Thursday, December 18, 2008

Apple After Autos?

Previously, Apple entered deals with auto makers for iPod integration.

Given the crummy user interface on Mercedes' "Command" system, I was excited Apple might sell high-end auto makers on a less user-hostile interface using Apple tech.

According to Apple's recent patent filings, the future is here. Apple describes multitouch skins that would put controls on steering wheels and enable context-sensitive modification of interfaces. Thus, the silly icon for the in-car built-in phone you didn't order need not roll your eyes the whole life of your auto ownership: the buttons you see would be multitouch surfaces whose descriptors would vary with what you were doing. Zooming and moving maps should be vastly better with this than with the existing map system, which is so heinous that I haven't had time to finish my excorciating comments on it.

The short story: the included maps are obsolete on the day the car is delivered, the categories in which destinations are sorted make it impossible to find the post office in the town you just drove in (or hell, your own town), and the slow and cumbersome mechanism for scrolling about and zooming on the map looks like something that might have been dreampt up decades ago for a sci-fi movie targted at a culture in love with buttons and happy to suffer. And it crashes.

So let's hope -- whether you own Apple, or just drive cars -- that Apple has some success pitching its UI tools to auto makers. At least at Mercedes, they're in desperate need of a lifeline.

Wednesday, December 17, 2008

Apple Cancellations

On the heels of Apple's recent announcement that MacWorld would be permanently canceled[*] -- improved access to customers through retail and online stores make it less relevant than when coverage of the event was a major source of new product press -- this press release confirms that Apple, for similar reasons, has also canceled Christmas.

You can visit an Apple Store year 'round, and have what is left of Christmas in July. And May.

And so on.

At the same time, it's been reported that Apple has just suffered its first computer sales decline in modern history. This claim is about what one should expect from the tech media, but it doesn't jive with the data. Apple has had wild unit sale fluctuations since it first introduced the iMac in the late 1990s, and often has had sequential declines, year-over-year declines, unit declines, dollar-value declines, and so on. What Apple has consistently done -- with notable exception in the case of the Enron-crash-era Quarter of the Cube -- is produce a profit. Apple is still producing a profit, as it appears set to dominate yet another market segment with its handheld products. Apple's profit has created such a glut of cash and cash equivalents that Apple is justifiably criticized for not doing more with the cash.

To Apple's credit, Apple hasn't lost that cash and cash equivalents in the market collapse because it was in ... drumroll please ... cash and cash equivalents.

When I wrote about Apple's "dismal performance" with its cash, I hadn't yet seen September and October of this year. As much as I think Apple's cash management has been a drag on shares, marking to market a bunch of materially impaired investments would have been rather worse. So, hat's off to Apple on its cash.

[*] In fact, Apple can't cancel MacWorld, as it's not an Apple-run event. This is part of the joke on cencelling Christmas, you see? MacWorld, like Christmas, is an event run by others. Apple is simply the highest-profile vendor in the MacWorld show (and if they're lucky and good then maybe sometimes Christmas, too). Steve Jobs didn't go to the first MacWorld, and indeed didn't attend one until his return to Apple in 1997. With Apple's improved power to obtain attention for its press releases without the platform of a third-party's computer trade show, the need to spend time and money on the show seems slight. On the other hand, based on the previous link's comments about the impact of encountering customers and developers, it's possible that Apple's folks might benefit from the trade show. On the gripping hand, the current world of instantaneous electronic communication makes it certain that awareness of users and their feedback is not the kind of thing that requires physical presence at an annual trade show.
My own take is that the increase in the impact of the Apple brand over the last decade makes it unnecessary to present in Moscone, when Apple could for less money announce a press event and host it on Apple's own campus, as Apple has done with some iPod-related announcements. Apple's gotten high profile acts like U2 to show up for these gigs, without even giving them billing. Apple may one day need a trade show to give it profile, but at present Apple can make its own press and doesn't need the expense or distraction. Plus, other developers will have a chance to do something that isn't rendered irrelevant by the keynote presentation.

Tuesday, December 16, 2008

CNN Censorship Slip

As I mentioned recently, I'm working too much just now to post much. The unpublished drafts are piling up, but they need polish; I have some pride. Also having some pride this week are Parisian nude models, who are outraged at (tax motivated) government intervention against their traditional supplementation of their minimum-wage art-school jobs by accepting tips from students and instructors. CNN covered the ensuing outdoor naked protest, with the expected American-media pixelation of nipples and a little effort to film only above the waist.

Worry about inadvertently objectifying women seems to have paid off as expected, but if you want to see a highly detailed male member whose partially exposed glans peeks from its foreskin in full focus, look at the chap laying on his back next to the sitting woman wearing the blue robe.

Cold out there in Paris this time of year, isn't it?

Tuesday, December 9, 2008

Lamb: A Read For The Season

I recently read Christopher Moore's comic Lamb and I approve.

Immediate reaction to a work claiming to present a lost Gospel -- especially a comic work -- is that its author will look for laughs at the expense of those who believe what is taught by the religion in question. Examples aren't hard to think of: Monty Python's Life of Brian comes to mind, trying to explain the conclusion that Mary, mother of Jesus, was concluded to have been a virgin because she refused to answer blunt questions about her sex life when posed by rude strangers. Some folks get worked up over that kind of thing.

Moore's Lamb avoids this by heaping the bulk of his irreverent and often obscene script onto the lap of Biff. Lest anyone stand tempted to attribute to this new character the virtues of other Biblical good guys, Moore introduces Biff by having an angel demand to know why he should be ordered to have such an a---ole write a new Gospel.

This is important to keep readers from inadvertently deciding he should be identified with the saints and apostles and becoming angry at the author's treatment. Most of the jokes, after all, depend on the reader having fairly conventional ideas about sex and bodily functions, and being easily surprised Jesus should have a lifelong buddy who is into hookers. The remainder of the humor is a series of just-so stories about the origin of Jewish consumption of Chinese food on Christmas, the invention of the pencil, the true origin of the theory of evolution, and the ultimate fate of the yeti. Biff is no saint, he's just a bystander -- and a loyal friend.

From the "action" standpoint, Moore actually gets the reader interested in the question whether Biff, while looking out for his buddy Jesus, is going to manage to botch the sacrifice and resurrection. Is he going to explain it all away with medicine, killing the miracle altogether, or is everything going to come out according to Canon? In my view this part of the story constitutes a thriller worth the trouble to experience the rest of the book to appreciate, even if you don't care for yetis or hookers. I nominate it into the running for the best part of the book.

Of some interest to people who know and like the New Testament is Moore's effort to "explain" Jesus' perspective on traditional Jewish religions matters by fabricating anecdotes to make them seem reasonable, human, and plausible.

Well, OK; not so much plausible. I mean, the last of the Yeti? But it's entertaining, especially if you like lowbrow humor. For a light and irreverent trip, and perhaps to stir more serious thoughts about what really did happen so many years ago, have a read.

Monday, December 8, 2008

MSFT "On Sale": Still Not Exciting

Microsoft (MSFT), which is bathing in cash generated from its enormous applications and operating systems business, is heading back up over $20 a share but I don't see a return to greatness, and am not buying.

Back in the day, Microsoft didn't pay a dividend. Today, MSFT pays a dividend, which is a subtle message that Microsoft thinks that even after paying taxes twice on the money it's making, you're in a better position to figure out how to invest it. The $0.52/sh per year Microsoft pays shareholders is a couple of percent at this share price, which while non-zero is nothing to write home about. MSFT's EPS of $1.89 is something to write home about, though, and with a P/E about 10, one would tend to get interested in the company.

There are two reasons not to buy a huge, well-known cash-generating machine like Microsoft.

Losing The Market To Competitors
Microsoft's share of the web browser use on the Internet -- an indicator of the importance of what Microsoft brings to the browser world, and the relevance of the company's web-authoring and web-serving products that enable developers to leverage proprietary MSFT browser features and thus force the world to keep using MSFT's broswer products -- has continued its fall from over 90% in the 1990s to dip this month below 70%. (Data source is here.) The chief culprits? Free browsers. Firefox' Netscape-derived Mozilla codebase and Apple's KHTML-derived WebKit code base offer no-fee, standards-based browsing. WebKit in particular is nefarious, as it has garnered a number of other business adopters seeking a portable-friendly, fast-rendering, full-featured browser. With but one phone model, Apple's WebKit-based phone browser already exceeds the browser use of all Microsoft phone products combined, from every hardware manufacturer that licenses Microsoft's mobile products.

The desktop is where it hurts, though: Netscape, in a sort of Ghost-of-Christmas-Future act, has taken the bulk of Microsoft's lost browser share. By showing the world that one in five on the Internet is using a standards-based browser, Netscape has killed the "everyone is using Internet Explorer, so all you need to do is to target IE" meme and thus has killed Microsoft's browser strategy. Microsoft's browser strategy, in essence, is to use proprietary variations to force users back onto the IE shipped with their copy of Microsoft Windows in order to keep being able to use the Internet.

