Economics, Finance & Investments (RETIRED BLOG): February 2005

Monday, February 28, 2005

Federated-May merger a go

Price: Each share of May stock will be converted into $17.75 in cash and 0.3115 shares of Federated stock. Based on the 10-day trading average of Federated stock as of last Friday, that equates to $35.50 per share, or $11 billion total purchase price. Federated would also assume May debt that totaled about $6 billion at the end of 2004.

The combined company would have about 950 department stores and an additional 700 bridal and formal wear stores. It would operate in every state except Alaska, along with Guam, Puerto Rico and the District of Columbia. The combined company will be in the nation's top 65 markets except Jacksonville, Florida.

Federated doesn't plan to change May store names before 2006, but then will rename its stores - even some Bloomingdale's stores - as Macy's. That means that May store names including Filene's, Foley's, Hecht's and Kaufmann's could disappear next year. The names Rich's (an institution in my current home of Atlanta) and Burdines (a Florida landmark) are in the process of disappearing right now.

Source: Associated Press

Some home buyers may be overextended, experts fear

I always worry when "experts" start pointing out what's blatantly obvious to the rest of us. "Some" home buyers "may" be overextended?

Experts are concerned that home buyers who have chosen adjustable-rate loans or interest-only mortgages could have financial problems if home prices decline or flatten out. Although nationwide prices, adjusted for inflation, have risen a dizzying 36% since 1995, according to the Center of Economic Policy Research, they are due for an adjustment eventually.

"Although"? Perhaps "because" is a more accurate word there.

Many people I know personally have over-extended to ridiculous proportions to buy the most house they can. ("Can" being a relative term here.) The confidence with which people say, "An interest-only loan is OK because when I have to start paying principal, my income will have gone up." Really? How do you know that ... cause my crystal ball is not quite that good. Particularly scary are adjustable-rate mortgages (or even worse, adjustable-rate interest-only loans) because when interest rates go up increasing these people's housing payments, that's precisely the same time that house prices fall because people can afford less house when rates rise.

And recently, I've even started hearing about an extreme case of the interest-only mortgage: the negative-equity mortgage, where the monthly payment is not sufficient to pay off even the interest due so your mortgage balance goes up. The rationale for taking on such a loan? "My house is going to appreciate more than the additional debt accruing on my mortgage." Yeah, good luck with that. What really upsets me is that if/when the market crashes down around people making idiotic decisions like that, my house price is going to suffer right along with theirs.
Ever heard the word "bubble," people?

[Source of the quoted paragraph was the business section of the Atlanta Journal-Constitution a few days ago. Sorry, no link.]

Friday, February 25, 2005

MCI in play

Wow. My prediction regading MCI took even less time to materialize than I expected.

The Cliff Notes version of the facts:

On February 4, MCI received an unsolicited $6.3 billion takeover bid from Qwest Communications International.
On February 14, Verizon made an offer to buy MCI for $6.7 billion in stock and cash. (Each share of MCI stock would garner $14.42 in Verizon stock, $1.50 in cash and $4.50 in MCI dividends.)
Today, Qwest upped its offer for the second time. (Under the latest Qwest offer, each share of MCI stock would receive $15.50 in Qwest stock, $3.10 in cash and $6 in MCI dividends.) The revised Qwest offer is worth about 20% more than the Verizon offer.
Also today, MCI reported a loss of $32 million in the fourth quarter of 2004 and a loss of $3.89 billion ($12.12 a share) for all of 2004 (due to heavy bankruptcy-related impairment charges in the third quarter). Quarterly revenue fell 10% to $4.97 billion (from $5.5 billion a year before) and annual revenue fell 15% to $20.7 billion.
MCI's board will review Qwest's offer while pressing ahead with a deal with Verizon, says CEO Michael Capellas told investors on a conference call. Verizon is the "right partner" for MCI, he said.

