Monday, November 23, 2009

The New Risk Factor: Expletive Deleted

A new “risk factor” is cropping up in company conference calls: healthcare legislation.

Before the Securities Litigation Reform Act came along in 1995, companies could—and would—be sued for things that influenced their stock prices, even if those things were beyond management’s control.

Nowadays, so long as a company starts off its earnings call or conference appearance with a long-winded disclaimer of “risks and uncertainties”—to the effect that “Anything we say today might turn out wrong”—the company is somewhat safe from tort lawyers with nothing better to do than trolling for companies to drag down like wolf packs.

Usually, the “risks and uncertainties” covered by these disclaimers relate to demand, supply, pricing, margins, currency fluctuations, tax rates, inflation, earthquakes, patents, intellectual property and, of course, litigation from tort lawyers—among much else.

We are here to report that this “much else” now includes a new “risk factor,” healthcare legislation, as management of Dick’s Sporting Goods—a well-run retailer currently suffering at the hands of a retrenched consumer—highlighted on last week’s conference call:

We believe there is much uncertainty around the consumer's attitude towards spending this holiday season, driven in part by the potential impact of healthcare legislation, possible new tax legislation, and the recently-announced 10.2% unemployment rate.

Dick’s management did not elucidate on the legislation coming out of Washington, but David Farr, the CEO of Emerson Electric Company, did, at a presentation on November 11 at an RW Baird Industrial Conference.

In fact, “elucidate” is too sedate a word for what Farr did: in fact, he unloaded.

Now, David Farr is not your normal grumpy CEO. He does not, for example, preside over a market-share-losing, money-losing, possible-NASDAQ-listing-losing enterprise like a certain irascible, finger-wagging, conspiracy-spewing CEO we could think of.

Nor has he done a discreditable job guiding his worldwide, industrial-sensitive enterprise through the financial crisis: indeed, despite a $4 billion sales drop (on a base of $24 billion), Emerson generated near-record cash flows in its just-ended fiscal year.

And since Emerson has its fingers in almost every aspect of the global economy, from chemicals to climate controls, attention ought to be paid.

Thus we thought it noteworthy to pass on Farr’s passionate, but informed, views on the current healthcare legislation and much else coming out of Washington, thanks to the indispensible StreetEvents. (Farr’s words in bold.)

“A Whole Different World”:

[This has been] a very drastic downturn.

And the key issue is how fast is it going to recover? I'll give you some ideas in a second on this. But I don't think it's going to be as fast as people believe. There's a lot of stress in the world today.

As I look at the Company and I look at the last two recessions, I just started my 10th year as CEO and I have had my second recession. It used to be ten-year cycles. We're going to five-year cycles now, it looks like.

And so if I look at the last downturn in '01 and '03, we took a 14% reduction in the headcount. We closed 75 facilities worldwide. We spent about $440 million restructuring, got the Company going and we grew quite rapidly.For five years, underlying growth rate of 8.5%, earnings growth close to 20%, certainly a lot of cash, the returns at an all-time high, close to 22% return on total capital for us at the endpoint. And then the shock came.

I look at this cycle and what's happening to us different than anything we have seen before. The world is definitely changing.

You're going to see a whole different world emerge in my opinion over the next five to 10 years as the mature markets -- the US, Japan and Western Europe which are highly stressed, highly increasing debt levels and basically restricted of what they can do; if you don't have a major play in the emerging markets, you will not see the type of growth that we have been seeing for the last four or five years.

“Definitely Getting Better”:

We are dealing with a very difficult environment. It's not going to change. It's going to get a little bit better. But we are still dealing with a very weak global manufacturing industrial environment, though not as bad as it was two or three months ago as you'll see.

So as I look at that this right now, we're looking at a very challenging year again; not as bad as last year. I mean, down 12% is the worst we have ever seen but it's definitely getting better and you'll start seeing this trend line coming. You will see that our orders will follow that very quickly….

“I’m Not Going to Hire Anybody in the United States”

Now, to tell you how bad this is and tell you what I think Washington is doing right now, Washington is doing everything in their manpower capability to destroy US manufacturers, fundamentally destroy US manufacturers.

