Big Three → Big Two

In last 15 years, Chrysler Motors has gone through every possible form of business entity – from a publicly traded corporation to acqusition by a prestigious European carmaker to a limited liability company owned by a private investment group to an impending merger with another near-bankrupt automaker with a possible government ownership. Nothing seems to have helped.

The details of GM-Chrysler merger are not finalized but if finalized this is what GM would get, in assets and in liabilities –

1. $11 billion in cash
2. Estimated $35 billion to $40 billion in yearly sales
3. 47,500 union workers and network of 3,700 dealers
4. Mostly unpopular products lines, very identical to GM’s own products (few exceptions like Jeep and Dodge Ram)
5. Stake in Chrysler; valued at zero by Daimler AG, which owns 20% of ownership.

[Grant Thornton’s Corporate Advisory and Restructuring Services Group just published a report on possible merger between GM and Chrysler. Its forecasts closure of half of Chrysler's 14 existing manufacturing facilities.]

What Detroit lacked is the long term vision. Here is an example - Toyota introduced its mid-size hybrid car in 2001 when average crude oil prices were in mid twenties. In two years Honda launched its mid-size hybrid car. It took 2007 for GM to launch its mid-size hybrid Saturn Aura Hybrid. By that time Toyota has already sold over half a million of hybrid cars, captured the majority of the market and established the strong brand identity. Chrysler even doesn’t have any hybrid model!

Oil Prices ($/bbl) since 2000 and Hybrid Car Launches

GM has asked the $10 billion in assistance from the treasury. This is on the top of $30 billion assistance from Department of Energy. Yesterday Larry Kudlow harshly criticized the Detroit’s bailout – “It’s like industrial policy. It’s saving a failed industry, that’s what it is doing. …  It’s a Franco-German style industrial planning bailout. We are just protecting a failed industry. And I think it’s a completely bad policy”

In the days of economic contraction, FED’s printing press has very aggressive expansion plans!

© Rohit Deshpande

In Search of Bottom

Recently I discovered two interesting correlations between exchange rates of leading currencies and S&P 500 index.

First relation is very well-known. If you compare Yen-US Dollar exchange rate with S&P 500 index (or Dow-Jones Industrial Average) in long term, you get near-perfect reflection images of each other. When S&P 500 falls, yen rises and vise versa.

US Dollar per Japanese Yen Vs. S&P 500 Index

The explanation is simple – Yen is relatively undervalued in terms of other major currencies partially because of monetary policies of Bank of Japan which keeps benchmark rates low in order to boost exports and fight deflation. Because of the low rates investors prefer to lend the money in cheap yen, convert to high yielding currency like US dollar and take risk by investing in US stock market for even more returns. But as US market slows down, investors start abandoning US market and buying Yen to cover their positions as well as in search of a safe and strong export dominated economy where central bank is to defend currency and fight deflation. 

The second relation is bit more complex. If you compare Euro- Yen (Yens per Euro) exchange rate and S&P 500, you will find that they perfectly follow each. 

Japanese Yen per Euro vs. S&P 500 Index

Again investors borrow money in yen and invest in another high yielding currencies, instruments and derivatives. But the carry trade of Euro in terms of yen apparently also overlap S&P 500 index. This trade collapse is parallel to the S&P 500 index collapse.

Both the graphs represent institutional investors readiness to take risk in the market. Higher spreads between JPYUSD and S&P 500 means investor is willing to take higher risks for higher returns. As the spreads narrow, the willingness of the risk also reduces. The second curve represent anti-growth environment where investors are running from new ventures, and capital investments to safer environment. Both graphs also confirm a widespread economic slowdown to the degree of recession.

But the real question is does this mean we are closer the bottom that to the top? 

© Rohit Deshpande

Commodity Crash

Remember, just few months back everyone was speculating over commodities - Analysts at Goldman-Sachs forecasted price of oil barrel could reach $ 200, even oil baron T. Boone Pickens forecasted $ 150 (Pickens also spent millions of dollar to promote his oil independence plan)

And today oil is below $ 75, and it’s not only oil. Copper dipped to $ 2.15, wheat neared $ 550.

Does it help the consumers? Well, at least for short term. Especially decline in energy prices brings tax cut effect estimated up to $ 100 billion. But as prices fall, conservation efforts also come to halt and so does alternative energy development projects. It is interesting to see how alternative energy index fund collapsed with crude price decline.

Bizarre Mechanism : Central banks all over the world are pouring liquidity in the market. That should increase the inflation. Then how the prices are coming down? 

The latest commodity price decline is another classical example of free market mechanism. For example as  oil prices peaked demand in developing markets reduced since governments can no longer afford subsidies. Even in United States demand reduced. On the other hand, supply increased to OPEC increased production. Decreased demand and increased supply brought prices down. 

© Rohit Deshpande

Citi never sleeps (?)

“Every time you sleep but your dreams are wide awake.  Because ambitions never sleep, aspirations neversleep, goals never sleep, hopes never sleep; opportunities never sleep; the world never sleeps. That’s why we work around the world. That’s why we work around the clock to turn dreams into realities. That’s why Citi never sleeps.”