With developers targeting standards Microsoft can't control, Microsoft is stuck trying to keep its own web sites broken-looking, as if anyone cared what Microsoft's web sites looked like. For example, Microsoft frankly admits that it sniffs browsers' user-agent strings to determine whether to send standard or non-standard content to requesting users. This so breaks users' experience on the Internet that developers of the Opera browser now support not only lying about your user-agent string when you visit web sites, but deciding which lie to tell on the basis of the domain name you are requesting. In my own experience, most sites that claim I can't use Safari on a site and serve me a "go get a different browser" page instead of my requested content turn out to work just fine if you tell Safari to lie and claim to be Internet Explorer for Windows. This is exactly the kind of scam Microsoft pulled to combat DR-DOS, a competing pre-Windows operating system that had created pricing pressure on Microsoft and threatened to offer a complete alternative at a lower price and with higher quality. Management's instructions were clear how to combat the threat of high-quality application interfaces: "Make sure it has problems running our software in the future." This monopoly-seeking behavior ultimately cost MSFT $100,000,000 in antitrust settlement of the DR-DOS claims, but it was a small price to pay: MSFT retained its monopoly and is reaping billions to this day.

Let's remember why Microsoft entered the browser market, and why it was important that the browser be available at no charge to Microsoft's existing base of consumers. Netscape was feared to be ready to offer a programming interface for its browser, which would have enabled a "deploy-anywhere" opportunity for developers and freed them from Microsoft's operating systems, development tools, and upgrade cycles. A migration path from MSFT's operating systems and applications to a platform that could me created anyplace Netscape chose to deploy its browser was a nightmare for Microsoft, which first sought to shackle Netscape contractually to MSFT's EOL'd 16-bit Windows APIs and then decided to bury the whole company by shipping a competing browser to undermine Netscape's capacity to deploy a universal platform. Microsoft deliberately made its browser different, and ensured all its authoring tools made sites look good in MSFT's browser and not in Netscape's.

Microsoft pulled a similar trick with Java. Remember Java, the computer language that was going to free everyone from dependence on operating systems by delivering a Java interpreter to any platform Sun chose to support? Microsoft sold Java development kits that created programs that would run only on Microsoft's own operating systems. Consumers figured out pretty fast that Java wasn't write-once, deploy-everywhere -- and developers didn't want to write their apps twice, so . . . .

Google has deployed a browser, Chrome, from which it need not make any money. (Google is making its pile of cash on advertising, and it gets eyeballs because it's got both the leading search tech and an enormous community of users of services you may have seen . . . like, uh, Blogger.) Google's release of Google Gears for numerous platforms, and its integration of Gears into Chrome, means that yet another hard-to-defend front has opened in the Microsoft-is-becoming-irrelevant movement.

So I suppose, since Microsoft's whole business -- applications and operating systems -- are dependent on users or their hardware vendors paying to deploy Microsoft APIs on virtually every system that is sold, I should have thought about leading with the other market in which Microsoft is losing share: the operating system. Microsoft's operating system has just turned in its lowest sales share in fifteen years. New-sold machines used to be virtually all shipped with Microsoft Windows Certificates of Authenticity, serial numbers, and so on. Recently, the share has dropped -- as Internet Explorer droped a while back -- to less than 90%.

This is significant for a few reasons. Fifteen years ago, there was serious desktop operating system competition from IBM in the form of a 32-bit, multithreaded, multitasking product that shipped with an object-oriented development environment; the product, OS/2, became a standard feature on ATMs and other mission-critical applications and was at one time widely deployed in financial enterprises. Microsoft captured nearly all this business when IBM withdrew OS/2 from the marketplace. The best you can do as an OS/2 fan now is to attend WarpStock. Fifteen years ago, Sun was a serious computer company with an apparent future in servers. Fifteen years ago, Microsoft didn't have protected memory on the desktop and its products required rebooting so routinely that shipping a better product was trivial; it's just making an API that wouldn't force everyone to re-buy their applications ... if any applications could be found. (This API arms race and relative dearth of native applications is the reason IBM could not keep OS/2 competitive.) The fact that Microsoft can now -- when it has killed all the non-Unix competition, when it delivers a 32-bit, multitasking, miltithreaded, protected-memory user environment -- lose market share . . . wow. This is Microsoft on its best possible product deployment environment: it has enough cash to buy anything it needs to produce anything it wants, and it controls both the desktop and most of the business back-office with its proprietary APIs. MSFT should be eating this for lunch.

What Happened?

CEO Has No Vision For The Future
Mr. Gates retired from active duty to while away his autumn years deciding how to give away his ill-gotten gains so he will be regarded as a major philanthropist when he dies (and to keep people from throwing pies in his face when he walks down the street), the leadership of the behemoth that is Microsoft has fallen to the company's most senior marketing manager. Steve Ballmer doesn't have a deep grasp of the technical underpinnings of the company's products, but he sure knows bad news when he hears it. Microsoft can create interesting new highly-dependable operating systems, but it hasn't any intent to deploy them. Instead, Microsoft continues to dole out successive MS-Windows versions to stretch as far as possible the period in which it can capitalize on the API monopoly it achieved in the 1990s when it poisoned DR-DOS, choked Netscape, rigged its Java tools to sabotage Sun, and re-rigged its Win32 API repeatedly to prevent IBM from being able to make a clean-room copy รก la DR-DOS with which to ship OS/2 Warp. With its current initiatives apparently unlikely to move the needle on corporate profits (XBox' lifelong result is still red, and its quarterly numbers look good only by dint of prior accounting charges to allocate funds for ongoing warranty problems; the iPod killer Zune is virtually dead, having won market share mostly from Windows Media partners rather than from Apple; you can find products like Microsoft Bob only secondhand, and they haven't even got a fan community like OS/2 has; and technologies like WinFS can't be found at all), Microsoft's corporate strategy appears to be the milking of last century's victories to generate this century's profits.

But what is Microsoft doing now?

At a developer's conference in Sydney, Ballmer faced a serious question from one of his developer constituents:
Q: Why is IE still relevant and why is it worth spending money on rendering engines when there are open source ones available that can respond to changes in Web standards faster?

A: That's cheeky, but a good question, but cheeky.

via TechWorld
Cheeky? This goes back to whether Microsoft is making effective use of capital, or should be giving the money to shareholders.

Ballmer's reported answer -- he didn't just call the man cheeky and move on, he did give an answer -- was apparently rambling. He reportedly said it was "likely" that there would be no innovation in browsers and that Microsoft would need to continue developing its own browser to be able to issue proprietary extensions to broaden its functionality. (Given what's happening in Chrome, and in client-side databases, why is it "likely" innovation will halt? No answer.) Ballmer has apparently not used products from the Mozilla project, and has no knowledge of the enormous ecosystem of browser plug-ins supported by products like Firefox. Extending open-source browsers with closed-source extensions is the whole point of the plug-in framework. Google's decision to have plug-ins run in their own address space to make sure they don't cause instability in the browser itself is an example of innovation to ensure that (a) plug-ins play nicely with one another, (b) developers can deploy plug-ins fearlessly because their operating and debugging environment will be consistent, and (c) users can choose the browser they want because the browser only requires content to meet standards, not to specifically target the browser, but users can use plug-ins to handle any wierd content proprietary vendors might foist on the internet. *cough*flash*cough*

Ballmer continued to claim that "Open source is interesting. Apple has embraced Webkit and we may look at that, but we will continue to build extensions for IE 8."

Microsoft has no current strategy to leverage open-source projects in the web area, and it doesn't describe a clear advantage to an entirely-in-house solution. Rather, Ballmer displayed the kind of out-of-touch mindset that he inavertently confessed to the world when he initially dissed the iPhone as unlikely to have a meaningful impact on the market due to its price, at a time Microsoft's Windows Mobile shipped in products that cost more.

What does the future hold for Microsoft?
The only big idea Microsoft displayed in Sydney was creating an online store opportunity to help independent vendors share their revenues with Microsoft, before they abandon the platform.

Also: Flying Cars For Everyone!

Yes, Ballmer predicted that in ten years folks "will talk to their computers, and they will respond." I hate to be the bearer of bad news, but this was a leading feature of OS/2 Warp v.4. You know, from the mid-1990s. And we know how well that went over.

Management's Deep Grasp of Application Development, English Grammar
Ballmer gave us this gem, on which I will close:
There is sure a lot of software left writing in this world.
via TechWorld

Friday, December 5, 2008

Not Trading

I've been out making money -- that is, working -- and haven't been completing posts I have in the works. I apologize. In the works is a post I started on Berkshire Hathaway when it was at $2500, touting it as a one-stop shopping opportunity for investors looking for fire-and-forget portfolio diversification, which I promised here. I see the company's B shares have been past $3500 since then, and are on the way back down. I'm sorry I haven't been able to spend more time here.

I keep getting posts about my developing thoughts on ACAS. I'm not trading, to get in or to get out.

The stock price collapse since the last quarter has been severe. I believe that the combined effect of ACAS losing its income investor constituency to the dividend suspension (necessary to maintain liquidity; gaming the rules to pay taxable income as late as possible will aid efforts to survive whatever happens in the near term, and will leave ACAS with time to work out whether a different tax structure -- and different accounting treatment -- would help the company survive the current panic) and the share price dropping low enough that some institutional investors are no longer permitted to buy it have created an environment in which the motive and reason to buy ACAS seems hard to fathom. After all, between the quarterly announcements, one hardly knows what's going in at ACAS.