Cap and trade, medical reform, labor rules, whatever they want to do, raise taxes. They're just going to destroyed jobs. We have already reached 7.3 million jobs in this downturn. We're going to 8. That is a summation of the last four downturns.

So what do you think the recovery is going to be in jobs? It ain't going to be very good. I listen to everything Washington is doing -- wasting money, raising the deficit to 10, $12 trillion -- the debt level to 10, $12 trillion, going to $23 trillion; raising taxes; putting regulations and requirements on me as a manufacturing company.

What do you think I'm going to do? I'm not going to hire anybody in the United States. I'm moving. So they're doing everything possible to destroy jobs, in my opinion. That's my opinion as a manufacturer and we employ 125,000 people worldwide. So I do know what the (expletive) I'm talking about.

We used to employ a lot more in the United States and we will continue to move [all this]. When I see guys like this, Wall Street bailouts, car bailouts, I'm looking -- what are these guys doing with our money? They're wasting trillions of dollars, trillions of dollars.

So what they are going to do, they're going to pass a new medical healthcare, raise my costs, jobs will go. Cap and trade, tax me, jobs will go. It's pretty straightforward. What they're doing right now ain't working. 8 million jobs, summation of the last four downturns….

“Where the Opportunity Right Now Is”

Why do you think we're moving our companies into the emerging markets? Because that's where the growth is. That's where the jobs are going to be. That's where we can create value. Share of this market is going to get less. It's going to go down to 45%.

So this is where we're making our investments because this is where we are going to grow. This is what is going to happen in the economy. And so if you look at where the opportunity right now is, it's not in Rhode Island. It's not in Connecticut, it's not in Illinois.

It is in India, it's in China. I'm taking another trip to China on Saturday. I go there seven, eight times a year. I go to Latin America, I go to the Middle East. That's where the growth is going to be, international.Since I've been CEO, we've added close to 19 points of emerging market sales. We're up to 33%.....

If you look at the last 10 years…73% of our growth has been in emerging markets. We have invested aggressively.

Where “The Degree of Freedom” Lies:

I lived over there, I ran Asia for a long time, for almost five years. I see the next five years an underlying growth rate of 5 to 7%. We're going to have over 60% of our growth in emerging markets, maybe 70% again.

The trend lines are there. Mature market growth will be a lot less just because the economics and the degree of freedom and the overcapacity issues we face in these countries.

So we as a Company today are putting our best people, our best technology and our best investments in these marketplaces to grow. Because my job is to grow that top line, grow my earnings, grow my cash flow and grow my returns to the shareholders.

My job is not to shrink and roll over for the US government. That is not my job. That's not what I get paid to do.

“Expletive Deleted”

You talk about in renewable and alternative, we have $50 million this year. We're going to go to over $800 million in five years. We created wind converters for China. We have pitch controls, electronic controls for the windmills.

At the bottom, we have solar products, both the systems and power conversion. So we have created a whole portfolio of products for this. But you're not going to see Emerson going out there with fancy commercials or sitting at the right hand of some president talking about this (expletive). We do it. We (expletive) do it (expletive).

I don't need to be told, I don't need to get government handouts, I can do it without them.

Before dismissing Farr as somewhat unhinged, recall that he employs 125,000 human beings and knows a thing or two about global competition—having lived in Asia himself, and more than doubling his company’s international business in ten years.

Also, companies do not call out items as “risk factors” just for the heck of it: clearly Dick's Sporting Goods sees a potential problem looming with its own customers.

And by way of coda, we’ll share a quote on the subject of healthcare reform from the calm, deliberate CEO of a small US-based company that manufacturers nearly all its product in China.

When asked if the recent drop in the US Dollar would hurt his price advantage versus US-sourced competitors, the CEO noted that, for one thing, dollar-priced raw materials consumed in China are paid for in a strong currency, keeping his cost of goods lower than for a US producer importing the same raw materials.

And for another thing, he added matter-of-factly, “When this healthcare bill passes, nobody’s going to want to manufacture in the U.S. anyway.”

Expletive deleted, indeed.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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 investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Anonymous said...

I like his take on future growth areas and where they will be investing as it makes perfect sense. But all that, expletive and all, begs the question: So what was the excuse for outsourcing before the downturn, before cap and trade, before health care reform?

