Tag Archives: Wall St

Book Blog – The Great Deformation – Part I, The Blackberry Panic Of 2008

Book Blogs are notes about books I’m reading, as I read them. They may or may not be followed up by wholesale reviews in traditional format.

The Great Deformation, by David A. Stockman published 2013 (buy on Amazon.com)

I received a copy of David Stockman’s 2013 analysis of the mechanics of the 2008 financial crisis and its aftermath as a gift from a friend and sat down to read the first 50 pages, Part I.

I think Stockman attempts to make several key points as a set up to the remainder of this lengthy tome:
-the mainstream/regime narrative of an incipient economic crisis catalyzed by a financial collapse originating in Wall Street credit markets controlled by major Wall Street institutions (such as Morgan Stanley and Goldman Sachs) is one part baseless lie and one part clueless ignorance of facts on the ground at the time
-there was a crisis, for these particular institutions, which was a result of years of non-value adding financial and accounting chicanery enabled by Fed Chairman Greenspan’s infamous “put” and the crisis would’ve resulted in the liquidation of these firms assets (and the termination of their managers) into abler hands which would’ve been a good thing for competitive financial markets and the capitalist economy as a whole
-this crisis was not only averted by the frantic lobbying of connected officials in Congress, the Treasury and other regulatory agencies by crony executives in the affected firms, but these same executives and officials worked in concert to turn the bailout moment into a massive payday/profit opportunity; most of the people making decisions about this in the government, particularly in the Treasury and the Fed, were inexperienced, miseducated or otherwise rankish amateurs with little understanding of the context of their decisions or their consequences beyond the immediate moment
-the scale of the bailouts in terms of pure dollars was completely without precedent or connection to actual costs and risks present in the system at the time
-memoirs of officials and executives involves in the bailout discussions published extemporaneously do not make a substantial case for their decisions based off of data available about the period years later
-much of the decision-making at the time, by concerned executives as well as captured officials, seems to be dominated by the twin desire to avoid taking responsibility for mistakes made in the past (thereby looking foolish) and to continue the illusion of the viability of the system based on these mistakes going forward

“All the rest,” as it has been said, “is illustration.”

There were parts of the narrative I found confusing to follow at times. Its possible I didn’t read clearly, but in several instances it seemed like on one page or at the beginning of a chapter Stockman would be arguing that the potential capital losses of a particular company were small enough relative to their total balance sheet that they could easily sweat the loss from a survival standpoint and then on the next page or at the end of the chapter, he seemed to suggest the same loss was so sizeable that it would threaten the viability of the enterprise itself.

I think there was a lot of question-begging in the narrative as well. Stockman builds a decent logical case for why there was no “contagion” that could spread from Wall Street (the financial markets) to Main Street (the rest of the economy) that would result in a general economic depression. But his argument always rests on the costs being shifted to various government backstop agencies and funding sources which could make things like commercial lending and payroll finance markets “money good”. It isn’t explained where these institutions would come by the required funds necessary to remain in operation without a bout of money printing (bailouts) and how this is different than the bailouts Wall Street received.

That leads to another concern I have with the overall thesis, which is that somehow, what happens on Wall Street is arbitrary and doesn’t affect greater economic outcomes. While I agree with the notion that purging the financial system of bad debts and bad business models during periods of crisis is a process of economic health rather than economic illness, I so far fail to see how the repricing and reorganization of economic capital taking place in these markets would not result in similar repricings and reorganizations of capital investment throughout the economy as a whole. Stockman details several multi billion dollar examples of ” predatory financial practices” in which members of Main Street America were able to finance lifestyles they couldn’t prudently afford the costs of and it seems like these are prime (or subprime, as it were) examples of assets that would need to be repriced and reorganized into abler hands. The gutters of both Streets would be filled with the purged excess, and it would eventually drain.

Annoyingly, Stockman repeatedly exalts “our political democracy” and even conflates its goodness and functioning with free market capitalism. For me, this is a fundamental flaw in reasoning and defining terms that throws his entire analysis into suspicion, at least from the standpoint of his analytical framework operant and his own agenda in terms of desired social outcomes. I don’t think Stockman and I are on the same page, in other words.

