Mr. Willoughby might have found that he had actually identified the source of State Street’s current dilemma in his original puff-piece, when he stated:

As always, State Street stands ready to exploit the next professional money-management trend.


Trends such as “conduits,” perhaps?



Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.