Monday, November 29, 2010

1,359 Words for “Caveat Emptor”

“We’re nothing but a mirror of our consistent thoughts. You tend to manifest what you focus on. If you look around for what’s wrong, you’ll find it. But as all we know up here in San Francisco, when you focus on what’s right, you see it all around you. … There is absolutely nothing wrong with California that can’t be fixed by what’s right with California. … If you’re from another state, you’d love to have the problems of California.”

–California Lieutenant Governor-elect Gavin Newsom

Leaving aside the new-age psycho-babble, as well as the fact the more than a few states do have “the problems of California,” we couldn’t help think of the San Francisco Mayor’s recent election-eve musings as we listened to the earnings call of a company that, we submit, gave a pretty good demonstration, if inadvertently, of something that is wrong not merely with California but with all of America.

Now, this large retailing success story has its detractors—zillions of them, if you were to believe the mainstream media, although when you scratch the surface of that mistrust, you find mainly disgruntled union bosses and superficially populist politicians (including our current Vice President, who once actually campaigned against the company’s expansion), scared by the company’s hyper-efficient operating methods, not to mention the fact that it isn’t a union shop.

Thus do people with one agenda look for whatever dark clouds they can find in the silver lining of a company that brings, by our brief calculations, more than ten billion dollars worth of reduced living costs to the American consumer each year.

The company is Wal-Mart, and fully 60% of American adults shop at one of their stores at least once a month. (By way of comparison, Target is shopped by 25% of American adults monthly).

It goes without saying that those 120 million or so monthly visitors to Wal-Mart are hardly a uniform picture of American poverty, as the mainstream media would have us believe. But, then, mainstream media types—not to mention Vice Presidents—don’t shop there, so what would they know?

If they did shop at Wal-Mart, however, what they would know is that a basket of typical good purchased at Wal-Mart costs anywhere from 2% less than the competition in the company’s original mass merchandise business (think Sears), to 10% less than the competition in the case of groceries, which now account for half the company’s U.S. sales.

Applying those savings to the company’s $300 million-plus in U.S. sales, you arrive at roughly $18 billion in savings Wal-Mart provides its customers. Each year.

Now you would think that a company that helps consumers save $18 billion a year would be justly celebrated and encouraged to flourish—within the bounds of legal competitive behavior and the rule of law.

But this is America, and America is now governed by trial lawyers—and that’s one thing that’s wrong with America, which Wal-Mart’s latest earnings call illustrated as well as anything we’ve seen since Congress passed so-called healthcare “reform” legislation without bothering to reform the tort system.

(Hey, when 56 Senators are lawyers—not to mention the President, Vice-President, and 36% of Congresspersons—while only two Senators are doctors, well, the fix on tort reform was in from the start.)

Now, it wasn’t so much the earnings discussion, which involved, as it usually does, Wal-Mart’s extensive retail operations—from Bentonville to Leeds—that shed a light on the trial lawyer problem in America.

It was the preamble—the so-called “Reg. FD” disclosure statement that public company executives make before launching into a discussion of business.

For the record, we’ve long thought Reg. FD was one of the really good rules promulgated by the Feds, eliminating, as it did, the kind of selective disclosures companies used to make to Wall Street’s Finest.

(We remember well the pre-Reg. FD days when conference calls were restricted to specific Wall Street analysts and specific buy-side investors. The chosen few would, for example, get on the Hewlett Packard earnings call not because they cared a whit about Hewlett Packard: they got on so they could find out what was happening to DRAM pricing—this was in the days before DRAM prices were instantly available on what Tracy Jordan calls “The Interweb”—and then would, while the HP call was still ongoing, trade shares of Micron and other various memory makers.)

The one downside of Reg. FD is that companies use part of the discussion to point out—strictly for the legal record—the obvious: that stuff they are going to talk about on their earnings call could change down the road, thanks to the fact that, well, stuff changes.

You might think this notion is fairly obvious, but whenever a public company announces a sudden, unexpected negative situation, like bad earnings or a lawsuit or an investigation of some sort, the company is invariably hit with lawsuits from trial lawyers looking to dredge up some cash flow.

Just last month, for example, Green Mountain Coffee Roasters was hit with lawsuits from a whole batch of trial lawyers a few days after announcing an SEC investigation into the company’s accounting.

Green Mountain made its announcement on Tuesday, September 28. On Friday, October 1, seven law firms announced “investigations” or “securities fraud class action lawsuits.” On Monday, three more jumped into the lottery sweepstakes, and by week’s end a few more joined in, including one firm that issued a press release with the following headline, which we are not making up:

“….Encourages Investors Who Have Losses in Excess of $500,000 From Investment in Green Mountain Coffee Roasters, Inc. to Inquire About the Lead Plaintiff Position in Securities Fraud Class Action Lawsuit Before the November 29, 2010 Lead Plaintiff Deadline”

Now, we’re all for good corporate governance, and for companies keeping things on the up-and-up. Short-selling is an investment tool we employ frequently, so it is a part of our business model to find companies that may not be doing all the things they like to say they’re doing on earnings calls. Few things in this business are as satisfying as spotting a public company masquerading as something it is not—and making money when the chickens come home to roost and things go kablooey.