The "insights" from the "experts" and other observations:

The SBC-AT&T and Verizon-MCI transactions are an acknowledgment of what insiders have known for a while: that the long-distance business as a stand-alone service is, for all practical purposes, dead. "I think we all knew it was over two to three years ago," says Dominic Endicott, head of the telecommunications practice at Booz Allen Hamilton. "The deals are just cleanup work." Raul Katz, CEO of Adventis, a consulting group in Boston, goes a step further. "The long-distance business was always dead," referring to the industry's ultimately fruitless scramble to figure a way around the Bells' grip on the local phone markets. "It was just a matter of when it was going to die."
Qwest has a market value of just $7.5 billion but $17 billion in debt. Analyst believe that if Qwest wins the bidding war, it will use MCI's $5 billion cash reserve to help pay down its debt.
Analysts have said Qwest is a weaker partner for strategic reasons. It doesn't own its own wireless network, which is considered critical for growth in the telecom industry. It also serves a primarily rural, 14-state region where there are few business centers, so a marriage with MCI would not likely result in as many cost efficiencies.
Although Verizon is the strongest among the regional phone companies, it faced a difficult task of determining whether it would be cheaper to build its own corporate client base, rather than buy MCI's, analysts said. With most of MCI's business going away or under attack from stiff competition, some said it could have been more effective for the company to build its own roster of customers.

Articles:

Wednesday, February 23, 2005

Trump Makes Out OK in Trump Bankruptcy

A judge refused to allow shareholders to file a competing bankruptcy plan for Trump Hotels & Casino Resorts, eliminating a key obstacle to court confirmation of the casino company's Chapter 11 reorganization.

The deal submitted by the company includes the following perks for Donald Trump:

Remains Chairman and CEO, at a $2 million a year salary
Retains a 26% stake in the restructured company (reduced from 56%) as well as a 25% stake in the Miss Universe Pageant
First dibs on serving as contractor for any construction project over $35 million undertaken by the company after it emerges from bankruptcy, including a proposed 1250-room hotel tower at Trump Taj Mahal Casino Resort and planned capital improvements at Trump Plaza Hotel and Casino and Trump Marina Hotel Casino
The right to veto any changes made in bankruptcy court
The right to veto the sale of any casinos. If any casinos are sold, he would receive up to $100 million in tax indemnification for personal tax liabilities incurred from the transaction.
A licensing deal giving Trump Hotels exclusive rights to the Trump name and image, valued at approximately $124 million

Not a bad deal for the person who ran the company into the ground in the first place.

Fed will probably increase rates again

Short-term interest-rate futures contracts traded at the Chicago Board of Trade show strong expectations that the Federal Reserve will follow up February's rate hike with quarter-point increases at its next two meetings, on March 22 and May 3. Fed funds contracts are fully priced for a quarter-point hike in March and despite the Fed's repeat projection for "measured" increases, the March contract reflects a 68 percent chance for a more-aggressive half-point hike that month. The odds that the Fed's target stands at 3% on May 3, up from its current 2.5%, are priced by the market at 97 percent. The futures market is less certain the Fed will raise its target to 3.25% on June 30, putting just better than 50-50 odds on that outcome.

Source: MarketWatch

Tuesday, February 22, 2005

Google

Google (GOOG) is worth $52 billion??? It's trading at 133x earnings. Absurd!!! Apparently we learned absolutely nothing from the dot-com bust. We seem to be cruisin' for another bruisin'.

Friday, February 18, 2005

XOM surpasses GE

ExxonMobil Corporation has replaced General Electric as the world's largest company in terms of market value. The market value of ExxonMobil, the world's largest publicly traded oil company, appreciated to $381 billion exceeding the market value of GE by about $1 billion.

Tuesday, February 15, 2005

German Economy Stagnant since July

Germany's economy shrank 0.2% in the last three months of 2004 (confounding hopes of a 0.2% expansion). The Federal Statistics Office said growth in the third quarter had been zero. It said growth for the whole of 2004 was 1.6% (down from an earlier estimate of 1.7%).

