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Monthly Archives: April 2011
more news from Japan on post-earthquake shortages
post-earthquake recovery
Industrial life in Japan is slowly recovering from the effects of last month’s earthquake and tsunamis. The Financial Times, for example, is reporting that the Big Three automakers of Japan, Toyota, Nissan and Honda, plan to have all their factories back in operation by a week from today. Output will only be about half the normal rate, as the industry continues to deal with component shortages.
autos and technology
We’ll begin to learn more about the effect of the disaster on the technology industry as March quarter 2011 earnings reporting season opens up in the US this week.
Everything I’ve heard/read about the auto and IT industries, however, is generally in accord with my initial thoughts. That is, that the auto industry would be more severely affected than IT, that initial reports would overestimate damage, that the main shortage items would likely be less well-known and lower tech parts.
Electric power is proving to be the most important shortage commodity, as well as the one least able to be alleviated by field-expedient workarounds.
new shortage areas
A number of items that I hadn’t thought about are also proving to be in shortage, namely:
–according to the Asahi Shimbun (newspaper), two of the six plants manufacturing cigarettes owned by Japan Tobacco, the dominant maker in Japan, suffered heavy damage in the earthquake. One of the two cigarette filter plants the company runs was flooded by a tsunami. Production at the other is being interrupted by rolling electric power blackouts. JT is hoping to reopen its earthquake-damaged plants today at 25% of capacity.
I don’t own tobacco stocks and I don’t particularly care for the industry. But the shortage of cigarettes is a serious issue in Japan, a country where half the adult males and 10% of the adult females smoke (maybe I should write “are addicted” instead of “smoke”). AS suggests that smokers are significantly increasing their usage as a means of coping with post-earthquake stress.
Therefore, the earthquake is providing an unusually favorable chance for foreign manufacturers, BAT and Phillip Morris, to get distribution. Both are airlifting large quantities of cigarettes into the country.
–the Yomuiri Shimbun reports that distribution of bottled water, in great demand because of fears of water contamination, is being slowed by earthquake damage done to key bottle caps manufacturing plants run by Japan Crown Cork and by Nihon Yamamura Glass. Nationwide output, coming from factories in western Japan, is only at about 60% of pre-earthquake levels.
–an ink shortage is causing postponement of scheduled comic book production. The plant responsible for 100% of Japan’s production of diisobutylene, a key ingredient in making ink has stopped production due to earthquake damage.
For investors who are willing to hold tobacco stocks, Japan is a big enough market that market share shifts there might be enough to affect the stocks of industry participants. The main significance of the other recently reported shortage items is likely that everyday life is unlikely to return to normal in Japan for a long time to come. The fact that these difficulties are surfacing predominantly in consumer goods suggests to me that my assumption that the Japanese government will give capital goods and export-oriented industries priority over consumer businesses in use of scarce resources.
Huawei: troubles getting business in the US
Huawei has become a leading supplier of telecom infrastructure equipment around the globe over the past decade. Its formula for success? …providing state-of-the-art products at low prices. Despite these attractions, Huawei has been unable to make much headway in the US. Like virtually all mainland companies, it has close connections with the Beijing government and the ruling Communist Party–in Huawei’s case, through the military. But that relationship has little direct connection with its inability to gain traction here.
The US government opposes Huawei’s attempt to penetrate the US market for two reasons:
–It’s a form of protectionism for domestic industry. Whoever appears to be the most threatening economic rival of the US at a given time simultaneously becomes the focus for denial of market share or market presence domestically. It doesn’t hurt at all that this activity plays very well with the voters at home.
In 1987, for example, when Japan was the competitor most feared by Americans, Fujitsu tried to buy a controlling interest in Fairchild Semiconductor. Although operating on American soil, Fairchild was not an American-owned company. It was a subsidiary of the French oilfield services giant, Schlumberger. Nevertheless, Washington opposed the sale on the grounds that foreign ownership of Fairchild was a threat to national security. Fujitsu withdrew its offer.
In 1989, Mitsubishi Estate wanted to buy 100% of Rockefeller Center for an astronomical price (it subsequently defaulted on the mortgage loan it took out to finance the deal). This, despite the fact that the Rockefeller Center buildings were old and needed substantial refurbishing. In addition, the Center’s tenants were about to decamp en masse for lower rents in newer buildings elsewhere midtown Manhattan, as their long-term leases in Rockefeller Center ran out in the following couple of years. Luckily for Mitsubishi Estate, it was saved from larger disaster by a firestorm of protest that arose in government circles about Japan “buying up America.” This forced Mitsubishi Estate to cut back the amount it was buying–thereby allowing many Americans to participate in the subsequent financial failure as well.
Today’s economic foe is China, and Washington is dishing out the same treatment.
In 2005, China National Offshore Oil bid for the US integrated oil company, Unocal. It’s object? …Unocal’s extensive hydrocarbon holdings in Asia. Again, a firestorm of protest from Washington, which forced CNOOC to drop its bid. Unocal was ultimately acquired by Chevron for about a billion dollars less than CNOOC had offered.