The problem with trial lawyers, of course, is that they rarely spot frauds before the frauds go kablooey. They spot the frauds after they go kablooey.

Thus it is that public companies feel pressured to offer Reg. FD “disclaimers” that can be a few short sentences or can verge into Gravity’s Rainbow-length missives, and Wal-Mart, being a target anyway, thanks to its fantastically successful non-union operation, goes to great lengths to cover all the bases.

To such great lengths does Wal-Mart go, in fact, that the disclaimer goes on for more than a few minutes: it goes on for more than ten minutes.

We are not making that up: of the 11,369 words spoken on the recent Wal-Mart earnings call, 1,359 of them—12%—came in the disclaimer section.

And if there was ever an example of something wrong with America, we think it is the notion that one of the world’s great corporate successes must waste 12% of its time on a prophylactic, legalistic mush of words, not one of which contributes to the general welfare of anyone.

But judge for yourself! Here’s the entire legal disclosure, thanks to the indispensible

Welcome to the Wal-Mart earnings call for the third quarter of fiscal year 2011. The date of this call is November 16, 2010. This call is the property of Wal-Mart Stores, Inc. and intended solely for the use of Wal-Mart shareholders. It should not be reproduced in any way.

This call will contain statements that Wal-Mart believes are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, and intended to enjoy the protection of the safe harbor for forward-looking statements provided by that Act.

These forward-looking statements generally are identified by the use of the words or phrases anticipate, are anticipating, are expecting, assume, could be, expect, forecasting, goal, guidance, guided, is expected, is planning, may affect, plan, will accelerate, will add, will be, could save, will drive, will ring, will be growing, will come, will continue, will cost, will experience, will generate, will grow, will improve, will not continue, will remodel, will see, will spend, will take, would represent, or a variation of one of those words or phrases in those statements or by the use of words and phrases of similar import.

Similarly, descriptions of our objectives, plans, goals, targets, or expectations are forward-looking statements. The forward-looking statements made in this call discuss, among other things, management's forecasts of our diluted earnings per share from continuing operations attributable to Wal-Mart for the fourth quarter of fiscal year 2011 and for all of fiscal year 2011; the assumption underlying those forecasts that currency exchange rates will remain at current levels; management's forecasts for the comparable store sales for our Wal-Mart U.S. segment and comparable club sales, without fuel, for our Sam's Club segment, in each case, for the current 13-week period; management's expectation that the comparable store sales of our Wal-Mart U.S. segment will be positive for the holidays and the fourth quarter of fiscal year 2011 and that the fourth quarter of fiscal year 2011 will be another quarter of sequentially improving comparable store sales for our Wal-Mart U.S. segment; management's expectations as to our anticipated tax rate for fiscal year 2011, quarterly fluctuations in that tax rate and factors that will affect that tax rate; management's forecasts for Wal-Mart's capital expenditures in fiscal year 2011 and fiscal year 2012; management's goal for return on investment being maintaining a stable return and management's expectations that Wal-Mart will continue to manage its inventory to be in line with its current business needs; although Wal-Mart will see year-over-year pressure from higher inventories in the fourth quarter of fiscal year 2011, that our Wal-Mart U.S. segment will be the price leader throughout the holidays; that inventory levels at our Wal-Mart U.S. segment will stabilize and Wal-Mart will once again generate even more cash flow; that our operations in Brazil will improve, growth in Wal-Mart's operations in China and India will accelerate, growth in Wal-Mart's Mexican operations will continue and supercentres will be added in Canada; and that the sales momentum of Wal-Mart's Sam's Club segment will continue into the fourth quarter of fiscal year 2011 and into fiscal year 2012; and the Sam's Club segment will leverage expenses in fiscal year 2012.

Those forward-looking statements also discuss management's expectations for the Wal-Mart U.S. segment relating bake centers driving the segment's sales in November and December 2010; supplier recalls in the health and wellness category remaining a headwind in the near term for the segment; a new Medicare Part D prescription drug plan driving incremental pharmacy traffic for the segment; the sales of Straight Talk by the segment in fiscal year 2011; and how the sales of that item could affect comparable store sales of the segment if the full transaction value for those sales was includable in the calculation of comparable store sales; the sales of Straight Talk and third party gift cards will ring through the Company's registers more than $2 billion for the full fiscal year; continued strong online sales in the 2010 holiday season for the segment and the factors to drive those sales; the number of new supercenters and other formats, including new units, to be opened in fiscal year 2012 by the segment; the number of the segment's stores to be remodeled in fiscal year 2012 and changes in the cost and time of those remodels; and the timing of Christmas spending in 2010.

Those forward-looking statements also address management's expectations that our Wal-Mart International segment will experience a very competitive fourth quarter in some of its markets; that such segment's sales will grow, although the segment will experience pressure on its overall gross margin; that the sales of that segment's operations in Mexico will grow by certain means; that such segment's Brazilian operations will continue to see pressure on those operations' results from the operating structure in Brazil, changes thereto and the effects of a conversion to an everyday low price approach, and regarding product offerings by that segment's ASDA subsidiary and the addition of new stores and square footage to that segment through an acquisition by ASDA and the timing for conversion of those new stores to a different format.