As bone headed as many moves out of Washington are, business are doing the same now as in the past 20 years: moving jobs out of the country. Doesn't matter if it's a D or an R, up or down, the response has been the same, for better or for worse. And it is rather ingenious to latch on to the downturn and a particular set of legislature as explanation for what's already been happening at Emerson and countless companies around the country.

So when the pendulum swings the other way, will they remember to bring jobs back?

Anonymous said...

It's sad that you even have to defend these comments as not coming from someone "unhinged." Surely the people that should have to defend themselves from that label are the ones who would saddle a struggling economy with onerous new regulations, cap & trade, who think healthcare reform will improve the situation AND be budget neutral, etc. Surely they're the unhinged folks.

Jeff Matthews said...

Anonymous 1 forgets that manufacturing has been moving to low cost areas ever since the textile mills moved from New England to the Carolinas.

Anonymous 2 raises a good point: those who question healthcare policy and anything else coming out of the new administration, tend to be ridiculed rather than debated.


Anonymous said...

Anonymous 1 remembers well that low cost areas get the jobs over high cost areas. It's in the same cliff notes to common sense as buy low, sell high.

What Jeff is missing in Anonymous 1 point is that despite the move overseas happening for a long time, somehow neither Infosys nor Intel nor IBM nor GM (as examples) cited government policy as reason for having work force overseas. The same types of political forces have been at play for a long time, but was Andrew Jackson blamed for industries changing locations? A company found a scapegoat for something they were doing already, big whoop.

Citizen AllenM said...

You forget the exporting of jobs is all built on the ability to freely export the finished products into the United States. I would reconsider the location of the production in his case if the tariff (carbon tax or whatever it will be called) kills that competitive outsourcing. Over the long run, expensive resources will dictate that the US dollar no longer commands 20 plus percent of the world output. If the dollar drop to half of the current value, something the commodity markets indicate is possible, how much advantage is there in continually exporting employment?

In short, the man only sees the unit costs, and not the fact that the source country can no longer support the export of employment, and the free ride from the reserve currency.

Short termism at the maximum- assuming the dollar will be long term strong. Not to say in trading terms it might not manage a punishing squeeze, but long term, when the terms of trade adjust, the export jobs trade will be dead.

Douglass Truth said...

wish one of these guys would let loose some expletives on what is really bankrupting us: military expenditures. It's an age-old losing-proposition. It's as if empires can't restrain themselves from such absurd scenarios as our Afghanistan catastrophe. Thank goodness it's open to question now. The topic being, our military addictions cost us far more than health care "reform".

Anonymous said...


I normally admire your ability to see through the bull. Unfortunately, I think you are too caught up in it this time. People have plenty of bigger reasons not to shop at Dick's like unemployment, underwater mortgage, etc. But hey, after two years if you havent turned the ship, time to come up with a new excuse. Points for creativity?

Regarding Emerson, give credit where credit is due. Rather than wait to become a target by some populist pol for moving jobs overseas, they are taking the offensive. That doesnt make it any less of a silly excuse as they would almost certainly be doing the same if the pols in DC were doing nothing. But at least they are taking the initiative and further kudos because they seem to genuinely believe it.

What's next, a hedge fund implodes because the manager concerned over health reform decided he needed to make more money and took on too much leverage?

Jeff Matthews said...

Always "Anonymous" are the fact-free comments.


Marty said...

So should those of us who have maintained geographically-diversified portfolios for years panic?

John said...

After reading David Farr's comments i couldn't help but think what a great addition he would have made to a Ronald " Old Europe" Rumsfeld lead Department of Defense. Old Europe was a term Rumsfeld used to discribe the European counties that refused to support Bush and his Iraq invasion. I wonder, did Mr. Farr discuss what that might do to his business ?

Anonymous said...

Hmmm... that Emerson CEO is probably not a democrat.

Similarly, I met a ceo of a small connector company in San Diego. He basically stopped capex and shut down his company because of Obama. He thought we were doomed starting late last year. Even though he has no idea how healthcare will really work, he's convinced it will kill business. He's basically gone into runoff mode. It's not the economy per se, it's his outlook. He's too negative. He hates Obama.

John said...

A different world indeed.