One thing I believe is happening at ACAS is that its investments are paying as expected. ACAS made $0.74/sh in NOI last quarter. Articles suggesting that ACAS got killed because it "dabbled in commercial mortgage-backed securities and structured finance products such as collateralized debt obligations" miss the point that those products are performing according to plan. ACAS isn't hammered because it made a shaky CDO bet. Understanding what's happening at ACAS is trickier.

ACAS has been killed by the accounting rules that apply to BDCs. Berkshire Hathaway, for example, need not report each quarter what GEICO is worth, or Dairy Queen, or any of its businesses that are intertwined with the housing industry. Berkshire just reports its income, and leaves you to work out what the enterprise value must be. Only for certain assets -- like derivatives -- does Berkshire have to apply mark-to-market. Because of its tax status, ACAS lives in a different world. FAS-157 and the use of bond-yield-analysis (for debt holdings) and comparables pricing (for modeling equity values) to create SEC-reportable values have the perverse effect of creating "losses" where there are no investment realizations, and where a company with different tax treatment, like Berkshire, would never have to report trouble. If ACAS were a bank, its performing loans would be carried at face value rather than at the steep discounts that the current credit market gives loans being dumped for liquidity. In fact, ACAS' senior loan syndications are sold at par, and not at a discount at all. ACAS never intended liquidating its subordinate debt in its portfolio companies; those are the tools by which ACAS makes money on its portfolio companies prior to liquidation. Who cares what strangers would pay for debt that yields ACAS regular payments?

ACAS has a problem that has nothing to do with its accurateness in underwriting investments. ACAS' problem has to do with unrealized valuation changes causing a liquidity crisis unconnected to its earnings. Redirecting liquidity into debt pay-down prevents ACAS from investing in good deals as bargains erupt in the marketplace, lest ACAS blow regulatory debt/equity ratio limits. I think ACAS' managed investment AGNC shows us something about ACAS' debt underwriting acumen.

The problem is that ACAS can't just sit back and enjoy the performance of its investments while the market re-values these investments. Ordinarily, a Buffett-like investment horizon (well, until the subordinated debt matures, which isn't really "forever") is no problem for ACAS. These times aren't ordinary. In a liquidity crisis, the long-term accuracy of underwriting is less important than the extent of the fear of the current market participants.

At the moment, I am neither buying nor selling. I think it's possible that ACAS is trading at a huge discount to NAV -- the last quarter's published NAV was easily more than six times current prices -- but the hard cold fact is that with only quarterly snapshots, ACAS' health at this point in the panic (and the market is in a panic) is at best an educated guess. I can't say whether tomorrow will be so much better a buying point that today is a fool's bet, and I can't say that the current panic has driven the price so far down that ACAS' efforts to control liquidity will cause a chorus of euphoric cheers when the next quarterly report appears. Frankly, I expect the current economic macro-conditions to remain bleak well into 2009. The effect on comparables pricing should be harsh. ACAS' announced plan to plow funds into debt reduction and its stated preference to work without leverage are on the mark for how to approach this environment ...

... but ACAS has been de-levering for over a year. ACAS' NAV has been clobbered not by the implementation of FAS-157 -- the bogeyman we were offered last year -- but by the need to mark to market investments which were intended to be held to maturity and are performing to model. Earlier this year, these discounts gave me reason to be confident the company was on sale. Today, the prospect of further depression of valuations of performing investments sends cold chills down my spine: it produces a liquidity crisis while risking breach of net worth covenants that would in turn trigger more liquidity problems (as lines of credit became at risk of withdrawal).

The irony is that I don't dislike ACAS' portfolio. ACAS had, in effect, the same problem I had in my own portfolio: good ideas whose performance have been clobbered by the application of leverage heading into a panic, creating a liquidity crisis. Entering counter-cyclical and non-cyclical businesses was a good idea, and shunning them in favor of debt reduction didn't seem reasonable to me before VIX hit 60. Closing offices and reducing staff aren't what ACAS wanted to do, but it's a solid cost-control measure that will impact ACAS' liquidity in the right direction.

Will ACAS be able to take ECAS private? If so, shareholders of both companies would benefit (ECAS from the increased liquidity of ACAS shares, and ACAS from the accounting impact of buying ECAS below NAV). If not, ACAS will suffer as ECAS' illiquid shares continue to be valued awfully low by a market distrustful of private equity. In the meantime, ECAS is producing nice income for ACAS, to the tune of €0.14/sh this quarter. Buying more of that income below NAV would be good stuff.

Failing to pull off the ECAS transaction would hurt.

My prediction is that ACAS will fight to keep its current tax status, but it's dicey. I believe the fallback position will be something like a bank holding company, which will have radically different accounting rules and freedom from mark-to-market on much of its portfolio (the equity will be, but much of ACAS' portfolio consist of debt holdings that would be carried at face value if performing), or an investment holding company like Berkshire Hathaway. Neither enjoys the tax-efficiency of pass-through tax status -- something that made ACAS as a BDC very attractive in pre-tax/tax-deferred accounts -- but either would position ACAS to weather the current economic storm on the strength of actual investment performance rather than suffer the illusory gain and loss risk caused by FAS-157.

I didn't think FAS-157 would have any impact but to lower my reinvestment price, so I thought it was an entertaining but good thing for me as an investor. The current panic reveals FAS-157 to be a truly dangerous opportunity to whipsaw both asset values and debt ratios on the basis of factors that may be substantially disconnected from actual investment performance. As I previously posted, if ACAS were to lose half its income production to debt-eradication efforts, its NOI would support a price several times current levels. That's a bad case.

That's not the worst case, though. The worst case involves a liquidity crisis that drives ACAS into liquidation. However, that kind of liquidity crisis seems strongly associated with ACAS' tax status, a condition within management's power to change. Conversion into a C corp, and registration for treatment as some different type of investment, would also change the accounting rules Kosher for ACAS to apply to its business. Management is loathe to ditch BDC status, but they've explicitly addressed it and therefore are looking at the factors that would drive them to it. Conversion to a C corp would result in a Berkshire-style dividend (zero, to avoid double-taxation), improved book value, and a share price that should stabilize as it becomes evident that NOI continues to perform and that banks haven't abandoned ACAS as a house of cards.

This last year makes me think diversifying out of Apple was a silly idea. Apple's phone has, after all, just passed Microsoft in smartphone operating system share after passing Motorola's RAZR in sales share ... while Apple is taking sales share from competitors. Apple shares are going to come out of this one very nicely if I'm not mistaken.

Monday, November 24, 2008

Lazy Man's Diversification, Part I: Berkshire Hathaway

Visitors to The Jaded Consumer will doubtless have noticed me pointing out the views of Warren Buffett in connection with timing purchases, choosing an investment horizon, and deciding where the economy is going. One thing not much discussed is how to make money off Buffett's own investment decisions. So, how can you do it?

There is a very simple way to bet on the judgment of Warren Buffett, and to obtain a low-overhead, nicely-diversified portfolio of investments in the bargain. Buy Berkshire Hathaway.

For the bargain investor, the route is surely to buy the B shares, a class of shares with reduced voting power designed to enable retail investors to participate without forcing them to cough up something on the order of six figures per share (that's excluding any decimals). The B shares have traded from over $5000 apiece to just $2000, and are currently trading at $3300 (though when I started writing this piece, the number was actually $2500, sorry I was so slow on the draw). There is no dividend, because that would result in company profits being taxed twice before potential reinvestment: once when earned by the company, and once when paid to shareholders as a taxable dividend. Berkshire Hathaway shares are to be held not for income (which is zero) but for capital gain; The Jaded Consumer does not advocate trading, has no advice on trading, and has no idea how to time investments, and thus suggests BRK.B for long term capital appreciation. A year ago I would have said BRK.B would allow one to invest money in a way that enables owners to sleep well at night and to avoid worry that some fluke in the credit or capital markets or in some particular industry would require sudden action on the part of investors, but let's face it: in the current economic panic environment, virtually anything is possible (especially if you are using leverage). If you avoid leverage like the plague, though, I give you this : BRK.B is a fully-approved Jaded Consumer fire-and-forget scheme for investing for the long term, so you can dedicate your time to having fun and earning your living and not wasting precious time following the markets.

Berkshire Hathaway's Class B shareholders are equity participants in the exact same way as the company's Class A shareholders, but the B shareholders have less fractional interest per share (and even less voting rights). There are two arguments why to buy Berkshire: it's easy diversity, and the thing is well-run.

At the time present management took control of Berkshire Hathaway, the company was principally occupied with U.S.-based textile operations. Its risk was concentrated in a dead-end segment, but management was able to obtain control at a relative bargain. Management began directing cash to investments with a brighter future, and ultimately exited the textile business altogether during the 1980s. Presently, Berkshire Hathaway is a holding company with significant insurance interests, which invests cash not needed for current and near-term obligations in a variety of businesses purchased on the basis of value. Unlike banks, which pay depositors and other creditors for the use of cash, Berkshire Hathaway's insurance business holds money for policy holders rent-free while awaiting the day a claim needs being paid. In short, Berkshire Hathaway has an enviably low cost of capital, and because much of its capital comes from insurance premiums, the company faces the possibility that an underwriting profit will enable it to keep some of the "borrowed" money permanently. This is like BRK.B getting to borrow capital with a negative interest rate. Cool, no?