Those forward-looking statements also discuss management's expectations that Wal-Mart's Sam's Club segment will not continue to feel the effects of a credit card processing fee in the fourth quarter of fiscal year 2011; that such segment's small business memberships will continue to pressure net membership income in that fiscal quarter and regarding the occurrence of promotional events in the segment's units relating to the holiday season.

The forward-looking statements also discuss the anticipation and expectations of Wal-Mart and its management as to other future occurrences, objectives, goals, trends and results. All of these forward-looking statements are subject to risks, uncertainties and other factors, domestically and internationally, including general economic conditions; geopolitical events and conditions; the cost of goods; competitive pressures; levels of unemployment; levels of consumer disposable income; changes in laws and regulations; consumer credit availability; inflation; deflation; consumer spending patterns and debt levels; currency exchange rate fluctuations; trade restrictions; changes in tariff and freight rates; changes in costs of gasoline, diesel fuel, other energy, transportation, utilities, labor and health care, accident costs, casualty and other insurance costs, interest rate fluctuations, financial and capital market conditions; developments in litigation to which Wal-Mart is a party; weather conditions; damage to our facilities resulting from natural disasters; regulatory matters; and other risks.

We discuss certain of these matters more fully in our filings with the SEC, including our most recent Annual Report on Form 10-K and our most recent Quarterly Report on Form 10-Q, and the information on this call should be read in conjunction with that Annual Report on Form 10-K and Quarterly Report on Form 10-Q, and together with all our other filings, including current reports on Form 8-K, which we have made with the SEC through the date of this call. We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating the forward-looking statements we make in this call.

Because of these factors, changes in facts, assumptions not being realized or other circumstances, our actual results may differ materially from anticipated results expressed or implied in these forward-looking statements. The forward-looking statements made in this call are made on and as of the date of this call, and we undertake no obligation to update these forward-looking statements to reflect subsequent events or circumstances.

The comp store sales for our total U.S. operations and comp club sales for our Sam's Club's segment and certain other financial measures relating to our Sam's Club segment discussed on this call exclude the impact of fuel sales of, and other amounts for, our Sam's Club segment. Those measures, our return on investment, free cash flow and amounts stated on a constant currency basis as discussed in this call may be considered non-GAAP financial measures. Reconciliations of certain non-GAAP financial measures to the most directly comparable GAAP measures are available for review on the Investor Relations portion of our corporate website at, or in the information included in our current report on Form 8-K that we furnished to the SEC on November 16, 2010.

In other words, “Caveat Emptor.”

Which we already knew.

Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

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

Monday, November 22, 2010

A Very Palpable Hit

We poke fun at many companies in these virtual pages, but there is one in particular that we tend to poke fun at more often than most. It is a company that has been immensely successful in its field and in a financial sense, and has certainly added more value to the human condition than any hedge fund or virtual column such as this.

Unfortunately, that value-add has been derived mainly from a now-fading monopoly that has also imparted so much frustration on its choice-hampered customers that the poking of fun is easy.

We speak of Microsoft, whose rigid devotion to its Windows operating system has resulted over the years in such a mind-boggling array of feature-rich, user-unfriendly product families that we wouldn’t be surprised to find that there exists, somewhere in a far-off Staples, several copies of “Microsoft Vista Home User Release (Version 2.1) Model-Train Enthusiast Edition™” gathering dust.

Our general contention has been this: so complete is Microsoft’s reliance on its Windows monopoly that whenever it ventured outside the confines of that monopoly, it brought the same feature-rich, user-unfriendly approach to everything it touched, yielding one dud after another.

For the genesis of this Windows-obsessed, customer-indifferent mindset, we pointed no further than CEO Steve Ballmer, who famously enjoined his children from using iPods made by Apple and search engines created by Google, thereby running the company more like a Big Three car company from the 1960s rather than a technology company in the 2000s.

How else to explain “Bob” (look it up, kids), the WebTV debacle (look that one up, too), the “Kin” black hole, not to mention a tablet PC operating system that will likely be dead on arrival in a market pioneered by Apple’s slick iPad and soon to be invaded by products using Google’s Droid OS, which has already taken the smart-phone market by storm.

Nevertheless, the title of this virtual column is “Not Making This Up,” and longtime readers know that we are more partial to facts of a case—whatever that case may be—than to the sentiment of the moment.

(Indeed, this is why we do not brook any Yahoo-Message-Board-style of crass, mindlessly lazy and grammatically incorrect comments to make their way into these pages—to the frequent astonishment of those same message-board-trained elements who cry foul when we do not publish inarticulate, sloppy, strident messages, no matter which side of the issue they come down on. We do not apologize for that: in free-market economies, bad money drives out good money; and in free discourse, sloppy commentary drowns out the helpful.)

And given the facts in this particular case, it would be a disservice to let pass without comment something that is happening under our very noses. What is happening is this: Microsoft has a hit product on its hands.

The hit product is “Kinect,” the Wii-style add-on to the X-Box video game player that doesn’t require physical controls.

Released around the same time as the much-hyped Windows Phone 7 for smart-phones, Kinect flew under the Windows Phone 7 radar until recently, when, in addition to the generally friendly press coverage of the thing, we began hearing distinct rumblings about the Kinect—that it had sold out in two days at a local Best Buy despite the lack of a fully-functioning demo, for example—and went to investigate.