So far, Stockman’s book expects a lot of prior knowledge on behalf of the reader. He doesn’t begin the book outlining his economic or financial theories, nor his concept of the purpose of government. We intuit bits and pieces of it as he proclaims this bad, that person good, this event horrid, etc. But he never really says “I’m from the School of X” or gives a summary of the key principles necessary to follow his analysis. Therefore, it comes off as strenuously assertive rather than rigorously logical. And I think part of Stockman’s goal is to spread blame in a bipartisan fashion, while building bridges and giving accolades in an “independent” manner. So far, though, it seems arbitrary due to this lack of explanation about his framework.

Review – Professional Investor Rules (#investing, @harrimanhouse, #WallSt)

Professional Investor Rules: Top Investors Reveal The Secrets of Their Success (buy on Amazon.com)

by various, introduction by Jonathan Davis, published 2013

A “valueprax” review always serves two purposes: to inform the reader, and to remind the writer. Find more reviews by visiting the Virtual Library. Please note, I received a copy of this book for review from the publisher, Harriman House, on a complimentary basis.

The many faces of money management

A 1948 Academy Award-winning film popularized the slogan “There are eight million stories in the Naked City”, and after reading the eclectic “Professional Investor Rules”, I’m beginning to think there are almost as many stories about how to manage money properly.

Value and growth, momentum and macro-geography, market-timing and voodoo superstition; all these major investment strategies and themes are on display, and many more to boot, and all come bearing their own often-tortured metaphors to convey their point.

What’s more, it seems the pacing and style of the book change along with the advice-giver: while some of the entries follow the books eponymous “rule” format for organizing their thoughts, others involve myths, lengthy prose paragraph-laden essays and headings with sub-headings. Some have charts, and some do not.

One things consistent, at least– all the advisors profiled contradict one another at some point or other, and some even manage to contradict themselves in their own sections.

But it’s got this going for it, which is nice

Those are some of the glaring cons to the book. It’s not entirely without it’s pros, however.

One of the things I liked about the book is, ironically, also one of its flaws– the great variety of personas. They run the gamut from the known to the unknown, the mainstream to the contrarian, the sell-side to the buy-side. This book is published by a UK outfit (Harriman House), which means many of the professional soothsayers will be unfamiliar to US audiences, but it also means you get a selection of icons from the Commonwealth and former British territories (such as Hong Kong and other Asia-based managers) that you’d likely never hear about on CNBC or other American publishing sources.

Following this contrarian inversion theme, I liked that all the phony  fuzzy thinkers were right there next to the sharper pencils because it made their baloney that much more rotten. I think this is a great service for an uninformed investor picking up this book. If they had come across some of the more foppish money dandies on their own, elsewhere, they’d be liable to get taken in and swindled like the thousands of others who sustain such frauds. But at least in this case you’ve got a go-go glamour guy saying no price is too high for a growing company right next to a value guy warning that that way lies the path to certain, eventual doom.

And maybe this isn’t a big deal to others but I like the packaging on this hardcover edition I’ve got– it’s truly a HANDy size, the fonts and color scheme are modern and eye-catching and the anecdotal organization of the book makes it easy to pick up and put down without feeling too upset over whether or not you’ve got the time to commit to a serious read right then.

Fave five

Here are five of my favorite ideas from the book, along with the person(s) who said it:

  1. At any one time, a few parts of your portfolio will be doing terribly… focus on the performance of the portfolio as a whole (William Bernstein, Efficient Frontier Advisors)
  2. Far more companies have failed than succeeded (Marc Faber, The Gloom, Boom and Doom Report)
  3. Fight the consensus, not the fundamentals (Max King, Investec Asset Management)
  4. When someone says ‘it’s not about the money,’ it’s about the money (H.L. Mencken… consequently not actually a money manager and not alive, but it was quoted in one of the in-betweens spacing out the chapters)
  5. Academics never rescind papers and never get fired (Robin Pabrook and Lee King Fuei, Schroeders Fund, Asia)

Conclusion

Who is this book for? Accomplished, well-read pro-am investors will find nothing new here and much they disagree with, so I’d recommend such readers stay away. Someone completely new to investing and the money management industry might find the book valuable as a current snapshot of the gamut of strategic strains present in the money management industry.