Of course, underwriting losses are possible, too; however, Berkshire Hathaway makes a point of engaging only in risks that are farly comprehensible, and staying clear of unknown risks that have surprised some competitors over the years. An example is the asbestos liability that threatened the London syndicates who reinsured commercial liability policies; surely, they didn't anticipate assuming something like long-term personal injry risk arising out of workplace breathing conditions, so the syndicates got hammered, but when it came time to reinsure this risk someplace that would remove it from the London syndicates' books, Berkshire Hathaway was there with a modern understanding of the asbestosis risk and enough capital to reinsure the whole thing forever. And Berkshire Hathaway gets to invest that mutibillion-dollar premium while the risk overhangs the company.

Berkshire Hathaway also accepts some other risks. Berkshire Hathaway isn't afraid of risk, you see: it's afraid of uncertainty. A good bet is still a bet, and the year Katrina hit the Gulf Coast was rough. On the other hand, the next year was a bonanza. Over the long term, accepting good risks pays off.

So Berkshire Hathaway has a multibillion-dollar derivatives exposure. Although Berkshire Hathaway isn't subject to FAS-157 and need not write down (or up) its holdings' value on a quarterly basis, derivatives are treated specially and give rise to unrealized losses (or gains) that don't impact the company's taxable income or its cash flow or its liquidity, but do impact its SEC-reportable income. Berkshire Hathaway manages this risk in several important ways. First, there is no counterparty risk. The derivatives that impact BRK.B don't depend in any way on the solvency of any third parties. The derivative positions were created when third parties handed Berkshire Hathaway billions of dollars in options premiums, and Berkshire Hathaway has that money in-hand. Berkshire Hathaway thus enjoys the ability to invest the premium, and obtain a return on these funds, while awaiting the expiration date; it's just like much of the insurance Berkshire writes, offering a potential underwriting profit while enabling investment free of interest. A more accurate way to view the options is that Berkshire Hathaway has written a naked put on the S&P 500, and gets to invest the premium until the expiration date. The second major risk management strategy is that the option cannot be exercised except on the expiration date. Thus, the current market gyrations may send the theoretical value of the options all over the place, but they can't give rise to a realized gain or loss because they will not possibly expire or be exercised for years.

The short answer here is you get Warren Buffett. However, you do get more. This isn't just a portfolio of publicly-traded stocks, although Berkshire Hathaway does own large stakes in a bunch of publicly-traded companies. Coco-cola, Goldman Sachs, American Express, Carmax, Wal-Mart, Anheuser Busch, Burlington Northern Santa Fe, Proctor and Gamble, Johnson & Johnson, NRG Energy, Conoco Phillips ... lots of stuff. You can read up on it in the numerous articles by folks suggesting you follow Buffett into the companies in which Berkshire invests. The problem? Berkshire is a big buyer, and can get terms others can't. Berkshire's deal with Goldman involves a Berkshire-only 10% dividend preferred and a pile of warrants. Berkshire gets 10% indefinitely, with a "free" option to buy in case Goldman goes through the roof. They don't offer this kind of thing to you and me. They offer it to Berkshire.

Some Examples of Berkshire's non-public portfolio:
GEICO (a massive cash cow, and possibly already your auto or property insurer, having about 7.4% share of the auto insurance market);
Dairy Queen, of which Orange Julius has been a wholly-owned subsidiary since 1987 (since 1998);
Sees Candies (since 1972); and
Berkshire USA (this is a reinsurer -- the kind of company that ultimately holds risks insured by insurance companies; with revenues of $18 billion, Berkshire USA had about 10% of the US reinsurance business in 2007).

Berkshire Hathaway's insurance business had $118 billion in revenues in 2007. While Berkshire stands back, waiting to see whether it will face claims, it gets to invest the premiums in a diverse portfolio of profitable companies that create cash. Pretty good, eh?

Berkshire Hathaway's investment in Burlington Northern railroad is part of Buffett's long-term bet on the American economy. Buying Berkshire B shares is a way to get a diverse portfolio with low overhead, and a bite of some great companies you can't buy on your own. Since there's no dividend, the tax consequences of long-term holding are nil until you sell; if you plan to own it until you die, there's no need even to put them in a tax-deferred account.

Berkshire Hathaway is a big buy.

Tuesday, November 18, 2008

Pystar Gets Poured Out

The court hearing the Pystar case (in which Apple sued a white-box maker for selling Apple's operating system without an OEM license as a pre-installed product on a non-Apple computer) just summarily dismissed Pystar's antitrust counterclaims. The fact that there's a universe of competition, and that Apple has been forced to offer more and more product for the same money, and has to advertise to attract buyers and has little power to entrap users unawares all seem to suggest this other anti-Apple antitrust case stands in similar jeopardy.

New Star Trek Movie Approaching At Warp Speed, Sir!

I noticed a new Star Trek movie when I stumbled upon its virtually content-free trailers. They are big on emotive grip, though: images of sweating welders with a sound track of classic clips from the first years of the space program, with the camera slowly giving the image of an Enterprise under construction. Looking over the official web site (warning: Flash), I note that there's no information about the timeline, characters, etc. However, it seems suggested that the story will pick up with the launch of the first Enterprise crew we knew from the TV series, complete with Kirk, Spock, Checkov, etc. -- but ... younger.

As seen here, the director of MI:III and Lost seems to envision Sylar from the first season of Heroes as the proper model for Spock. A bit much emotion in that one-handed choke hold, though. He's supposed to be half-Vulcan, and passionless. Or maybe they are playing on the half that isn't Vulcan, and writing him as an on-the-edge head case who hasn't yet mastered the irrational impulses with which he is cursed by his unnatural heritage. According to the web site, we're supposed to find out near Christmas, or else 5-8-09 -- a suggestion that maybe they blew an initial release target and ended up in summer of '09, and didn't take the time to re-edit all that Flash.

Being long addicted, I'll definitely want to see more ....

Election? We Don't Need No Steenking Election!

Apparently members of the Senate haven't been reading the literature produced by their near neighbor, the United States Supreme Court. This Reuters article discusses the fact that both Democrat and Republican members of the United States Senate are in agreement that a convicted felon should not be permitted to take a seat in the Senate. According to Powell v. McCormack, a chamber of Congress lacks the power to refuse to seat a duly elected member who satisfies the age, citizenship, and residence requirements articulated in the Constitution.

Presumably they will seat him -- then promptly conduct proceedings to expel him. Of course, if they do this too quickly, the Senate could embarrass itself if his still-pending appeal succeeds in overturning his conviction.

Bah! What am I saying? A member of Congress, capable of being embarrassed?

Shameless, the lot of them. The fact a mere felony should cause members of Congress to be up in arms over one of their member is silly: Mark Twain explained Congress was America's only distinctly native American criminal class. Felony is part of the initiation ritual, I'm sure.

Maybe his sin was getting caught. But, no: members of Congress have been repeatedly spotted doing terrible things -- sometimes, with the vote of their offices -- with no ill effects.

Why not let this felon join their exalted ranks? A convicted felon in Congress would be something new for that august body: truth in advertising.

Fannie Mae Ga-Ga For Golf

After being bailed out by federal regulators and recapitalized with taxpayer dollars, Fannie Mae launched a $6,000 golf outing. Maybe not as offensive in cost as AIG's luxury getaway (which included over $20,000 in spa charges alone), Fannie Mae's may be more offensive in principle because -- with only 20 attendees of which several were Fannie Mae execs -- it's much less plausibly a training or marketing opportunity.

It's just a bit of fun on your nickel.

Okay, so it was a lousy six grand. But it adds up. And there's the principle of the thing.

It's not a new problem, it's just a problem previously never of much concern: jobs holding others' money tend to attract folks inclined to treat it as their own. You see it in the public sphere (such as in Congress, where Clinton's aides referred to earmark legislation as a privilege which she used effectively for her constituents, which leads one to wonder who she thinks her "constituents" are) as easily as in the private sphere. It's a classic agency problem. The kind of immunity to oversight with which we've inoculated our top agents seems to prevent them from having their interests aligned with those of the public (for organizations like Congress when they decide how to use money taxed from strangers) or the shareholders (for corporations whose managers aren't the owners).

Fueling Conservation

The recent drop in oil and fuel prices has raised a new question: will Americans' recent decreases in driving (which seemed to be a consistent phenomenon as prices rose) evaporate like gasoline vapors on a hot day?

The answer -- at least in the teeth of severe economic turmoil -- seems to be "not yet."

Of course, this isn't all good news. As Jenna Wade of Roseville, California explains:
Q: How have plunging gas prices changed your driving habits?
A: Not at all. I’ve no job to go to any longer so I no longer drive.
Of course, others simply see their reduced driving as a good habit worth maintaining, and a way to keep money in the bank.

Speaking of keeping money in the bank, some utility companies want to be paid -- just as they would be paid for delivering a kilowatt-hour of electricity -- for investments that help reduce consumer consumption of energy. Their argument is that conservation is capital intensive, and that utilities have a lower cost of capital, so they should be paid to deliver what consumers aren't necessarily in a position to afford -- but to be compensated for it. Depending on the lifespan of some of those improvements, and the accuracy with which savings can be modeled, that might make sense. On the other hand, efficiency that leads to excess -- making the house colder in the summer than previously, because the home holds more of the chill -- might not lead to net gains. There may be some expenses users don't care to avoid, if the total cost isn't big enough to them. The idea is interesting, but I'd like to see the math. And maybe a local demonstration project to see that it works on a city-wide basis, among people unaffiliated with the power company.