It was a quiet weekday afternoon at a non-descript strip-mall where we came across an otherwise empty electronics store in which the three customers were a father watching his two young children, who were standing in an octagonal pen, facing a large screen, hooked up to a Kinect.

Uncertain at first, the children began participating in the soccer game playing on the screen. They learned quickly—as kids do—how to control the movements of the players with their feet and body movements. Soon the boy was playing goalie and his sister forward. They shed their overcoats and settled in, mesmerized.

A brief talk with the store manager—yes, Kinect is flying out the door; yes, the technology is fantastic; yes, it’s easy to set up; yes, it’s taking share from the Wii (and, in fact, some customers are trading in their Wii to buy Kinect)—prompted follow-up calls elsewhere to determine whether what we were seeing with our own eyes was being replicated elsewhere.

And it is.

Now, we do not write this column to encourage readers to think highly of Microsoft as an investment. After all, no amount of Kinect sales—whether hardware or software or both—will make more than a meaningful impact on Microsoft overall.

But facts are stubborn things, as John Adams once said. And in the Kinect, as Shakespeare once wrote, Microsoft has scored “A hit, a very palpable hit.”

Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

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

Sunday, November 14, 2010

This Just In: Tenured Professor Blasts Monopolies

The most incomprehensible treatise on business monopolies that we have read since…well, ever, appears in today’s online Wall Street Journal.

The treatise appears not, however, courtesy of an English professor—as one suspects when reading the half-baked argument that appears to originate more from a deep-seated distrust of the Internet and its most successful progeny, including Google and Facebook, than from an understanding of monopolies—but, as we find at the end of the column, “a professor at Columbia Law School.”

And a tenured professor at that.

For the moment we will leave aside the supreme irony that a tenured professor—i.e. a teacher who has been granted a monopoly on his or her area of expertise within a specific institution—hereby seeks to define the current leaders among the extremely competitive meritocracy otherwise known as Silicon Valley as “New Monopolists,” and reprint gist of the article itself:

In the Grip of the New Monopolists
Do away with Google? Break up Facebook? We can't imagine life without them—and that's the problem

By Tim Wu

How hard would it be to go a week without Google? Or, to up the ante, without Facebook, Amazon, Skype, Twitter, Apple, eBay and Google? It wouldn't be impossible, but for even a moderate Internet user, it would be a real pain. Forgoing Google and Amazon is just inconvenient; forgoing Facebook or Twitter means giving up whole categories of activity. For most of us, avoiding the Internet's dominant firms would be a lot harder than bypassing Starbucks, Wal-Mart or other companies that dominate some corner of what was once called the real world.

The Internet has long been held up as a model for what the free market is supposed to look like—competition in its purest form. So why does it look increasingly like a Monopoly board? Most of the major sectors today are controlled by one dominant company or an oligopoly. Google "owns" search; Facebook, social networking; eBay rules auctions; Apple dominates online content delivery; Amazon, retail; and so on.

Let’s start with the obvious howler—that “Google ‘owns’ search.”

While it is undisputable that Google dominates search, Google had, at last count—as anybody with a computer and an internet connection can find—66.1% of the U.S. search market, with Microsoft, Yahoo, Ask and AOL splitting the remaining 34%.

As anybody with a computer and an internet connection can find the definition of a monopoly, and as that definition includes “Exclusive control of a commodity or service in a particular market”; “the exclusive possession or control of something”; and “the market condition that exists when there is only one seller,” it is exceedingly clear to anyone with a computer and an internet connection that Google’s two-thirds share of the search market does not constitute a “monopoly.”

After all, nobody has to use Google to search for something online.

They can use Bing, or Yahoo!, or AOL, or Safari…. It’s just that Google works better for most people in this part of the world. (In China, on the other hand, Baidu is the preferred search tool, with 73% of the searches, while Google—the “New Monopolist”—straggles behind with 25%.)

Indeed, Google does not have “exclusive control” of search any more than Facebook has “exclusive control” of social networking: the professor seems to forget that people network socially every day—via MySpace, or Google Chat, or AOL Instant Message, or Twitter.

Why, people even network socially by telephone and standing in line at the Safeway, for that matter.

How is it, again, that Facebook has a “monopoly” on our social networking?

But our tenured professor doesn’t leave well enough alone and end his missive on this somewhat frightening—for a Law School professor—perspective on what constitutes a “monopoly.”

He instead aims his case to at even higher level—or lower level, as the case may be—by first arguing that monopolies would be okay if they could be “somehow restricted to, say, 10 years,” and then missing exactly the point of this entire exercise in brutal free-market competitiveness—i.e. that Google and Facebook and the rest are only as good as their technology platform, and that they will die when their advantages no longer attract the free choice of consumers:

We wouldn't fret over monopoly so much if it came with a term limit. If Facebook's rule over social networking were somehow restricted to, say, 10 years—or better, ended the moment the firm lost its technical superiority—the very idea of monopoly might seem almost wholesome. The problem is that dominant firms are like congressional incumbents and African dictators: They rarely give up even when they are clearly past their prime. Facing decline, they do everything possible to stay in power. And that's when the rest of us suffer.