The German economy actually contracted in 2003 (as opposed to the near-zero but positive growth previously reported), in what was a year of healthy growth for most other OECD countries.

[Thanks to DVD for bringing this to my attention]

Thursday, February 10, 2005

WSJ weighs in on HP

Text in black is mine; text in blue is the Wall Street Journal's; text in red is FTP Online's.

http://www.ftponline.com/weblogger/forum.aspx?id=1&Date=1/26/2005&blog=#311

"Many knew it at the time, but now everyone should: Walter Hewlett was right."

Hewlett was the board member from the founding family who argued that the Compaq merger would depress HP's stock and make the company overly reliant on the PC industry with its negligible or nonexistent profit margins. Since then HP has laid off thousands of workers and has a 55% decline in its stock price to show for those sacrifices.

"Since the merger, HP has lost market share and failed to revive its profit margins. It relinquished the #1 position in market share of personal computers last year to Dell. The Compaq merger hasn't helped in other areas either. In the 12 months ended in September, IBM and Dell gained share in network servers, while HP fell to 26.6% from 28.7%, Morgan Stanley says. HP's operating margins in business services have fallen for two years."

http://www.ftponline.com/weblogger/forum.aspx?ID=1&DATE=01/27/2005&BLOG=#313

"At bottom, they made a huge error in asserting that the merger of two losing computer operations, HP's and Compaq's, would produce a financially fit computer business. The irrefutable evidence on how wrong they were is contained in the two companies' own merger proxy, which precisely laid out the healthy operating margins that the combined company expected to be earning in its 2003 fiscal year (HP's ends Oct. 31) on its computer operations. The margins weren't earned then, and in 2004 they weren't either—not by a long shot. Only the prodigious, money-coining strength of HP's star business, Imaging and Printing (better known as 'printers'), has kept the company looking respectable."

Public accounting standards could force HP to write off $14.5 billion in goodwill allocated toward the value of Compaq. HP is carrying $15.8 billion in goodwill [that's the excess of purchase price over book value for an acquisition] on its books.

Twenty top executives have left in what some call a brain drain, and the legendary HP culture has been deliberately destroyed to be replaced by an "East Coast management culture." But the fundamental problem is that HP is not a leader in any of its markets other than printers. Fiorina recently decried the media's and analysts' inability to see HP as a software company, yet she has virtually gutted all marketing for HP's software.

Wednesday, February 09, 2005

HP Chronology

I have cross-referenced the chronology against the stock price (adjusted for dividends and an October 2000 2:1 stock split).

July 1999: HP appoints Fiorina as president and CEO. [$27.24]

June 2000: HP completes divestiture of Agilent Technologies. [$58.18]

September 2000: Fiorina is named chairman of the board of directors. [$45.33]

October 2000: HP announces plans to acquire middleware vendor Bluestone Software. [$43.46]

March 2001: HP creates a new business organization, HP Services. [$29.39]

September 2001: Plans are revealed for HP to acquire Compaq in an all-stock deal. [$15.20]

May 2002: HP officially closes its acquisition of Compaq. [$18.22]

January 2005: HP announces that it will merge its PC and printer divisions. [$19.59]

That's an annualized return of -5.8% per year over Fiorina's 5.5-year reign.

Fiorina out!

Carly Fiorina's nearly six-year reign at Hewlett-Packard ended today as the company's board forced her out as chief executive, disappointed by her efforts to make the technology giant whose strongest business is printers more nimble and innovative. HP shares jumped more than 6%. Board members said they fired Fiorina because she failed to execute a planned strategy of slashing costs and boosting revenue as quickly as directors had hoped. Fiorina had championed the 2002 acquisition of Compaq despite fierce resistance from shareholders and directors. Critics have called the merger a drag on profits.

Good riddance. She was not a good leader at Lucent, and she has not been a good leader at HP. Here is a good chronology of the highlights of Fiorina's tenure at HP.