If we really can induce good energy practices, all the better.

One Laptop Per Child

If Microsoft had its way, that'd be one software vendor per child.

The One Laptop Per Child (OLPC) program, led by Nicholas Negroponte, is hoping to deliver budget laptops around the world to keep even low-income people abreast of modern technology and to allow them to leverage high tech to improve their lives. OLPC is, in essence, about trying to maintain the possibility of modern education in a world of scarce resources; it is an idealistic effort to provide the tools needed to make sure children can learn to use the tools that make the future possible.

Microsoft's efforts to get pre-installed status on the XO haven't been exactly smooth. OLPC, after all, reportedly rebuffed a no-fee offer by Apple to license MacOS X (whose open-source kernel is derived from the FreeBSD project to which Apple is a contributor, and the Mach project which Apple's retired Avadis Tevanian had nursed at MIT), purportedly because of non-open-source code also involved in MacOS X made the system politically unsatisfactory to OLPC. But apparently you can buy satisfaction. Microsoft, apparently concerned about a future in which discount laptops around the world would obsolete its proprietary file formats and render its high-margin products irrelevant, poured significant resources into a version of Microsoft-Windows designed to run on XO. Microsoft has insinuated its products into the OLPC program, even to the point of causing hardware modifications in OLPC in order to allow its enormous code to be stored and run on the machines. The fact that retail buyers in the US are not yet assured the ability to buy XO with pre-installed Microsoft products is of little concern to either Microsoft (which assumes you as an American can afford a costlier copy, and will do so on your next computer purchase) or OLPC (which is trying to look like an Open-Source advocate).

The fact that towns in Columbia have begun deploying Microsoft-Windows-equipped XO machines in schools (at least in part on Microsoft's nickel, hence the product placement opportunity) suggests that OLPC hasn't really stuck to its principled stance that recipients need to enjoy the Four Freedoms when they use and study software. OLPC is more interested in keeping its own project from becoming irrelevant through lack of funding. And there, OLPC and Microsoft can find common ground.

Monday, November 17, 2008

Citizens Clobber Klan

The Knights of the Ku Klux Klan suffered a potentially serious economic blow when a not-really-an-illegal-alien-after-all (an American of Native-American and Panamanian descent) victim of a serious 2006 Klan beating was awarded by an all-White jury a verdict finding him entitled to $2.5 million in damages.

The Klan's freedom to assemble cannot be lawfully barred, but the likelihood that the judgment will be levied against the the group's 15-acre compound threatens to reduce the local Klan chapter's convenience in conducting identity-building ceremonies, indoctrination rituals, and creating a feeling of reassurance that one is surrounded on all sides by likeminded believers.

People who think jury awards are somehow out of hand haven't been paying attention. Without juries to see the right of cases, we'd have to cede justice to an entrenched bureaucracy. Without punitive damages, people could commit calculated evils for fun or profit and remain safe from serious consequences so long as they were careful in selecting their victims. This Klan verdict is a reminder that there are evils in the world -- old-time evils we would like to think long laid to rest -- and that we need juries to spot when the line has been crossed and the public should inflict a punishemnt designed not only to repay injured parties for their medical bills, but to reform behavior for future generations, to protect victims who would suffer if the same calculations that caused earlier injury were not derailed and replaced with something more concerned about the welfare of others.

I doubt the $2.5 million judgment will be satisfied in full, but it'll likely be enough to ensure that all the organization's high-profile, hard-to-hide assets are transferred to parties aligned with the defendants' victims.

UAW to Gov't: Loan GM Money!

Keeping GM in business -- and any other large employer of its members -- is surely of considerable interest to officials of the UAW (which, interestingly, stands for International Union, United Automobile, Aerospace and Agricultural Implement Workers of America). The reason strangers need to loan GM this money, rather than the UAW or its members, is that they aren't looking to lose money, but to get paid. The union collects dues it spends, and the members collect paychecks they spend. They can't be throwing good money after bad, or it'd quick catch up with them. And they feel they've done enough already to support GM, thank you very much.

That is apparently why loaning money to GM is your problem.

My problem with loaning GM money isn't just that many of its cars are being thrashed in the market by safe, reliable, price-competitive alternatives. This is a problem of U.S. auto makers generally. GM's special problem is sort of interesting. See, GM has been mortgaging its future for a while now.

A few years ago, a friend explained what a smoking deal he got on his new Hummer. He was upside-down on his SUV note, and angry at the dealership, and they worked out a financing plan whose details blew straight past him, but what he remembers is this:
  1. his monthly payment didn't go up (though it was no doubt extended), but
  2. he swapped out his little SUV for a bright new H3, and
  3. GM promised him price protection on the H3.
That third point was the sale-closer. To make him feel confident entering a sale on a vehicle in which he was concerned his collateral would quickly be worth less than the note securing it, and to make sure he came back to GM, GM guaranteed him that it'd give my buddy a trade-in price on the Hummer that was equal to his purchase price. I forget how many years that deal was supposed to last -- maybe the length of his note, or a year after -- but it obliges GM to pay way over market for a used car down the road when it's hungry to sell him some new vehicle. The problem is that GM won't be able to raise prices across all its lines in the face of fierce price competition in the auto business -- certainly not during a credit-crushing recession that drives up unemployment. All that surplus trade-in value is coming right out of GM's future bottom line: right out of the recession-discounted givaway pricing I expect GM to fall into as part of its fight to retain some kind of sales share.

The problem with simply throwing money at GM is that there's no reason to expect different results from the same operations. It's not like auto sales are exploding so greatly that there's good money to be had by every vendor with a product. The auto market is competitive, and everyone in the market is selling a different grade of commodity. Even the luxury vendors are up against luxury competitors; nobody is safe, and nobody's product is so differentiated that it hasn't got competition.

In the 1980s, when the Japanese economic miracle was producing cheap, efficient, reliable cars that were actually beginning to take safety seriously, some folks looked at Japanese organizations to determine what enabled their success. Pursuing Deming's teachings and using a number of innovations to detect, eliminate, and prevent product defects, the Japanese learned to build American designs better than could Americans. Americans who thought implementing quality circles, mixing management and line workers in teams, and broad cross-training to enable people to understand the whole process of a product's creation all tended to run into the same problem: the UAW. Collectively-bargained contracts enforceable under the NLRA specified that certain job titles needed to exist, and protected people from doing jobs outside those descriptions. Allowing (non-union) management to perform line jobs threatened the dues base, and cross-training tended to make people more easily replaceable.


So American auto manufacturers kept with their same old broken systems, occasionally scaring workers into fits of relative productivity but not addressing the systemic issues that led to the defects that embarrassed the non-Japanese manufacturers. I heard a tale from the early 1980s of an observer of an American auto assembly line watching a worker stop bolting fenders onto the passing cars long enough for a couple to go by with no bolts at all on that side. Confronted with the fact, the worker allegedly explained, "I had to light a cigarette." The same collectively-bargained agreements that prevented radical organizational re-engineering also made it extremely costly to threaten a worker's job, so there was no recourse. Even if the tale was apocryphal -- and it may well have been, though it sounded plausible enough when I heard it -- the fact remains that Americans have been unable (despite the famed productivity of the American worker) to build automobiles with as few defects, or for as little money, as Japanese competitors. To the extent that organizational re-engineering was thwarted by job classification rigidity in union contracts, and employers' inability to create meaningful incentives to encourage production quality targets under the union contracts, the industry was essentially destroyed by factional infighting. In theory, management and labor could have worked out a scheme that enabled superior competition; however, to the extent the solution appeared to require blurring the line between labor and management, it was political anathema for a union to accept such a proposal. Labor and management knew better how to exist as adversaries than they knew how to both profit from cooperation.

And the chickens have come home to roost.

While the same political forces keep the business utterly broken, I strongly urge anyone with a voice to speak out against throwing the innocent public's hard-earned and quickly taken tax dollars at an enterprise with such dismal prospects for the future. Americans can make cars, of course -- and without GM, they might have made them even better -- but saving these dinosaurs might not be in anyone's interest. Much better that GM be allowed to go into bankruptcy where creditors can work out how to arrange a future for GM that involves some profit. Saddling GM with its existing array of obligations -- including the collectively-bargained labor agreements that prevent the kind of labor/management admixture needed to duplicate the successes of American firms' Japanese rivals -- is sure to kill further investment just as it has killed prior investment.

What American auto manufacturers and their workers need is an opportunity to begin again with a clean slate. Saddling employees with brainless zombie employers doomed by longstanding agreements to repeat the organizational failures of the last forty years -- or saddling employers with sure-fail organizational designs enshrined in 1950s-style collectively bargained employment contracts full of specialist job titles and limited work duties that preclude process re-engineering -- does no good for employees' job security or employers' fiscal plausibility. We need better than a mere handout to GM.

What we need may turn out to be is a creative bankruptcy judge. Anybody know one?

Saturday, November 15, 2008

Islamofascists Maybe Trainable After All

Muqtada al-Sadr is in the news, and it's not for renewed attacks by his Medhi Army. The Islamist has, instead, called for a peaceful demonstration against an Iraqi government agreement on the terms of U.S. military presence in Iraq, to take place following evening prayers.