African dictators and congressional incumbents do not get booted out of power when their “technical superiority” is lost: internet-based companies do.

Hence improved on eBay’s sales model and prospered; Google improved on Overture’s key-word bidding model and prospered; Facebook improved on MySpace’s social networking model and prospered...the list is too long even for this virtual column.

Nevertheless, while this survival-of-the-fittest world is a reality that even a tenured professor should grasp, he fails to grasp it.

And since the ferocious and wide-open technological meritocracy that dominates Silicon Valley today would not back up his weird theory, Our Tenured Professor must go all the way back to the telephone system founded by Alexander Graham Bell to attempt to prove his point—which he then backs up with an only slightly-more modern example from the Hollywood movie studio system of the 1930s:

AT&T's near-absolute dominion over the telephone lasted from about 1914 until the 1984 breakup, all the while delaying the advent of lower prices and innovative technologies that new entrants would eventually bring. The Hollywood studios took effective control of American film in the 1930s, and even now, weakened versions of them remain in charge. Information monopolies can have very long half-lives.

AT&T, of course, is no comparison to Google, Facebook or anyone else cited by Our Tenured Professor: AT&T was a true monopoly because there was no way to make phone calls other than on an AT&T line.

In other words, AT&T had 100% market share.

As for the Hollywood studio analogy—well, a quick perusal of the top movies of 2010 reveals seven movie studious splitting the top ten grossing movies thus far in 2010—hardly constituting anyone being “in charge.”

Thankfully, Our Tenured Professor concludes his dark, error-riddled vision with a relatively upbeat coda—albeit one that only serves to highlight the banality of his case:

The Internet is still relatively young, and we remain in the golden age of these monopolists. We can also take comfort from the fact that most of the Internet's giants profess an awareness of their awesome powers and some sense of attendant duty to the public. Perhaps if we're vigilant, we can prolong the benign phase of their rule. But let's not pretend that we live in anything but an age of monopolies.

Indeed, the internet is young. Facebook was founded all of six years ago. Google, 12 years ago.

Oh, and the dominant—one might say, monopolistic—search methodology (it was not precisely a search engine in those days) the year Google was founded happened to be Yahoo!

And as of September of 2010, Yahoo!’s “monopoly” had shrunk to 16.7% thanks to nothing so enlightened as a benevolent government or “sense of attendant duty to the public.”

Yahoo!’s decline was, in fact, due to fierce, ferocious, free competition in which one group of human beings dreamed up, built, executed and perfected a meaningfully better mousetrap that appealed to other human beings.

That is something tenured professors, who have jobs for life and no accountability to any bottom line, don’t seem to grasp.

Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

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

Wednesday, November 10, 2010

Don’t Tell Ben

Google to Give Staff 10% Raise
—Wall Street Journal, November 10, 2010

That is the headline and this is the story, which we are not making up:

Moving to plug the defection of staff to competitors, Google Inc. is giving a 10% raise to all of its 23,000 employees, according to people familiar with the matter.

The raise, which will be given to executives and staff across the globe, is effective in January.

According to the Journal, there is a competition for talent in Silicon Valley that is forcing Google’s hand:

Chief Executive Eric Schmidt disclosed the raise in an email to employees, saying the company wants to lift morale. "We want to make sure that you feel rewarded for your hard work," Mr. Schmidt wrote. "We want to continue to attract the best people to Google."

Mr. Schmidt has apparently not been reading the same, backward-looking economic statistics that recently prompted Fed Chairman Ben Bernanke to announce a second round of quantitative easing, by which he intends to buy Treasury notes yielding less than one-tenth the raise now being showered on Google’s rather hefty employee base of 23,000 souls.

What with Kellogg’s recent price increase on 40% of its U.S. product lines and a host of positive earnings announcement from railroad companies to watch makers, not to mention Google’s voluntary increase in employee compensation at 5x the backward-looking CPI, one might deduce that the outlook for employment is a tad better than Bernanke believes it to be.

And that buying Treasuries at all-time low yields will go down as folly.

But, as is usually the case with officials living in Washington DC, it may be best not to confuse him with the facts. This is, after all, the same Fed Chairman who said—as late as March 2007—the subprime housing crisis was "likely to be contained"....

Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

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

Monday, November 01, 2010

An Open Letter to Ben Bernanke

Dear Mr. Bernanke,

Ours is not an economics column, nor do we profess to grasp the mechanics of how it is, exactly, that you do what you do.

Indeed, the truth is, Macroeconomics was, for us, a snooze-fest—and a fairly literal one at that.

Our impression of the dismal science from those, er, hazy days from 30 years ago, if you get our drift, includes mainly random lines on charts—red lines and green lines and blue lines—and equations of the “GDP = C+ I + G” type, which as best we can recall means Gross Domestic Product equals Consumption plus Ingestion plus Gastronomy, or something.

Nonetheless, while we admit to not being schooled enough to grasp the finer points of your job as Fed Chairman, we do have a strong opinion about your persistence in bemoaning the state of the current unemployment rate, as well as your determination to plow ahead with the purchase of billions of dollars of Federal debt at negligible interest rates in order to, somehow, cure that high unemployment rate.