Problems at Krispy Kreme

Krispy Kreme's turnaround efforts began in earnest Tuesday with the layoff of about 125 workers, or 25% of the work force, at its corporate headquarters and other key facilities. The struggling doughnut chain also said it was getting rid of its corporate jet to conserve cash. Krispy Kreme said the cuts would affect workers about one quarter of the workers at its Winston-Salem headquarters and at plants where doughnut mix is made, equipment is manufactured and doughnuts are distributed. Krispy Kreme's 360 United States stores are owned and operated by franchisees; as such, they are not affected by the corporate cuts announced Tuesday.

Krispy Kreme said the moves are necessary to avoid a cash crunch. The company said it also will need additional credit to fund operations and capital expenditures by March 25, when a waiver from its primary lenders expires. "There can be no assurance that the company will be able to reach any agreement with the banks or that funding will be available when and in the amounts needed," the company said. Last month, the company's lenders agreed to push back to March 25 a deadline under which the company would be in default of its credit line because it has not filed quarterly financial statements for the period that ended Oct. 31. In the agreement, Krispy Kreme agreed not to borrow any more cash without its lenders' consent.

Krispy Kreme closed at $7.21, down 9.2% for the day and 85% from its all-time high. (When I wrote this post, the stock was trading at $9.64.)

Wednesday, February 02, 2005

Vacation v The Economy

The next time you get one of those emails (or see one of those TV commercials) pontificating on how American workers are getting cheated and abused because European workers get so much more vacation than American workers...

Average Vacation Days
France 37 days
Germany 35 days
U.S. 13 days

... I urge you to remember the other side of the coin ...

Unemployment Rate (January 2005)
Germany 10.0%
France 9.7%
U.S. 5.4%

Real GDP Growth (2005 Prediction)
Germany 1.0% [Edited based on more recent information]
France 1.7%
U.S. 3.5%

This thought was inspired by this Bloomberg article (condensed below).

German unemployment jumped to the highest level since World War II as new rules added welfare recipients to the jobless register. The number of people out of work in January rose by 227,000 to 4.71 million in seasonally adjusted terms, including 230,000 new jobless claimants. The adjusted unemployment rate rose to 11.4%, a seven-year high, while the unadjusted jobless total passed 5 million for the first time since the war. Schroeder's government had cut jobless benefits and forced claimants to take low-paid jobs in an attempt to get more people into work in Europe's largest economy.

Economy and Labor Minister Wolfgang Clement said he expects a further rise in unemployment in February, though experience from other countries suggests the new policies may eventually cut the jobless total by as much as 20%. Even before the labor-market changes, German unemployment had risen for 11 straight months, as companies moved jobs to countries with lower labor costs and stagnant domestic demand deterred hiring. In December, Germany had the second highest unemployment rate after Spain among the 12 countries that share the euro, at 10% on a comparable basis.

Disregarding the effects of the new labor law, seasonally adjusted unemployment was "stable," Labor Agency Vice-President Heinrich Alt said. The adjusted unemployment rate is higher than it has been since March 1998, when it was 11.5%. The record rate was set in October 1997 at 11.8%. "Unemployment has grown steadily over the last three decades and then reunification came on top of that," said Bert Ruerup, the head of Schroeder's council of economic advisers. The government last week pared its forecast for economic growth in 2005 to 1.6% from 1.7%. [New predictions indicate that even this number is overly optimistic. March estimates indicate growth could be as small as 1%. By contrast U.S. growth is predicted to be 3.5% in 2005. - ALD] Germany is losing 1,200 full-time jobs a day, Juergen Thumann, head of the BDI industry federation, said last week. Unemployment won't decline unless labor costs are cut, he said.

[Thanks to DVD for emailing the Bloomberg article to me.]
[Edited on 3/1/2005 based on more recent information.]

Fed boosts rates another quarter point

The Federal Reserve raised the fed funds rate to 2.5%, but after six rate hikes is it time to slow down?