Late last year, Huawei appeared to have won a multi-billion dollar portion of an infrastructure contract with Sprint. But, according to the Wall Street Journal, the then Secretary of Commerce, Gary Locke called the CEO of Sprint. When Dan Hesse hung up the phone, Huawei was out of the bidding.
A recent Financial Times article analyzing Huawei’s problems closes with a reference to a small rural broadband contract Huawei won from Northeast Wireless in Maine. The FT says the win came despite a call by the FBI on the Northeast Wireless management, apparently in an attempt to pressure them not to select the Chinese equipment supplier.
So far, this sounds like standard jingoistic fare–politicians wrap themselves in the flag, but act against the country’s long-term economic interests to score points with voters at home and keep domestic corporate contributors to their campaign coffers happy.
–There’s a second reason for government opposition to Huawei that makes its case unique, however. It’s the issue of cyber warfare. The worry is that China may secretly embed in Huawei equipment the capability to monitor or disrupt the flow of communications through it.
We already know there have been sophisticated cyber attacks on government and corporate computer systems in the US, emanating from the military in China. Although it’s a somewhat different issue, the Stuxnet computer worm that has attacked Iranian nuclear installations is generally believed to have been born in US and Israeli government cyberlabs. So the idea that a government would prevail on a telecom equipment provider in its country to secretly place disruptive or monitoring capability in its products is not that far-fetched.
Although the threat may be framed in military terms–suppose China wants to invade the US?–the much more substantial worry, in my opinion, is corporate espionage through the possible undetected monitoring of corporate communications.
There’s no way to know whether Huawei is doing this now or would ever attempt to do so. But this uncertainty seems to me to guarantee that the road to success in selling telecom infrastructure in the US for Huawei will continue to be long and hard.
the curious case of David Sokol and Berkshire Hathaway
The case of David Sokol, late of Berkshire Hathaway, has been widely reported over recent days. The facts, as I understand them, are as follows:
Sokol’s behavior…
1. One of Warren Buffett’s chief lieutenants and touted as a potential successor to the Sage of Omaha, Mr. Sokol had the task of finding a suitable target for the merger and acquisition “elephant gun” Mr. Buffett proclaimed last year he had primed to fire. There may have been others looking as well, but Mr. Sokol certainly was one.
2. Mr. Sokol decided to recommend Lubrizol to Mr. Buffett as a company that Berkshire should purchase.
3. Prior to approaching his boss, Mr. Sokol bought $9+ million in Lubrizol stock for himself.
4. In his presentation to Mr. Buffett, Mr. Sokol mentioned his own holding, but only in passing. He apparently did so in a way that it didn’t highlight the relevant points of how recent or how large his purchase had been.
5. Buffett decided to buy Lubrizol. Sokol sold his stock for a $3 million personal profit.
6. After this became know, Sokol resigned from Berkshire. Buffett maintains that Sokol did nothing wrong and that the resignation has nothing to do with his Lubrizol stock purchase.
7. The SEC is now investigating Sokol, with the focus of the inquiry on whether there are other instances of the same buy-for-yourself-then-recommend behavior.
…isn’t the issue on Wall Street. Buffett’s is.
People buy Berkshire Hathaway stock because they regard Warren Buffett as a master investor and a person of absolute integrity. His public appearances draw immense media attention for the same reasons. Other investors parse each sentence he pens or utters for sophisticated investment insights. Why, then, would such a hero defend a subordinate who appears to have taken advantage of Mr. Buffett’s trust and used his corporate position for personal gain? …especially when this conduct appears to fly in the face of the fair-play rules every investment company must follow.
why do this?
No one outside Berkshire Hathaway knows for sure. I have two observations:
1. Imagine what Mr. Sokol’s defense against charges of failing in his fiduciary duty to Berkshire Hathaway shareholders might be. If it were me, I’d argue along three lines:
a) First, I would say that Sokol is an industrialist working for a conglomerate, not a portfolio manager working for a regulated securities company. Therefore, he’s not subject to the severe controls on the latter’s activities.
b) I’d then say that Berkshire doesn’t have adequate compliance procedures that establish and monitor standards of conduct. As as result of this corporate failure, he was ignorant of proper procedures.
c) Then I’d try to argue that his behavior was common practice at Berkshire.
In fact, it appears Sokol is already asserting that what he did is just the same as Charlie Munger (Buffett’s long-time associate and vice-chairman of Berkshire) holding shares of Chinese battery company BYD prior to Berkshire taking a large stake.
In the press, there has been no discussion of Berkshire compliance procedures. Yes, Buffett wrote a letter on the subject all newly hired executives are required to state that they have read–but nothing else. No one I’m aware of has written that Berkshire implemented the kind of strict controls over, and intense scrutiny of, personal trading that is mandatory for investment companies. Nor is there talk of periodic compliance training that is also required for professional investors. My guess is that, while these procedures may exist in the company’s insurance subsidiaries, there’s no company-wide effort.