Our opinion is that your plan it is doomed to look foolish thanks to an impending rise in employment, and corresponding drop in unemployment, that we think will happen even without you buying a single government bond.

How, you may ask, do we dare argue given our own lack of schooling in your own chosen field?

Well, we listen to a lot of earnings calls with companies that do business all over the world. And we think if you bothered to do the same, it would change your mind about the inevitable persistence of that “stubbornly high unemployment rate,” to quote the well-worn phrase.

The conference calls we speak of comprise the earnings calls that publicly-listed companies routinely hold on a quarterly basis with investors to review the previous three months’ worth of their business activities.

They are free of charge—your minions can find them archived on corporate websites—and only take an hour or so apiece.

If, however, you’re in a hurry and don’t have an hour to spare, you can fast forward past the usual CEO patter about “executing our strategic plan” and the frequently mind-numbing financial report from the CFO, and get right to the Q&A.

And if you did this, you would hear a few things you are not seeing in the muted employment numbers that seem to have your kickers in a proverbial twist.

For example, you would hear the CEO of one of the world’s largest outplacement firms, Manpower, say:

As I've stated before, as early as a year ago, we believed that the, slow but steady, demand for our clients' goods and services, coupled with uncertainty and a will to change the flexibility of their workforce, is creating sustainable positive secular trends for us. The growth we experienced in September, and to date in October, is also very important. As we stated in the past, the ability to see growth after the August break in Europe and the Labor Day break in the US was an extremely important indicator for us, for the health for the rest of the year.

For the most part, we picked up where we left off, with growth rates across all geographies quite strong.

And the CEO of the world’s largest private equity firm, Blackstone Group:

Our current portfolio is benefiting from the recovery. It's been underway in commercial real estate. We feel very good about the $15 billion of investments we made during the 2004 to 2008 period, which are now valued above cost including realized proceeds.

Our office markets have generally stabilized. And certain markets such as New York and London are seeing improvements in both leasing activity and asking rents.

New supply remains extremely limited with construction starts 80% below historical averages. In hospitality, RevPAR has been positive for six straight months, benefiting from both improving occupancy and more recently, higher room rates.

Indeed, you’d also hear the CEO of the world’s largest advertising group, WPP PLC, say:

So just in terms of summary of the regional growth, United States was the first to recover, and it has had five quarters of improving like-for-like revenues, with 9.7% in quarter three, more like an emerging market status.

Western Continental Europe is our second-largest region, with significant improvement in like-for-like growth, with quarter three up 4.7%. The UK and Asia Pacific, Latin America, Africa and the Middle East and Central and Eastern Europe were both up well over 7% on a like-for-like basis in the quarter.

And in Asia Pacific, Mainland China and India lead the region with like-for-like revenue growth of over 22% and 15%, respectively. Australia has recovered with like-for-like growth of almost 7%. And Japan was up in this quarter, as it was in quarter two. So we've had two quarters of growth from our Japanese business.

And the Chairman of a little railroad called Union Pacific:

As for the third quarter we are reporting record results….our most profitable quarter ever. Similar to last quarter, we achieved volume growth across each of our six business teams. Total third quarter car loadings were up about 14% to more than 2.3 million. That's our highest level in two years but still 9% below our peak in 2007.

Yes, it is a fact that business at the UP is still below peak levels, as is US employment. But things do not seem to be slowing down there, as the company’s head of marketing made clear:

Let me give you a quick overview of some the specific growth drivers that we expect to see in the fourth quarter. Our industrial products business look to have the most upside with the best opportunities in markets that are benefiting from improved product production, increasing drilling activity and hazardous waste disposal. International and domestic intermodal segments will continue to drive growth with some indication that the international peak may be slightly longer than we thought. Fall demand for fertilizer is expected to be stronger than last year and petroleum should post gains with crude -- growth of crude oil shipments to St. James and increased residual fuel oil moves.

Also looks like industrial chemicals and soda ash will hold their current run rates and that will close the rate stronger than a year ago. Increased electrical demand and expectation of inventory replenishment following a hot summer are expected to keep our coal trains moving and while feed grain exports will likely not be able to match last year's near record levels, wheat exports should supply a nice boost to our ag products business as we close the year and move into next.

Finally we expect our automotive run rate to hold -- our automotive run rate to hold steady but sales forecast to stay in the mid-$11 million range through the end of the year with production slightly ahead of the fourth quarter of last year. That's how we see the quarter shaping up…

Exactly how, Mr. Bernanke, do you expect to do push the Union Pacific to higher heights than it is achieving without your bond purchases?

Now, the good times are not limited to the western side of the country, from which the UP hails: its eastern counterpart, the Norfolk Southern, is also seeing good things in the heartland:

Volumes in the third quarter improved 15% year-over-year and 2% sequentially from the second quarter. We also posted 52-week highs in several commodity groups …. Against this strengthening economic back drop, we continue to improve productivity as we safely handled increasing traffic levels. As compared to the 15% volume increase, crew starts were up only 8% and total employment up a modest 2%.

We know what you’re thinking. You’re thinking: ‘See! There’s the problem! Employment at Norfolk Southern has not risen in line with revenues.’

But, again, we wonder, how exactly would your bond purchases make the good times any better than they are?