Grand Ayatollah Ali al-Sistani, who didn't take sides when Hussein was being ousted by the United States, issued a slightly cryptic statement "forbid[ding] any stance that targets the sovereignty of Iraq no matter how small it is." It's unclear whether specific terms of the force reduction agreement offend al-Sistani as impugning the sovereignty of Iraq, although one lingering and offensive issue involving U.S. troops has been the power to try U.S. troops for activities within Iraq. Obvoiusly, United States officials cannot agree to turn American volunteer soldiers over to a nation with a recent history of protecting those who were engaged in murdering Americans for the crime of being American; however, Iraqi officials offended at the conduct of Blackwater contractors have a natural reason to demand meaningful accountability for the activities of armed foreigners roaming freely in their jurisdiction.

I assume that Americans won't be clearly subject to Iraqi civil and criminal authority under the terms of the agreement governing the draw-down and withdrawal of remaining U.S. troops, and that this alone is sufficient to offend al-Sistani. The presence of U.S. troops on any terms is, of course, a grave concern to al-Sadr, whose efforts to sieze power by naked force have been reeatedly thwarted by U.S. response.

The question remains whether al-Sadr will keep preaching nonviolent protest after Americans leave, or whether this is simply an ad campaign for future Islamist revolt against civil government. In the meantime, the plausible threat of force seems to be effective in dampening the overt threat posed by al-Sadr to the rule of law in Iraq. The fact that peaceful protest results in fewer deaths will hopefully not be lost on participants.

On the other hand, Fox News reports al-Sadr's actual position is that a new agreement on force deployment will be grounds to renew attacks. Maybe he hasn't learned his lesson, after all ....

Friday, November 14, 2008

Time Running Out To Ditch Unruly Teens

The safe haven law, intended to reduce risk to children by granting immunity to parents who deposit unwanted children where they will be safe at Nebraska hospitals, was apparently intended to target unwanted infants and wasn't expected to draw a wave of despairing parents of unruly teens to drive into Nebraska to rid themselves of their little tormentors. (Of the dozens dropped off under the law, none have been infants.)

Seeing what conduct the law actually caused, Nebraska's legislature has amended it, effective January 2009, to make the teen drop-off-and-drive-away a thing of the fond past. Time is running out! And so are some teens who realize they're about to be turned over to the State of Nebraska ...

So, beat the rush and dump those worthless ingrates sooner than later. Fuel is getting cheaper again, so there's no excuse for delay. Holidays can be expensive, and you know times are tough ....

Thursday, November 13, 2008

Reading Tea Leaves: Predicting Obama's Moves As President

Okay, I'm guilty: I've been looking at the news for indications of what to expect in January. And I've discovered something. There's no telling what we'll get in January.

Aim High
The Second Amendment crowd has been in the news snapping up firearms in the wake of the election that strengthened Democrat control of Congress and placed its legislation in a place of relative safety from Presidential veto. Are they justifiably afraid? Back in February, before the Supreme Court clarified the issue, Obama as the democratic nominee said at a Milwaukee event: "I believe the Second Amendment means something. I do think it speaks to an individual right." The idea that Obama has taken the view of the Second Amendment as creating an individually-enforceable right even before that view was declared to be the clear law of the land is something I doubt came through NRA advertisements about the impact of the election on gun control. Democrats have long worked to create window-dressing legislation to restrict transactions involving firearms, even in the absence of evidence that such laws had any effect at all on anyone except law-abiding collectors and sportsmen. The ban on so-called "assault weapons" (a definition unknown to the world of firearms until Congress created it, entertainingly including weapons with plastic stocks but not necessarily weapons with wooden stocks, for example) was an old favorite of the NRA: it made no sense and helped prevent no identifiable evil, but offended gun collectors. If this article is right, it'll be coming back, with Obama's support. The right to bear arms might mean something to Obama, but apparently not what the NRA thinks it means. The Second Amendment folks worried about Obama's calls while in the Illinois legislature for federal taxation increases of 500% on firearms and ammunition haven't led him to introduce any related bills while actually in the federal legislature. Although Obama mentioned gun control in his speech accepting the Democratic nomination, he didn't confess any particular policy objectives and could easily have thrown that in to mollify those wanting all the party planks polished rather than because it's particularly important for him to address.

My question: if you plan employing Americans in a venture that involves boating into pirate-infested waters, or territory perilously near drug runners, is there some reason Congress doesn't want you to have high-powered automatic weapons with which to repel would-be attackers on the high seas? Granted, this isn't the general case. But it is a case I've had to deal with recently, and it was entertaining to learn that the accepted solution was to buy a weapon on the black market in the vicinity of the work area. Buying one in the U.S., paying taxes on it, and lawfully exporting it seems too fraught with red tape to bother with. European manufacturers will be getting this security business.

The good news? "With the U.S. economy in a tailspin, however, the president-elect's advisers say gun legislation is not a high priority." Well, thank goodness for that!

Order Up
One quick thing to do is to obsolete offensive Executive Orders.

Abortion: Under Reagan, a "Mexico City" abortion policy was attacked through an executive order prohibiting funding organizations that perform or promote abortion overseas. The order was dropped under Clinton and re-instated under Bush. I want to hail pro-choice movement, but I hesitate to cheer a move like the one Obama is believed to support. My question is this: given our tight economic situation, and ignoring the question of whether abortions are or are not appropriate for any particular case, why would we use federal dollars to help send people abroad for medical interventions available virtually everywhere in the United States?

Birth Control: Another executive order brings crazy funding into sharper focus. An executive order bans federal funding to organizations like the U.N. Population Fund that operate in countries that practice forced sterilization. Exactly why does the United States need to solve foreign public health problems when we have a desperate need for public health programs in this country? Forced sterilizations are vile, period. Sure. But why do we need to single them out for special treatment, and to fund some alternative? Unless it's a national security issue to promote stability, and therefore a justifiable part of the budget of the Department of Defense, why on Earth would be be involved in other nations' family planning programs? We need some education and immunization right here, and we could fund it better if the local money for these interventions weren't taxed away to the federal level then exported to some distant land and squandered where it will create no U.S. jobs and improve the quality of life of no U.S. families. Oh, I get it: visiting Africa is nicer for U.S. tourists if we control overpopulation there. Hello? Operator? I have found a brain, is someone missing theirs? I think there's a serious opportunity here to start looking at U.S. involvement in foreign charity conducted by federal officials using funds taxed from Americans by force. (To the bleeding hearts who disagree taxes are taken by force: try not paying it and see how long you can go without experiencing force. Hint: if you resort to lying about your income to avoid detection when you neglect to pay the taxes, that is cheating.)

Gitmo: Oddly, Obama sounds remarkably like Bush on Gitmo's on-base prison. He'd like to close it down, but he wonders what to do with its residents. He's going to have to spend a while reviewing their cases, and might set up some kind of tribunal that hopefully passes Constitutional muster. Ahem. Did I miss something here?

Oil: Drilling agreements in federal lands in Utah and other places beloved by environmentalists could be halted by the same kind of executive action that set exploration into motion. Well, assuming there's not already an enforceable contract, in which case you buy a lawsuit as you do it.

Stem Cells: An executive order barring use of federal funds for creating new stem cell lines from human embryos was entered by Bush43 out of pro-life concerns that each new attempt would end a human life. (At least, for some people's definition of human life; many reasonable people have not decided that a frozen embryo whose owners don't plan to use it, and won't be paying for its maintenance, and which might as easily be lawfully disposed of as medical waste and destroyed without contributing to a scientific study, is "human life".) Due to the creeping federalization of everything under the sun, it turns it that developing new medical therapies that can be sold for profit, and conducting research into treatments for human health conditions for which insurers and benefit plans routinely provide payment, are activities that are overwhelmingly intertwined with federal funding. This is so obviously an arena for health-related venture capital enterprises and state and private universities that take a share in the intellectual property created with university funding, that I cannot conceive of a reason the United States should risk federal funds without even a scintilla of a hope that the resulting findings will produce a return for the taxpayers whose money funds the elevation of the academic careers based on the research. The offensiveness of the executive order's impact on stem cell research was so great that California created its own multibillion dollar research program. This seems to undermine the very thesis that federal funding is required at all. Federal conditions of funding are obviously a political football -- in research as in education -- and should not be part of the American research landscape outside the limited scope of bona fide national security projects.

Real Change and Justice
One thing that can happen for the better is the appointment of an Attorney General who will restore to the Justice Department the nonpartisan ethic it once was felt to have. Ideally, an officer who believes in what the Constitution says and will stand up for those beliefs, even when under pressure by allies to do expedient things instead of good things. There's a serious opportunity to clean house in the Justice Department, and I for one hope this goes off like clockwork.

One thing to keep in mind is that the United States is an enormous employer, full of numerous bureaucrats that can't be fired at will (due to due process issues that don't face private employers in many parts of the country). A revolution at the federal level may involve long lag times between the initial acts of reform and the ultimate changes seen by people encountering the "new" government. The Justice Department, for example, will be run through with political recruits ideologically opposed to some of the changes that may be proposed. The INS, IRS, SEC, NSA, FBI, and numerous other agencies involved in surveilling Americans and their foreign dealings, and enforcing various interpretations of the rules governing the complex relationships people have in their business lives ... all these will have inertia and it could take a while for change to manifest even if initial efforts are swift.