The Decline of Lucent

Adapted from chapter one of Optical Illusions by Lisa Endlich. The comments in brackets are my own.

No industry looked more promising [in 1996] or bled more money [in 2000-2002] than telecommunications. With a collapse in market capitalization of more than $4 trillion [yes, that's Trillion with a capital T] and job losses in excess of 500,000, the telecom meltdown ranks as the greatest stock market debacle ever.

[This is something that's often lost as the dot-com bust has somehow dominated headlines related to the 2000-2002 stock market collapse. The dot-com losses in terms of both the companies' bottom lines and the stock market wealth wiped out are the merest drop in the bucket compared to the telecom collapse.]

Lucent was born in April 1996 as a spin-off of the foundering telecom giant AT&T. It was the largest initial public offering ever, and because each AT&T shareholder became a Lucent shareholder (along with the new investors attracted by Lucent's stellar performance), it was not long before Lucent was the most widely held stock in America. Lucent was born at the inception of the greatest market bubble ever, at the outset of an investment boom that poured billions of dollars into the telecommunications industry. Lucent's startling transformation from an obscure division of AT&T to the sixth-largest corporation in America and then to a company gasping for its financial life left investors and observers by turns delighted, shocked, confused, and finally dismayed as they sought an explanation for the company's descent. The speed of Lucent's decline was as staggering as its magnitude. In the space of twenty-four months, the market capitalization of the company dropped by a quarter of a trillion dollars as its stock price plummeted by 99 percent. Lucent went from spending $100 million to advertise its new name to turning off lights and shuttering bathrooms to save pennies. [emphasis mine]

This is the story of a financially sound company steeped in world-class talent, dominant in one of the world's fastest-growing industries, that in the space of two painful years found itself branded with a junk-bond credit rating, under investigation by the SEC for its fraudulent accounting practices, fighting off rumors of insolvency, and, hat in hand, begging its bankers for a little more time. But the story is surprisingly dramatic for a telecom equipment vendor, complete with a boardroom coup, a stock rise and fall in the shape of Mount Everest, and a series of financial and product decisions that left the company enfeebled.

Lucent's leaders were the men and women of AT&T, the people who practically invented the modern corporate structure. As an old-world stalwart turned new-world bellwether, Lucent experienced the fallout from this historic event with as much force as any ethereal dot-com. When it was over, CEO Henry Schacht was forced to admit that the frenzy that engulfed the stock markets had badly distorted the company's value structure, tampered with its moral compass, and led to decisions that would never have been made in saner times. [Right, Henry, it's the market's fault.]

Additional mistakes by AT&T

Hanging on to Western Electric for years when it should have spun out on Day 1 after divestiture in 1984.
Handing over its wireless licenses to the RBOCs at divestiture
Spinning out its recently acquired McCaw Cellular/Vanguard Cellular, the one industry sector that demonstrated growth and value creation.
Acquiring NCR and then completely dropping the ball in the computer industry.
Failing to join with other industry participants in a full-scale assault on the regulatory foundations of RBOC dominance, letting the RBOCs fight tactically as needed and ultimately be victorious.

Some of the above are discussed in this article.

Some Telecom Predictions

(1) AT&T will not re-enter the wireless arena. The pending merger will put the kibosh on the pending deal to lease wireless capacity from Sprint.

(2) MCI can not survive as an independent company. It will be bought by either Verizon (in a bid to regain its number one slot from SBC, which will be number one after combining with AT&T) or BellSouth (in a bid to join the big boys SBC and Verizon).

(3) If BellSouth is not the one to merge with MCI, it will be in trouble itself in the new telecom landscape.

(4) Sprint will be in trouble too, no matter what else happens. Maybe it can merge with whoever doesn't get MCI.