If two railroads that cover most of the United States can’t convince you that fundamental business conditions are quite decent, let’s look at one of the nation’s largest industrial distributors—W.W. Grainger:

All segments were up versus the prior year quarter. Specifically, reseller was up in the high 30s related to the Gulf of Mexico oil spill cleanup. Heavy manufacturing was up in the low 20s. Light manufacturing was up in the low double digits. Retail was up in the high single digits. Commercial was up in the mid-single digits. Government and contractor were up in the low single digits.

Not a weak spot in the joint.

Still, after listening to the repeated use of the term “up,” you may well wonder why, then, companies have been so slow to hire.

Caterpillar, the heavy equipment maker, sheds some light on that very question:

….we are seeing growth in the developed countries of North America and Europe, albeit off depressed levels from 2009. With weak economic recoveries in the US and Europe and with depressed construction activity, I know it is tough to understand why sales of Cat machines are up so much. And new machine sales in the United States are a good example that illustrates the point.

Here is what is happening - First, sales to users peaked in 2006, then declined in 2007, declined again in 2008 and then declined even more significantly in 2009. From the peak quarter in 2006 to the bottom in late 2009, dealer machine sales to end users in the US declined nearly 80%.

That’s right: Caterpillar equipment sales to end customers were off 80% from their peak at the apocalyptic bottom.

Is it any wonder that hiring has not come back as quickly as in years past? Wouldn’t you be a little gun-shy about adding FTEs until you were convinced things were trending in the right direction?

Here’s how advertising giant WPP PLC described the downdraft during the crisis, and the slow rebound in hiring:

On the other side, taking the headcount down by 12% in 2009 was very severe, and there had to be some bounce-back from what we had done. I think people responded to the challenge very well, but there probably -- there was too much tightness, if that is the right word, in the system. So it had to be -- we had to invest a bit more, particularly when we started to see revenue growth, not so much in the first quarter, but we saw a five-point shift in the second quarter, and we've seen another three-point shift upwards in the third quarter.

And it is not only advertising agencies and equipment makers that are hiring—the Union Pacific is hiring, too:

In terms of employees we have 1100 on furlough while recall rates have averaged better than 80% this year, the current furlough pool has been out of work since late 2008. So we expect only about half of these to return to service. Because of this we were ramping up our hiring efforts systemwide for 2011.

So is Norfolk Southern:

Turning to the next slide, train and engine employment increased by 501, or 4.8%, in the third quarter as we continue to strategically hire to support traffic growth where we had let attrition decrease in employee counts in 2008 and 2009. As I stated last quarter, all T&E employees have been returned from furlough status. To date we have authorized the hiring of 1,550 conductor trainees with the first of those trainees now starting to come off training program ready for placement.

And Manpower as well, albeit slowly:

We're continuing to see the benefits of strong momentum, as we moved into the third quarter. Across all areas our infrastructure is intact and we are quickly filling in the capacity. As you would suspect, not all areas are filling in at the same pace. So, even with excess capacity, we had to increase our staff in areas, adding just over 600 people in the third quarter.

Now, with all this business going around, you’d think hotels would be seeing more business—and they are. Here’s the CEO of Marriott International:

The business traveler is back. We're excited to see demand so strong in so many places with prices moving up. But we know what you want to know, essentially where do we go from here? According to the National Bureau of Economic Research, the recession officially ended in June 2009.

Notwithstanding that, many seemed to wonder whether the economic recovery has any strength and about the risk of a double dip. Let's be clear. There is nothing in our business which indicates that sort of weakness. Both business transient and leisure travel remain strong.

If travel is strong, airlines must be better—and here’s how Delta described things:

Turning to revenue, our revenue for the quarter was $9 billion, up $1.4 billion, or 18%, on a year-over-year basis against a 2% increase in capacity. Our consolidated passenger unit revenues increased over 16% year-over-year, driven by a higher corporate revenue and international mix. Corporate revenue was up 35% year-over-year, driven largely by a 27% increase in corporate volumes. Our domestic unit revenues increased 10% over the prior year on a two point increase in capacity. Our domestic yields were up 12%.

Turning to international markets, we are seeing continuing strength with unit revenues up 29% year-over-year, with both yields and load factors showing significant improvement. The Transatlantic business is above its 2007 run rates, with unit revenues up 25% year-over-year on a one point increase in capacity. Our Pacific routes have performed very well and we're seeing especially strong results in the beach markets, particularly between Japan and Hawaii. Our overall Pacific unit revenues have increased 45% year-over-year on a six point growth in capacity. Our Latin unit revenue increased 16% on an 8% increase in capacity. South America's performing well driven by the recovery of business traffic.

What is it, exactly, Ben, that are you so panicked about?