Yahoo tells us Mr. Farr has been CEO of Emerson about 10 years. Yahoo tells us he has over $40 million in stock and is paid $4 million a year. Not bad. He certainly will not have to worry his pension is cancelled. He will not have to worry about his healthy insurance. But he just might have to worry about his tax bill ! ...The world certainly is changing Mr. Farr. The top 5% have or control 50% of the nations or worlds wealth. My figures might be wrong but the point is clear. I don't know what will help but i don't believe you do either.

But What do I Know? said...

This is some great commentary. As Citizen AllenM puts it, the difference betweeen us and other high cost manufacturing areas like say, Germany or France or Japan, is that the executives of American companies have the ability to move their operations overseas and still import into this country. As one of the Anonymous poster said, there are always reasons for moving from developed to underdeveloped countries to do manufacturing. The reason they generally don't in Germany or France or Japan is that they wouldn't be able to get back into an essentially closed home market (I'm generalizing, of course.)

A high tariff made this country great--there's an inconvenient truth for all of the economists and B-school majors out there.

Anonymous said...

Jeff, a zero substance response to something that points out a flaw in your hero's new found logic? At best, you are treading a ground between pot and kettle. At worst, you are conceding to the point that several posters made here: the excuse of government messing around has been around for decades, using it now is nothing but a (Wall Street) populist trick.

Jeff Matthews said...

There's no need for "excuses" to move manufacturing. Companies go where the costs are lowest.

For a CEO to point out, forcefully, that raising the cost of being in America by $1 trillion a year thanks to healthcare reform--on top of everything else--will merely exacerbate the exodus...well, "It's not personal, Sonny. It's business."


John said...

Companies also list their stock were capital is the cheapest and most available. That is until they decide to delist, like Canada's Fairfax financial did the other day. I wonder why ?

But What do I Know? said...

""Companies go where the costs are lowest.""

No, Mr. Matthews, that's just the point. *American* companies go to where the costs are lowest. European and Japanese companies do not (in general.) Now, I will admit that there are advantages to both ways of doing things (lower prices for consumers is our way--more stable employment is theirs.) But there are costs to moving manufacturing out of this country--including innovation and new discoveries--that are not included in a company balance sheet or income statement.

What is good for Mr. Farr (and the EMR shareholders) is not necessarily good for the country.

Jeff Matthews said...

"But What Do I Know?": You're wrong on the facts. I'm sorry, but you're wrong.

For starters, European governments make it extremely difficult to fire people--this is not a sweeping generalization of a know-nothing hedge fund guy: it's just the way it is, and you can ask anybody who's ever run a plant in Belgium or Germany--so moving production out of Europe is infinitely tougher than in the U.S.

That notwithstanding, anyone who follows the technology industry knows that even European companies moved much of their production offshore long ago.

Just as one example, here's an article from as far back as 2001, when Nokia (based in Finland) decided to move production out of Texas to Asia and Mexico.

Please note the comments about Ericsson (Sweden) as well.

Nokia sends some US manufacturing to Korea, Mexico
By Corey Grice, CNET,
Monday, February 05, 2001 04:25 PM
Nokia, the world's No. 1 maker of mobile phones, said Friday it will shift some of its manufacturing from Texas to factories in Korea and Mexico, making it the latest handset manufacturer to alter production plans amid the industry's slowing sales.
The Finnish wireless company also plans to lay off about 800 full-time employees at two Texas production plants over the next five months.

Nokia's move follows manufacturing alterations made by rival cellular phone makers over the past year. Last month, Swedish wireless company Ericsson, the world's No. 3 mobile phone maker, announced plans to exit the handset manufacturing business as it reduced revenue and profit forecasts for the year. Instead, Ericsson will out source its phone production to Flextronics International.

David Chamberlain, a senior wireless industry analyst at market research company Probe Research, said that geography could have a strong place in Nokia's finances.

"The biggest area of growth is in the lower-end handsets. Typically, it's the (production of) lower-end phones that get(s) pushed offshore," Chamberlain said. "A lot of the time the components are made in Asia. So the closer you can have the manufacturing and assembly, the lower your expenses will be."



Anonymous said...

We have a few college students online from Fairfield University and we love your blog postings, so well add your rss or news feed for them, Thanks and please post us and leave a comment back and well link to you. Thanks Jen , Blog

Paris Hilton said...