The best case for quick change is high-profile change that makes clear not only to government agents but to the public that interacts with them what the new order of business is, so that nobody gets away with Old Business approaches once a new standard has been set. Unfortunately, the media won't be covering the details that will make the changes work. We run a risk that those implementing federal programs will either not be with the new program, or will be stuck with old rules that run contrary to the new program while waiting for legislative interventions that have not yet been devised.

Show Me The Money
With respect to the economy, there's some good news: the problem is so high-profile that it will get quick attention, and will be widely covered. Everyone will know what changes are afoot. Movement could be fast. However, as Buffett indicated, even doing everything right could leave considerable lag time -- many months -- while the effect of interventions ripple through the economic system.

Let's hope those initial steps are in the right direction, eh?

During the campaign, all the candidates said what they thought would get them into office. This isn't unlike Supreme Court nominees trying to give the right answers before being confirmed, after which they are free to do whatever pleases them until they hear their last case. If you give the right story, you eventually get a position from which you can pretty much do as you please and can't be removed until the timer rings. We therefore can't know what officials will do once in power.

However, we have a pretty good idea (a) what each party argues for, and (b) what the specific players have advocated. Still, this makes for a bad set of tea leaves: once in, they're free.

Also, to the extent Congress must create new positions, authority, or funding to make a solution work, the President needs to get a consensus from folks who may want quite different things. There will be quite a bit of salesmanship and arm-twisting. What we get on the other end of the sausage machine is hard to guess.

The really good news is that, unlike other countries that have sporadic revolutions, nobody was killed in ours. Even if this goes into the toilet, we will be in a position to start replacing officials in a mere two years. The Republican Party, whose high-profile and wholesale betrayal of its small-government and pro-individual rhetoric caused it to be driven from office in a major rout, will be hard at work trying to find something relevant to offer Americans, and the fallout should include some improvement in the public examination of our fiscal policy.

It's too much to hope Americans stay serious about their concerns over government -- already, they don't care how the Congress votes on issues -- but perhaps we can drive attention toward major economic issues and keep them in the spotlight long enough to make sure they don't become political casualties.

Wednesday, November 12, 2008

Responding to ACAS 3Q Comments

Thanks for showing up and taking the time to comment. The third quarter definitely got people's attention, and mostly for the worse. ACAS presented today at Merrill Lynch, and you can catch both the presentation and the Q&A on webcast. Make sure to look at the slides.

Kawa asked:
I thought a company incurs a liability when the board declares a dividend; so even though the record date of Q308 dividend is in October, I still expect to see a dividend payable line in its balance sheet dated 9/30/08. In the conference call when being asked, they replied that GAAP doesn't require it, but the analyst can do their on calculation and trade the stock themsevles; I'm a bit concerned/confused why they choose such response.
I was sort of surprised that when this question came up, the discussion turned to a discussion of materiality. I think the questioner and the answerer were talking past one another. I certainly can't explain why the questioner was fixated on an unpaid future dividend that had not gone ex- by quarter-end when he seemed to agree it wasn't an enormous amount of money, or why it was important to the questioner that management express an opinion on accounting that might be required under Delaware law. I also can't explain why -- other than hypothesizing unpreparedness due to surprise -- management chose to tell the analyst to go build his own pro forma financial statementss and to value the stock on their basis if he didn't like the accounting ACAS believed required by GAAP. I tend to suspect management didn't understand the question as having any purpose than to allege the balance sheet understated liabilities, which would explain why materiality would be offered as an argument and why home-made pro formas would be offered as a solution.

My own take is that everyone is probably right. Different accounting is used at different times for different purposes. Tax accounting is rather different from the accounting that is used to gauge internal performance (some of this internal performance accounting, particularly within portfolio companies, might not even use currency units as its functional unit of measure), and the accounting required by the SEC is surely different than the statutory accounting that might be required by Delaware law. With respect to state-law accounting schemes, I offer a little perspective: insurers are required to apply a statutory accounting scheme that values assets with huge discounts to the values of liquid investments. This doesn't mean that the insurers must report these values when filing GAAP financial statements with the SEC, this simply means that the insurers must balance their books with the statutory accounting tools and have these books ready in case they are demanded by someone making a lawful request for inspection of the state-law accounting. You probably will never see these accounting products for any insurer, because they are different from the accounting required by the SEC and aren't required to be made publicly available. It's not fraud, it's just different accounting. Indeed, publicly-traded companies don't show the public the tax accounting they do, and they all do tax accounting in addition to the SEC-required disclosures. Moreover, if investors reading financial statements filed with the SEC expect the statements to be comparable, it's important that some standard -- even one with clear flaws -- be used across the board. No matter what Delaware would want an accounting produced (say, in litigation over the value of a closely-held corporation) with one set of rules and effective dates for future payment obligations, it's clear that whatever standard obtains with the SEC is what should be in SEC-filed statements.

I don't pretend to have special expertise in accounting for future dividends -- I've never declared a dividend or accounted for it -- but there are explanations more plausible than "evil conduct" that have the advantage of also explaining all the observed conduct.

All these accounting principles have a purpose, all have some legitimate use, and all give different numbers. The reason I bash FAS-157 is that it tends to cause strange problems unconnected with investment performance. Warren Buffett doesn't have to report from quarter to quarter what GEICO would be worth if he had to liquidate it, and he doesn't have to report what that Israeli tool manufacturer would be worth if liquidated. Berkshire Hathaway accounts for these in a much less responsive fashion, and the best you can hope for is to see earnings. The book values BRK gives for acquisitions are simply not numbers you can trade on. Indeed, reading Buffett's letters, it's clear that some of the numbers Berkshire has published (or, has been required to publish) are straight-up fictions -- whether done to appease accounting standards, or whether discovered after the fact as hard-to-value assets' values became clearer. The difference is that with fewer assets Berkshire must mark to market, the effect of comparables pricing isn't visible.

Also, since Berkshire isn't levered (it entered the financial blowup chock full of cash), and isn't regulated to 1:1 leverage, nobody is worried about Berkshire having a liquidity problem brought on by net asset value throwing debt-to-equity ratios into chaos. The fact that organizations that aren't BDCs can avoid some of the liquidity challenges ACAS faces are a reason Malon Wilkus gave a long and rambling answer to the question about BDC status: BDC status is great for some things and has done well by investors, but it also creates problems.

Then, Kawa said:
I have no problems with cancelling the dividend to weather this financial storms with better capital position; I am delighted to see their NOI results; I think they have managed well given the tough mark to market and bond yield analysis rules. I can see the NAV for Q408 might go down another $1000M (20% down with market, 200M of dividend?, offset by realized gains and potential increase in NAV due to ECAS deal); however, I also think they'll successfully amend their ~1.3B credit facilities with Wachovia even though the covenant is breached. All in all, what is your view of a potential NAV range and why are many people stating management is losing their credibility?
I'm not sure how banks will view amendment's to ACAS' credit line. I think ACAS wants to maintain a big credit line so that as the current multiples compression expands, and as bond-yield analysis begins re-inflating ACAS' debt holdings' value, ACAS will be able to quickly produce cash to make attractive deals even if share price remains below NAV. Therefore, I expect ACAS to try as long as possible to cling to the current credit facilities. It wouldn't take much more abuse from the marketplace (in terms of FAS-157 valuations using bond yield analysis and comparables-based pricing) to bust the current debt covenants. I think management recognized that, which is why I believe Wilkus brought up operating with no leverage at all while answering questions. He's looking at the possibility of disaster on the horizon, and planning accordingly.

Management's credibility has taken a hit for several reasons. First, the stock price last summer nearly hit $50, and it's threatening now to scrape $5. People are scared. Yes, ACAS announced a NAV close to $25, but let's face it: on the date that NAV was calculated, the share price was close to $25. Heck, the NAV was just under $25 and the price was just over $25. And the share price is now about $6. Management's comment that ACAS was trading above NAV at quarter end tends to frighten people into wondering about present NAV -- a topic ACAS didn't provide insight on because calculating NAV for quarter-end takes lots of time for a three-digit number of people, and ACAS doesn't calculate NAV for any other purpose. However, failing to deliver a current NAV number leaves the door open for frightened investors to speculate that ACAS might still trade above NAV. But perhaps the biggest reason management has taken a credibility hit is management's own rhetoric. ACAS has long pointed to its dividend as evidence of ACAS' ongoing and increasing profits. ACAS has repeatedly stated that the paid dividends are a performance measure that cannot be faked in the marketplace and cannot be restated. ACAS has essentially instructed the public to look at ACAS' dividend as proof of management's competence and good faith. Cutting the dividend simultaneously admits that management was mistaken about its ability to set dividends at levels that would never require reduction and reduces to zero the performance metric management had been holding out as the gold standard and indisputable proof that management continued to execute successfully on behalf of shareholders.