If it’s deflation, well, outside of the housing market, you won’t hear about that. Here’s what the Union Pacific had to say about your deflation:

As we close out the year, we continue to feel very positive about our future pricing opportunities and are committed to achieving real pricing gains that will drive higher returns. Let's discuss the expense details starting with compensation and benefits at $1.1 billion in the third quarter, a 9% increase versus last year. Roughly half of the higher year-over-year expense relates to wage and benefit inflation. We also seeing higher costs as train starts increase generating more starts per employee as well as paying more for overtime and training expenses. In addition, equity and incentive compensation was a little higher year-over-year driving about 10% of the increase. Offsetting a portion of these higher costs is our strong employee productivity…

In fact, the UP is starting to see exactly what you’d expect to see at this point in the cycle: upward wage pressure as existing employees work overtime:

We had a lot of overtime. We have been pushing the overtime curve here in terms of absorbing some of the volume. That's out of here. Our health care costs have jumped up pretty substantially here in third quarter. You look out to the future. Our inflation number that we look at is in that 3.5% to 4% range. That's what you have to think about.

Norfolk Southern is seeing higher labor costs:

Slide five reflects the components of the 14% increase in compensation and benefits. First volume related payroll increased $34 million including $18 million for train and engine employees. Second, medical benefits increased $20 million largely related to higher agreement employee health and welfare premiums coupled with increased retiree medical costs. Third, incentive compensation was up $13 million due primarily to stronger financial results. Pension expenses were $8 million higher and payroll taxes increased $7 million. Finally, increased agreement wage rates and other compensation expenses were offset by lower stock based compensation which reflected last year's strong improvement in performance metrics.

And so is Caterpillar:

Before I move on to the full-year outlook, I would like to cover employee incentive compensation in just a little more depth. As you may be aware, a portion of the compensation for management support and some of our hourly employees is at risk and it varies based on the financial performance of the Company. Given the economic environment in 2009, the profit target related to our short-term incentive plan was aggressive and it did not trigger.

Financial performance in 2010 has been much better and based on the newly-revised and higher profit outlook for 2010, we expect incentive compensation to be higher. Our practice is to accrue the expense as we go through the year based on our full-year expectations. That means when we change the outlook, we have a year-to-date catch-up in the provision. And that happened this quarter.

The outlook we provided with our second-quarter release included $600 million in incentive compensation. $300 million of that was in the first half and we had an expectation of about $150 million in each of the third and fourth quarters.

And so is Marriott:

Our corporate G&A spending increased 4% in the third quarter, reflecting higher incentive compensation. There isn't much more to cut but we continue to look for ways of doing things more efficiently.

In fact, we’re hearing more about inflation than deflation. Here’s what Marriott said:

The recovery is here and we're doing things differently. First, we're reducing discounting and improving our mix. For example, in the third quarter the Marriott Hotels and Resorts brand reduced the availability of rooms at discount and transient rates such as packages, wholesale, government and other similar programs. While we reduced these room nights by 16% in the quarter, they were more than replaced by a 16% increase in corporate and special corporate guests paying $57 more on average than the discounted business. We expect to continue to improve our mix in 2011. And we're raising room rates.

Even in the capital markets, inflation is back. Here’s how serial-acquirer WPP PLC put it when discussing acquisition targets:

But I think pricing is an issue. There is a lot of aggressive dealmaking. Investment banking advisers and brokers are being very aggressive on process, and that's a little bit disturbing. It would make the Guy Hands' Citibank-EMI process look relatively pedestrian.

“Disturbing” indeed—especially when a certain Fed Chairman wants to buy half a trillion in Treasury paper at all-time high prices.

Now, we are well aware that you may perceive that the quotes above have merely been selected to prove a point, and thus are likely to view them with suspicion, especially since they do not seem to gibe with months-old economics statistics.

So we wondered if there was a way to somehow put numbers on what we heard.

After minutes of tinkering with our Bloomberg, we came up with the following statistical summary of this conference call season that might help put a less subjective face on the previous body of evidence: it is the first ever NotMakingThisUp Conference Call Survey.

The results of this survey, we think, are illuminating.

For example, in the previous nine weeks (the heart of third quarter earnings season), the phrase “Very weak” appeared in 91 earnings calls—a 29% decline from last year, when the phrase appeared during 150 earnings calls.

Furthermore, the phrase “Very strong growth” appeared in 132 calls this year compared to 112 last year—an 18% increase.

As far as your concern about deflation goes, well, the term “deflation” was used in 61 calls this year, compared to 101 calls last year—a 40% drop.

Meanwhile, “inflation” was spoken of on 399 conference calls, compared to 385 last year—a modest and perhaps statistically insignificant gain of nearly 4%, but more than six-times the number in which “deflation” reared its ugly head.

Encouragingly, too, the use of “layoffs” collapsed, from 78 last year to 48 this year—a 38.5% drop.

Finally, we note with absolutely no surprise that the use of the phrase “executing our strategic plan” did not materially change this year versus last. If you read “My Dog Charles, Executing His Yadda-Yadda”
you would know there is always a bull market in, well, bull.

And so, Mr. Bernanke, we here at NotMakingThisUp sincerely hope you skip today’s reading of statistical reports at your quiet lunch in some nuclear-attack-protected bunker deep within the bowels of Washington, and get out and listen to real people discuss real business, before you go and “execute your strategic plan” of buying half a trillion in Treasuries to somehow make employment start to go up at the very moment it looks like it may well start to be moving that way anyhow.

If, however, in the course doing so, you become nauseous at the recurring use of the phrase “executing our strategic plan” by America’s CEOs, well, don’t say we didn’t warn you.

Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

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