Overall, while “Professional Investor Rules” has its moments, overall I came away less enthused than I did with Harriman House’s earlier offering, Free Capital. For anyone looking to learn investing techniques from accomplished, self-made millionaires, that’s the book I’d point them to– the advice therein is worth multiples of that being given by the mass of asset gathering managers of OPM contained in this one.

Inside The Minds Of Wall St Analysts & Earnings Reports: Spotlight Nintendo ($NTDOY)

This post is about Nintendo, specifically, and about the logic of the earnings season and Wall St analysts, generally. Let’s start in reverse order.

The following is from Michael Pachter, a securities analyst with Wedbush Securities (WallStCheatSheet.com):

We expect a Q2 miss. Nintendo is likely to report Q2 results below our estimates for revenue of ¥100 billion and EPS of ¥(127), compared to consensus of ¥108 billion and ¥(84) and implied guidance of ¥145 billion and ¥(22).

I don’t really care what the forecast or expectations are, here. What Nintendo does or does not report tomorrow is immaterial to the point I want to make. Look at who is responsible here.

According to Wall St logic, a company is responsible for missing Wall St’s targets. It is not Wall St that is responsible for accurately modeling and anticipating a company’s results. In this sense, there is something holy and sacred and inviolable about such forecasts– they represent a hurdle for a company like Nintendo to cross over, if it’s good enough. If it’s not good enough, the company will “disappoint” everyone in the financial community by not overcoming these (somewhat arbitrarily chosen) performance targets.

It seems entirely backwards. The company is going to perform as it’s going to perform, regardless of Wall St expectations. If anyone creates disappointment, it should be the Wall St analysts who are held responsible. What should be disappointing is that with their salaries, schooling and deep focus on these companies, they still can’t manage to accurately forecast their earnings from quarter to quarter.

If you think about it, it’s ridiculous for a company to ever “miss” its Wall St earnings forecast because these can be adjusted on the fly, all the time. In fact, this entire exercise of writing a report like this saying you “expect a miss” is an absurdity. If you expect a miss, then recalibrate your forecast to what you think is actually going to happen. It’s preposterous to act surprised with a “miss” tomorrow, when you said ahead of time that you were expecting it.

This seems to be part of the Wall St priesthood tradition. Analysts can’t accurately forecast earnings just like investors can’t– the future is uncertain. This is one of the tenets of value investing. But somehow, despite Wall St analysts trying and failing to do the impossible, the ill result is not their fault.

The last bit of commentary is specific to Nintendo:

We think that Wii U’s price points are appropriate given likely demand from Nintendo’s core fan base, but believe that pricing will be too high to sustain long-term demand. Demand for the Wii U will likely wane once Nintendo’s core fan base has purchased the first 6-7 million units, especially given the number of cheaper, comparable alternatives. For example, the prices of the Xbox 360 Kinect bundles have been reduced by $50 at Amazon, GameStop, and Wal-Mart.

DS and 3DS unit guidance is likely unrealistic. Nintendo guided to growth for combined DS/3DS hardware and software units for FY:13. In our view, handheld hardware sales will continue to decline due to migration of casual gamers to mobile devices. We do not expect handheld hardware to see a rebound in sales without price cuts. Similarly, we think that overall handheld software growth is unlikely.

Maintaining our NEUTRAL rating and our 12-month price target of ¥10,000, a slight premium to Nintendo’s ¥9,000/share in cash, giving it credit for brand equity. We cannot assign a P/E, given the company’s low potential to generate significant profits in light of declining product demand and unfavorable F/X.

I don’t know how to put this… this is just stupid. And it demonstrates zero creativity and zero ability to think beyond the end of one’s nose.

First, the analyst is confusing things. Perhaps casual gamers were partly responsible for the booming success of the Nintendo Wii, but few have ever made the argument that “casual gamers” are a big market demographic for the company’s handheld systems, like the Nintendo DS. Surely, wouldn’t someone who is so in love with gaming that they must have a portable system to carry with them everywhere they go be the opposite of a “casual gamer”?

Second, the analyst is being pseudo-precise. The Nintendo Wii sold almost 100M units worldwide since release. But the analyst calculates that the “core audience” is only 6-7M customers? So approximately 90M, or about 90%, of all sales were to casual, non-core gamers? How precise can an estimate like this be?