Some links with additional analysis and predictions (with more detailed explanations of the reasoning):
http://www.business2.com/b2/web/articles/0,17863,1022825,00.html
http://www.internetnews.com/xSP/article.php/3466691
http://www.itworld.com/Tech/2428/050131sbcattdeal/

The Job Losses Begin

SBC and AT&T plan to eliminate about 13,000 jobs — twice as many as some on Wall Street had expected — as part of a plan to slash costs by $15 billion. Of those cost savings, which the companies dubbed "synergies," about 60% will come from job cuts, said Rick Lindner, SBC's CFO, in a meeting with analysts Tuesday. The companies now employ a combined total of 210,000 workers.

SBC itemized where some of the cuts will come. For example, it said it plans to jettison at least 5,125 jobs (26% of the total that both companies have) in a segment that serves business and government customers. An additional 2,600 people in corporate functions such as legal, human resources, finance and advertising will be let go. The cuts are in addition to those already announced by the two companies for 2005.

Response to Comment

On a related note, it looks like AT&T will be getting back into the wireless game once again, after the Cingular aquisition is complete, by leasing bandwidth from Sprint.

(1) I don't think that will happen anymore. Here's a link to another story from the same source you provide in your comment below. http://www.engadget.com/entry/1234000163029846/

(2) I'll go further, I don't think this re-entering the wireless market will happen at all now. Why would SBC set up an operation to compete with its own Cingular joint venture?

(3) This is further evidence that AT&T has been run by a bunch of yahoos. You divest your wireless business, and just a couple of years later you are going to invest what I'm guessing would be huge amounts of money to get back in? WTH?

Tuesday, February 01, 2005

The Decline and Fall of AT&T

AT&T's revenue has declined from $51 billion in 1999 to $30 billion in 2004, and its residential customer base declining from a peak of 60 million in 2000 to about 24 million at the end of 2004. Now those numbers are not QUITE as horrible as they look in that the 1999 numbers include all the cable and wireless customers who were spun-off and not lost outright, but they are nonetheless very poor results.

In 1999, I (and others) looked at AT&T as a massive cash cow. It was declining in influence and size, and its markets were under attack by wireless and broadband companies and its core business long distance operations were under attack by fiercer-than-expected competition from WorldCom, MCI and Sprint. But it also didn't need to make any massive investments to maintain its existing business, and this business was (a) quite profitable and (b) generating a great deal of revenue and free cash flow. Under these circumstances, I would have expected AT&T to follow a conservative strategy for its core business. If innovation or a new market needed exploring, a joint venture or subsidiary could be set up with the cash flows from the core telephone and business services operation. Beyond that, the company could have / should have paid dividends, lots of them. It didn't need and couldn't effectively use the excess cash.

Instead of this, AT&T embarked on an ill-advised (and ill-fated) strategy under former Chairman and CEO C. Michael Armstrong, which resulted in losses of over $53 billion related to a cable company acquisition spree (MediaOne, TCI, etc.) and the subsequent divestiture of these same companies. Armstrong later advocated splitting the company into four separate entities, a plan which was only partially implemented with the sale of the cable operations to Comcast and the spin-off of AT&T Wireless into a separate company (a company which was utterly unable to compete in the wireless marketplace and was very quickly gobbled up by Cingular Wireless).

[Come to think of it, that sounds almost word-for-word like what happened at Tyco, with an acquisition spree ending in 2001, and the subsequent abortive strategy to break up into 5 companies.]

In October 1999, AT&T had a market capitalization of $152 billion. Today, what's left of that mighty empire is less than $16 billion. Add to that the $47 billion that Comcast paid for AT&T's cable assets and the $50 billion that AT&T Wireless was worth at its spin-off (ignoring the fact that AWE's return was basically a straight line decline and the company was valued at considerably less than that when it was finally put out of its misery by Cingular), and you arrive at $113 billion. So in five years, Armstrong made $39 billion disappear like a fart in the wind. That's a total return of -25.7% or -4.5% per year for five years. Thank you, and good riddance.

Economics, Finance & Investments (RETIRED BLOG)