Also, if it is correct that the thrust of an SEC investigation of Sokol is on a pattern of behavior rather than this one incident, this suggests that points a) and b) above have merit.
To sum up, at least in the very narrow sense of “can he be convicted?”, Mr. Sokol may actually have done nothing wrong. Unethical, maybe, but illegal, no. So there’s little Mr. Buffett can do other than to ask for Mr. Sokol’s resignation.
Ironically, if Berkshire were a regulated investment company, it may well be that Mr. Buffett’s supervisory failure to publicize and enforce the rules would be the main actionable offense.
2. There could be a second reason for Berkshire wanting to put this incident behind it as quickly as possible.
The shock and outrage in the investment community over the Sokol affair illustrates Wall Street’s belief about what Berkshire is: the investment company run by one of the greatest American investors of the twentieth century.
To defend itself, Berkshire would likely have to emphasize that Berkshire is a financial services/industrial conglomerate (Geico is its best-known brand), not a regulated investment firm.
What’s so bad about that? The stock doesn’t trade at the discount to asset value that’s characteristic of multi-industry companies, insurance firms in particular. Berkshire trades at a substantial, though slowly shrinking, premium to book. Defense of Berkshire’s behavior regarding Sokol might well end up being an attack on that premium as well, and accelerate its decline.
“Financial Markets 2020”: an IBM study of the investment management industry
the survey
Talk about ugly.
In the April 4th issue of FTfm, its review of the fund management industry, the Financial Times outlines the conclusions of an as yet unpublished study by IBM of the investment management industry, Financial Markets 2020.
the findings
FM2000’s bottom line? …the worldwide investment management industry loses US$1.3 trillion of its clients’ money every year. That’s over $100 million during the time it takes a fast reader to reach this point in the post. Wow!!
The main offenders? Here they are, in order of the magnitude of client losses:
—$459 billion credit rating agencies and sell-side research, because the analysis is weak
—$300 billion fees paid to underperforming portfolio managers
—$250 billion fees paid for advisory services that underachieve
—$213 billion excess expenses caused by investment managers’ organizational inefficiency
—$51 billion fees paid to underperforming hedge funds.
the conclusions
IBM argues that clients are gradually waking up and smelling the coffee …and firing the offending service providers, as they work out how bad the performance has been. The computer giant thinks upward of a third of the people involved in today’s fund management industry will be gone before clients are through with their housecleaning. Among sell-side researchers and credit rating agency analysts, the winnowing will remove closer to half.
my thoughts
First of all, I haven’t seen the study. I’m assuming that it’s being accurately portrayed in the FT.
In the nitpicking department, the data seem to have come from an internet survey. If so, its conclusions represent the input of the respondents, and may not be representative of the views of clients as a whole. In addition, the numbers are overly (maybe “ludicrously” would be a better word) precise, suggesting inexperience on the part of the IBM Institute for Business Value, which wrote the report. The assertion that credit rating agencies et al lose their clients $459 billion a year implies the figure is not $458 billion or $460 billion. How could IBM possibly be confident that this is right?
The general direction of the report is doubtless correct, though. Early in my career as an investor, I remember reading the famous comment by Charles Ellis, the founder of Greenwich Associates, a pension consulting firm, that the average portfolio manager is just that–average. At the time, I was offended. Thirty years later, I’d be tempted to amend it to read that the average portfolio manager is just that–a little below average. The credit rating agencies have been notorious for as long as I’ve been in the business for being behind the curve. And everyone knows, or should know, that brokers make their money by having you trade with them, not by having you achieve superior returns.
I think IBM’s idea that clients will quickly take the axe to many of their investment service providers is much too simplistic. Yes, chronic underperformance is a big issue. But there seem to me to be three factors IBM overlooks:
1. The head of virtually every investment management organization is a highly polished marketer, not an investor. A big reason for this is that investment firms are not only in the business of selling performance, they also sell intangibles–like feelings of prestige, exclusivity, reliability, safety–especially to individuals. Some people will hire a hedge fund manager instead of buying a Vanguard index fund (which will likely provide superior returns) for the same reason they buy an $8000 Hermès leather handbag instead of a $50 nylon equivalent, or a $150,000 Porsche instead of a $30,000 Subaru Impreza. It’s to exhibit their wealth. Having your yearly performance review in a major city, with dinner and a show and your favorite flowers in the hotel suite your manager provides may be just as important as the performance figures–maybe more so.
2. Companies typically don’t want to manage their employees pensions money in-house for legal reasons. Hiring a pension consultant and a series of specialist third-party managers transfers responsibility to them. Doing so acts as a form of insurance.
3. Suppose you go ahead and fire all your investment advisors. What do you do then? What do you substitute for them? Maybe losing a trillion dollars a year is good in comparison with the alternatives.