Third, the analyst confuses apples and oranges. The emphasis on price cuts to make Nintendo’s products competitive from here on out implies that the experience Nintendo sells is identical to the one offered for free or cheaply on mobile phones and other devices which are now deemed to be “competitors” to Nintendo’s product. By this logic, Nintendo is vastly overcharging for its wares. It’s hard to spell this out in simple terms but, is there an analog experience to that of an epic puzzle adventure game such as the Legend of Zelda series on smartphone app games? How would one play something as complex as Pikmin with the ability only to tap on the screen to control the gameplay experience? Or even something as simple as Mario Kart? These are not comparable experiences so the argument that Nintendo must cut prices to be competitive doesn’t hold water– it’s like arguing that Mercedes-Benz needs to cut the price of the S-Class or else they’ll lose all their customers to the Nissan Sentra.

Fourth, the analyst is being inconsistent. To give the company brand equity credit, and any non-zero valuation at all when one argues that Nintendo must cut their prices when they can’t and won’t do this is idiotic. Because Nintendo won’t do this, by the previous logic they’re doomed to fail, but if they’re doomed to fail the brand has no equity and it certainly shouldn’t get a premium to the cash value of shares. If anything, it should get a discount to the cash value as it’ll probably burn through more.

Fifth, the analyst is being disproportional and lacks perspective. Negative charges due to forex translation have been more than de minimis but are still a small, small fraction of revenues and total earnings. To cite ongoing forex issues as an earnings problem for the company shows a lack of respect for the true magnitude of this issue.

Sixth, and finally, this is another demonstration of Wall St’s short-term focus and inability to think of the big, long-term picture. The analyst doesn’t see ANY WAY that Nintendo can generate meaningful earnings in the next 12 months, even though it’s rolling out a brand new system without any competition from Sony or Microsoft doing the same, and even though it’s gaining sales momentum with the new 3DS system. The analyst sees NO optionality in any initiatives or efforts by this company, whatsoever. And, even though the stock market is supposed to be discounting all future cash flows of a company, therefore qualifying it as a “forward-looking” market, this analyst only cares about the next year.

Will Nintendo even be around 13 months from now? This analyst doesn’t know and doesn’t care, and seems to think that either way, the company represents such a frightening risk with 90% of his share price target in cash and no debt, that he is only willing to assign it a small premium value over that cash.

If Nintendo just scrapes by, the market should lift off once it realizes it’s not dead in the water like this analyst believes it is. And if Nintendo has another hit on its hands, with the Wii U or otherwise, it’s really going to catch everyone with their pants down.

Which is quite an embarrassing position to be in.

Oh, and one other thing– the smartphone gaming ecosystem seems to be in the process of cannibalizing itself. I don’t think they’ll present much of a threat for ol’ Nintendo.

Fees, Firepower & Funds: The Incentives Faced By Private Equity (@EpicureanDeal, #PrivateEquity)

I know very little about the private equity world, mindset, incentive structure and investment strategy, but I am eager to understand it better. I found a recent post, “Too Much Is Never Enough” at the Epicurean Dealmaker blog, to be informative reading, assuming the author knows what he is talking about. Plus, it came chock full of Seven Samurai quotes, which is pretty awesome:

Tempting as it may be to imagine Steve Schwarzman and Leon Black dressed in top hat, tails, and duck bill masks whooping and hollering atop $10 billion mountains of gold coins in swimming pool vaults deep under Midtown Manhattan streets, private equity firms almost never get to hold the actual money nominally under their control for longer than it takes to keystroke a wire transfer into somebody else’s bank account. The multibillion dollar funds they raise with such fanfare in the press represent commitments by their limited partners to invest up to that amount in appropriate investments described and limited by the master fund agreement, not actual currency sitting in a bank account. When the financial sponsor finds and buys a company, it levies a capital call on its investors, and they are contractually obligated to deliver those funds in a timely fashion so the general partner can purchase the target. The trillion dollars which Mr. Sorkin so gleefully describes is not actual money gathering dust under the Carlyle Group’s mattress but rather a promise to invest that much by the pension funds, university endowments, and other institutional investors who employ it and its brethren to make money.