Speaking of Nokia, their stock looks pretty good to me. Any opinions?

Trader said...

Overstock on Lex. Jeff, Sorry about this off-topic post but I know you're a fan of Byrne. See the MSM reporting on his latest tricks at FT's Lex column.

Dean said...

In light of having just read the sobering Copenhagen Diagnosis (the latest update on the IPCC), I'd like to point out that this is why cap and trade doesn't make sense if it's not done globally.

The costs are lower if you can pollute without paying for it. Therefore, as Emerson's CEO shows us, the cost-minimizing response to cap and trade regulation is to move to a country that doesn't have these regulations.

Cap & trade should be global, so that you can't game the system. But as it is now, it rewards the countries that allow pollution with jobs & growth, while punishing responsible countries. Hmm.

Tragedy of the commons par excellence.

Jeff Matthews said...

Thanks, Fairfield U!

And Dean makes an excellent point. Spot-on.


spare me said...

Western companies are following the most vapid of market signals from countries like China - for instance China has no problem building an empty city capable of housing 1 million people. And also doesn't mind building the worlds largest mall, despite it also being empty. The returns on these projects are nil...but boy does it churn the wheels!

The whole Country has a return of nil. It's one big ponzi scheme that says and does whatever impresses the West, despite how hollow those words and actions are. But apparently, at least according to Emerson's CEO, it sounds better than the US...right?!

Who's the dumb *expletive* now?

Anonymous said...

Ok, so let's all get angry at the rich CEO and the large corporations that moved jobs out. The bigger point is that bonehead increases in taxes, with poorly designed bills (and cap-and-trade and the versions of health care bills, and a poorly done stimulus package etc etc), will hurt all businesses. You want to add on expensive wars, and incredible wastefulness in most government departments, ok!

But the populist response to Jeff's posting of the remarks misses the bigger points. It's not just about outsourcing, it's about jobs and the ability to hire.

Small business will be particularly hurt by the rules and regs, and guess what, small companies might not be able to outsource, and will get stuck with the tab. They won't hire...they are not hiring now. They can't, with all this uncertainty, and if the price tag is too high, they never WILL if they can get away without it.

But What do I Know? said...

Look, I know there are going to be some instances of European or Japanese companies moving some of their production out of their home countries--I mean, look at the car assembly which they do in this country. But one swallow doesn't make a summer. In general, they keep a lot of production of high value-added stuff there that could be done more efficiently elsewhere--and they keep the business and design offices in the home country as well--quite possibly because it is so difficult for them to fire people, as you rightly point out. But that has kept employment more stable, and maintained their manufacturing base--while ours has been hollowed out. If our job market is so wonderfully flexible in comparison, how come no one's hiring here? Because we are too expensive to compete with the other flexible labor market countries like China, Vietnam, etc.

You are perfectly correct on cap-and-trade--it sounds like a scam from the get-go: a system designed by academics and insiders which will have gaping loopholes and will be manipulated and contorted the way Enron twisted the energy market.

Proudhon said...

Call me crazy, but it would seem to be that employers who provide health insurance to their workers would welcome this health care bill.

Is this just the reflexive "socialist" rhetoric we've come to know and love, or have people really thought through the issues?

The CBO scored the Senate bill as a net deficit reducer, and there are a slew of cost containment measures that employers should be welcoming.

Dick's is no slacker when it comes to offering employee benefits - they're well above average for retail. I'd just love to hear specific details of how this bill will hurt them. I know the bill and I honestly don't see the problem. What is the source of the trillion dollar number? Real numbers, anyone?

Tahoe Kid said...

There once was a CEO from Nantucket
Who ran things on a tight budget
Higher taxes his company paid-day after day!
The government cried “Hire more AND with more pay!”
“Enough!” cried the man, every which way!
Government leaders ignored all he did say,
He spied out his window “The world is quite flat!”
All while his government got much too fat!

PT said...

I'm with proudhon, real values behind the opinion would be conducive to a better discussion. Emerson has, by-the-bye a very sweet retiree's health plan as well as some of the better benefit/compensation packages around. So what is it about the health care plan that is so onerous it will make them take further flight?