The concern about management is therefore not without basis. However, management could have done what others have done and cooked the books -- but did not. Management produced the ugly numbers of increased debt:equity, and published the unvarnished FAS-157 writedowns exactly as required by the regulations governing its structure. Moreover, management didn't say that it had everything in the bag and all was hunky-dory, it admitted frankly its view that the economic situation was likely to continue forcing write-downs as multiples compression and bond-yield-analysis painted worsening pictures of existing holdings even though they performed as underwritten. In other words, ACAS openly stated that there is no good-case surprise scenario in which its effective due diligence would protect the company from writedowns: it repeated that regardless of credit quality, the existing accounting rules would cause ongoing mounting of paper losses provided the economy continued as badly as management expected. This kind of brutal honesty -- which as ACAS' chart shows does not help share prices during the quarter and doesn't set up ACAS to issue equity above NAV -- is not what one expects of a management that is out to cheat its shareholders. Openly admitting that ACAS' tax status is a subject of potential future review tends to reassure investors that management is willing to look at every option in order to keep the company operating for the long run, while in the short run driving out investors who invested in ACAS in tax-advantaged accounts and liked getting paid pretax dividends.

Management is clearly looking to the long term and not the quarter, and it doesn't conceal this when it explains its behavior or gives guidance.

Peachberry_Tea wrote:
The thing I hate about ACAS is that it's opaque. You really can't see how the portfolio companies are going, and it seems like management won't say anything in reassurance except they're "continuing to perform".


I listened to the conference call and it didn't sound anything like ACAS management was letting the quarter's numbers go to hell for the long term good of the company. To me it sounded like they screwed up big time and they didn't exactly just come out and admit it. I had a lot of faith in management with the deleveraging they've done, but today I didn't get the impression that management was being honest and upfront. With a black box company like ACAS, again, this should be cause for worries for shareholders.
I'm as disappointed as you that ACAS has been slammed like it has. For the reasons I state above, though, I don't think the 3Q2008 quarterly conference call or the subsequent presentation to analysts at Merrill Lynch are indicative of character flaws or of poor judgment. I can't imagine anyone planning to model for a VIX of 90. I myself got slammed as the markets tanked. Being levered less than 1:1 was a great benefit when considering that firms like Merrill Lynch that were levered 40:1 have already failed (Okay, been bought by a bank that itself is on sale and taking federal handouts), and management's prescience to have entered the quarter at even less leverage probably meant the difference between surviving the quarter and being destroyed in a liquidity crisis.

ACAS' willingness to announce it plans to use cash to de-lever is an admission that it will be focusing defensively on surviving for the future, rather than snapping up bargains now in the hope that a quick turnaround will make it possible to eke by with clever accounting. ACAS is really working to reduce its risk, not to play games or pray for federal deliverance. Nowhere in the conference call did I hear false hope offered to investors. ACAS did stress that its assets were performing, but was clear that this didn't protect it from FAS-157 in an environment of severe and widespread financial recession.

Peachberry_Tea also wrote:
The fact that they confirmed the dividend a few weeks back, and now all of a sudden this - this certainly shows cracks in their armour. Assuming management really believed that they would be able to fund the dividend a few months back, the only thing that could've caused the dividend to stop altogether is that some of their investments exits have seriously turned sour. Which again points to the health of ACAS' portfolio companies. I think this and the possibility of a prolonged recession should have ACAS investors worried.
I don't think the only explanation is that ACAS' due diligence proved faulty. Especially in light of the continued NOI and ongoing syndication of senior debt, it seems that the investments are performing and that third-party buyers (who are buying senior debt at par rather than at FAS-157 discounted rates) also see the investments as performing. Rather, the FAS-157 valuation reductions have caused a liquidity crisis of the sort I described in earlier posts (such as after the second quarter's report). With its debt-to-equity ratio regulated as a BDC at a maximum of 1:1, ACAS need not have investments fail to perform as anticipated (i.e., it need not suffer a reduction in operating earnings) in order to face a liquidity crisis. Moreover, the debt covenants create a further cause for concern.

As for the worries facing investors in the form of a prolonged recession: investors in anything should consider worry. Gold isn't safe, as the destruction of so much value by the financial implosion could cause deflation. Debt instruments aren't safe, as the valuation concerns that decrease the market value of ACAS' deb holdings will hit anyone's debt holdings (except, haha, for banks which are allowed to carry performing loans at face value) and credit deterioration could endanger repaymet prospects. Heck, with benchmark interest rates heading into the toilet to make money available in the economy, inflation is a serious risk -- especially as the turnaround gets underway and credit actually becomes available. Many vendors are in danger as consumers threaten to tighten their belts and unemployed people have to hock their belts for bread. Investing in criminal defense or bankruptcy representation might be an angle. Of course, betting on short-play instruments isn't safe: multiples are so compressed and investments are so historically undervalued that one would need great care in choosing an exit, or one would risk being slaughtered as prices return toward historically more common multiples.

On the news I heard that safes and firearms are currently enjoying a sales boom. This is probably a sign that many people view the investment markets broadly as a place to avoid. While this sentiment persists, where will investment come from?

If you have the skill to time the market, God bless you -- it'll be a fantastic opportunity as the market's gyrations unfold. I have no claim to such skill and am simply working to ensure I have no leverage with which a crazed market can destroy my portfolio without my having to have picked poor investments. Interestingly, this seems to be exactly what ACAS' own management is doing: de-levering to reduce risks generated by third-party pricing lunacy.

Although some folks have lost confidence in ACAS' management, and it's certainly worth running for the doors if your investment thesis has been undermined, I haven't gotten there yet. I bought ACAS because Berkshire Hathaway was too big to capitalize on the small opportunities that are ACAS' bread and butter. I wanted a company that was able to find something to do with its cash, and didn't have to sit on tens of billions because no good deals were big enough to bother. Obviously from the standpoint of a short-term trade, BRK.B would have been far superior to the performance we've gotten from the stock price of ACAS over the last year. On the other hand, ACAS turned in $0.74 in operating income last quarter, or more than 10% of the current share price; BRK.A earned just $1335 per share, which given today's $97,000 share price (a 2-year low) is still less than 1.4%. Derivatives contracts weren't much more gentle to Berkshire Hathaway than to American Capital, but just looking at operating earnings, it looks like ACAS is the one in the sweet spot.

Moreover, Berkshire Hathaway has been on a buying spree -- including in financials -- as the market has gone into a panic. Buffet doesn't claim to time markets, he claims to spot deals. The fact that Buffett can find "deals" in companies so large they are worth his time to invest in (read his letters to the shareholers about this; the company just can't make material amounts of money on little deals) offers serious reason to rethink the hypothesis that nobody can find deals, even if they are willing to look in illiquid, hard-to-value, smaller companies. I think this latter class of companies offers a better long-term return. I love Berkshire's management, I just wish they were small enough to make money on the little deals where the explosive growth lay. In the meantime, since BRK.B doesn't have mark-to-market pressure because it doesn't have a requirement to place quarter-by-quarter values on its portfolio companies (it's not a BDC), nobody is going mad over Berkshire's "losses" (because it isn't required to report them as losses; it's just, you know, depreciating goodwill and that kind of thing). Instead, Berkshire has suffered a substantial operating earnings haircut as its main-line business (insurance) comes under pressure. ACAS, which has nearly three hundred portfolio companies, hasn't got this kind of risk concentration in one industry.

Consider ACAS' requirement to apply FAS-157 across the whole of its portfolio with this comment about Berkshire's need to apply it to a couple of classes of investments:
The company has disclosed many derivative contracts tied to the performance of the Standard & Poor's 500 and three foreign stock indexes, and to the credit quality of high-yield bonds. Accounting rules require Berkshire to regularly report unrealised gains and losses on those contracts.
Reuters, "Berkshire Hathaway Q3 Profit Down 77pc"
Instead of having its operating income of $1335/sh turned into a quarterly profit of $682/sh, imagine how FAS-157 would have caused a massive loss as Berkshire Hathaway's performing intra-holding-company loans had to be written down, and the value of its numerous holding companies had to be slashed as multiples compression killed the value of tool makers, ice cream franchisers, print newspspers, and insurance companies. Were Berkshire Hathaway required to apply FAS-157, what kind of haricut do you think it would have?

So I don't think ACAS is somehow bad at managing a portfolio of companies, or has bad investement picks, or the like. ACAS' transparency makes it an easy target for people afraid of the market as a whole and who don't want to wait around to receive operating earnings from profitable portfolio companies and think they must liquidate everything, now, to obtain value from holdings. Frankly, I think that's crazy.

Peachberry_Tea offered:
So there is a lot of uncertainty with regards to ACAS. I'm not sure that it deserves the valuation it does ($6 a share now) but then again, even firms without this uncertainy are priced this way at this time.
Insiders like the pricing created by this uncertainty. Why shouldn't I?

Peachberry_Tea concluded:
I honestly think your analysis of ACAS has been excellent. But as to what to do with one's money in this market, there are certainly better places for your money than ACAS. That would be my take on this.
I'm all ears on investment ideas. I'm particularly keen on ideas that call for solid earnings growth through a severe recession. I don't invest for a living, so I don't end up with tons of investment ideas. ACAS has been a long-term pick of mine, and remains one. I've not sold. If I should see my thesis collapse -- that ACAS is an underpriced way to buy a diverse lot of medium-sized companies which have been selected through a gruelling due diligence process to offer outstanding opportunities to provide a return -- then I'm sure I'll bail. However, I am not inclined to bail from fear of near-term pricing. Moreover, I'm still confident that I'm no good at all at picking entry points, and will continue to have to make due understanding the companies in which I risk an investment.

That said, if you want to be sure you have money at the end of the recession, the value of a safe and an array of firearms with which to defend its contents is probably not as volatile as the value of most of what you might buy after reading the financial section of the newspaper.