Second, there is the issue of how long financial sponsors actually get to call that money from investors, the key issue at hand but one which Mr. Sorkin skips rather lightly over in his haste to portend doom. For while most private equity firms raise investment funds with lives of a decade or more, by the same token most of them have significantly shorter actual investment periods. Usually, if the general partner is unable to find appropriate companies to buy or other investments to make within four to six years of the initial closing of the fund, the limited partners’ obligation to fund further capital calls goes away. More importantly, from the private equity firm’s perspective, the fund agreement dictates that it can no longer charge its full (2%) management fee on the full committed amount. In other words, if financial sponsor Dewey Trickem & Howe only spends $4 billion of its $10 billion DTH Rape and Pillage Fund XXIII by year six, it can no longer charge its limited partners $200 millionper year in management fees. Instead, it can only dun them for 2% (or less) of the actual money invested, $4 billion, or a paltry $80 million. Given that DT&H has lots of expenses to pay, including luxurious Park Avenue office space, oodles of advisors and consultants, and legions of sharp-toothed Henry Kravis wannabes, you can just imagine how little they want to let that $6 billion of uncommitted capital (and, more importantly, $120 million of annual income) slip through their fingers.

Gross these management fees up across the multiple funds which large asset managers run in parallel (Fund I, fully invested and in harvest mode; Fund II, recently fully invested; and Fund III, recently raised and currently being invested), and you can see the 2% management fees which these firms charge add up to some serious revenue. Spread it out across multibillion dollar investment firms which employ a relatively paltry few hundred professionals, and you may understand that incentives to make investments which actually make money for limited partners get materially blurred by the incentive to gather assets.

This Is How Analyst Earnings Calls Look To Me, Too (@JeffreyMatthews, #WallSt)

I’m glad to know I’m not crazy and Jeff Matthews has a similar experience to my own. This is hilarious and represents satire at its best, satire that is essentially just reality with the names changed:

CFO Cathie Lesjack: “The following discussion is subject to all sorts of risk factors, and since most of your clients have already lost a lot of money in HP stock by listening to me in the past talk about how great we were doing and taking it at face value, I figure you should already know enough not to pay much attention to what we’re going to say.”

  CEO Meg Whitman: “Thanks Cathie.  We’re going to dispense with reading the press release and the boo-ya stuff, since most of you know how to read—at least you can read everything but a balance sheet.  (Giggles)  Operator?”
 Operator: “Thank you.” (Reads instructions)  “Our first question is from the line of Glen Obvious.  Mr. Obvious?
 Glen Obvious: (Confused) “Hey, thanks.  That was quick. Umm…”
 Whitman:  “Operator, Glen, is trying to figure out what to congratulate us for, because he always starts out saying ‘congratulations’ on something so his poor clients who own our stock feel better no matter how bad the actual news is.  Why don’t you move on to the next question while Glen gets his brain going.”
 Operator: “Yes ma’am.  Next is Janet Literal.”
 Janet Literal: “Thank you for taking my question—”
 Whitman:  “Why wouldn’t we?  This is a conference call.”
 Literal:  “Well, I always say that…so you’ll think well of me.”
Whitman:  “Well cut it out.  We’re all grown-ups here.  You don’t have to thank us for foisting dopey acquisitions, massive write-offs, a negative tangible book value, a highly leveraged balance sheet and non-GAAP earnings on America’s small investors.  Just get on with it.”
 Literal:  “Okay—well, that’s my question: you don’t have anynon-GAAP numbers in the press release.”
Whitman:  “Yeah, we figured since those aren’t actually based on ‘Generally Accepted Accounted Principles,’ we should probably start going with just plain old GAAP.  It’s a lot closer to the truth that way.”
 Literal:  “But these GAAP numbers are terrible.  You didn’t make any money.”
 Whitman: “Bingo.”
 Literal:  “So how come your non-GAAP guidance was so much better than this?”
 Whitman:  “D’oh!”
 Literal:  “I’ll get back in the queue.”
 Whitman: “We won’t hold our breath, honey.  Next!”
 Operator:  “Your next question is from Fred Forehead.  Mr. Forehead, your line is open.”
 Fred Forehead:  “Thank you for—oh, sorry, never mind that. Meg, how should we think about the revenue decline?”
 Whitman:  “You want me to tell you how to think about something?!  Didn’t God give you a brain?”