 That’s the TV commercial CitiGroups has been airing for last many months. Citi, itself suffering financial crisis, last Monday announced buying commercial banking division of Wachovia, another mortgage security hit bank for $ 2.1 billion. The deal was backed by FDIC - Citi would have assumed $53 billion worth of debt and agreed to absorb up to $42 billion of losses from Wachovia's $312 billion loan portfolio. The FDIC agreed to cover any remaining losses in exchange for $12 billion in Citigroup preferred stock and warrants. The deal, referred as a forced acquisition, was almost done. But the dynamics changed since that – 

1. Liquidity crisis becomes severe even after central banks over the world poured liquidity. (LIBOR peaks to 5.3%). On the contrary, bank deposits provide easy stream of liquid cash.
2. On Tuesday, the Internal Revenue Service issued new guidance that would allow banks to take larger tax write-offs from the losses from loans and other bad debts held by other banks they acquire.
3. Hopes rise as the Congress come closer to the financial rescue plan

 And deposit rich banks like Wachovia become valuable assets. On Friday, in a surprise announcement Wachovia Corp. agreed to be acquired by San Francisco-based Wells Fargo & Co. in the all-stock deal for about $15 billion. The deal would not need assistance from government.

 These are not the everyday deals. JP Morgan Chase gets Bear Stearns and WAMU; Bank of America gets Countrywide and Merrill Lynch; Barclays gets Lehman Capital; Well Fargo would get Wachovia. As Warren Buffet says – “You buy a farm during drought”.

 

It is not the end of the world for Citi.  It has announced a legal action. It will try to get something from the deal. Or will buy a regional bank. But for now it looks like Citi did sleep for 48 hours. 

© Rohit Deshpande

Too big to let fail ; Too big to save - It's WAMU WAY

There is an interesting relationship between a bank's financial state and its deposit rates: IndyMac was offering 4.85 % just before it was put into conservatorship. WaMu is still offering 5% on 12 month CD when national average is 3.69% ! Here are some facts about WaMu:

• WAMU has lost 90% of its market value in last 12 months.

• Standard and Poor lowered credit ratings on WaMu to BBB- on long-term, just shy of the "junk bond" status.

• The bank has already lost over $ 6 billions in write-offs mainly in risky mortgages; many billions to come in near future.

• Despite of the its reduced market cap to $ 9.1 billion, the huge assets over $ 300 billions make it difficult to be acquired.

Would WaMu become 12^th bank to fail in 2008 ? I don't think so. The real question is WHO will save the bank ?

(By the way, small depositors are safe; FDIC has them covered. But the outlook doesn't look too promising” Berkshire Hathaway subsidiary's plan to stop insuring bank deposits above federal limits may reflects Warren Buffett's worries about future bank failures?)

Browser Wars III – Google Strikes Back !!

Today's biggest buzz in the tech world was the news that Google would soon be launching it's own open source web browser 'Chrome'. The news came exactly three days after Microsoft released newest version of its legendary web browser - IE 8 beta.

Who cares? Web browsers are free today – Microsoft made them free years back. Interestingly, the primary function a web browser have transformed in last 15 years - from a simple browsing tool to the machine to control the web searches and thus online ad revenues. Online ads is the biggest revenue stream for Google and thats where Microsoft struggling to make its way.

On the other hand, Microsoft is fighting back on different fronts to protect its market from Apple and Google. Both Apple and Google are targeting Microsoft's core businesses. (In my view, Microsoft is the most diversified technology company today with it's businesses and operations in operating systems, business solutions softwares, online services and entertainment devices vastly dodge the risk exposure). All of these three companies are well capitalized, have constantly demonstrated satisfactory financial earnings and led by some of the greatest visionary business leaders. (Though there is significant difference in the brand characters - Apple has kind of 'Cool' brand, Google is more 'anti-establishment and maverick' while Microsoft's brand style is rather 'serious and corporate' !)

The war is getting serious everyday...

1. http://www.marketshare.hitslink.com
2. http://www.attributor.com/blog/get-your-fair-share-of-the-ad-network-pie/


© Rohit Deshpande

Airline Industry – “High” and “Dry”

Recently I came across a very funny video on You Tube. In this video, flight attendance charges passengers fees for use of seat belts, reading material and even emergency oxygen masks. It seems that the parody is coming to reality. Just yesterday, in a letter to the Federal Aviation Administration, United Airlines' Pilot Union alleged that four recent engine failures or compressor stalls on United 737 aircraft may signal the "maintenance standards have deteriorated at United as operational decisions are increasingly driven by economic considerations." [WSJ]. Last Month US Airline Pilots Association complained that the airline was pressuring pilots to carry less fuel to reduce the weight of the plane. [Fox Business]

The sky-rocketing oil prices have clearly crippled the airline industry. Airlines are taking major decisions to keep operating costs low; ranging from consolidations, eliminating routes, and cutting jobs to charging for check-in baggage and in-flight services including food, beverages, blankets and pillows. There have many arguments from both sides of the fence. The critics criticize declining value of service while supporters argue pointing that the cost of air travel has not been increased significantly with the increased fuel prices.

In my opinion issue real problem is not oil price but the business model itself. 5 of “Big Six” airlines have gone through chapter 11; some of them have gone more than one time. There is an urgent need to refine the complete business model:

1. Demanding cutting edge technologies that will reduce the risk exposure to volatile energy market;


2. Building strategic partnerships with all the stakeholders, particularly with the customers;


3. Eliminating the non-value addition processes. They have done it well in recent days; But most importantly:


4. Defining the business as ‘transportation business’ instead of just ‘airline business’. This will open avenues to sustainable horizontal growth. (This is much analogues to railroad industry decline in “Marketing Myopia” by Theodore Levitt)

Few days back I got email letter signed by the CEOs of major airline companies urging to join campaign against speculation in oil futures market that allegedly drives oil prices. With 20% drop in oil prices in last few days, I hope they don’t take away the ‘complimentary’ seat belts.

Airline stock performance with compared Dow Jones Industrial average (last six months)

Airline stock performance with compared Dow Jones Industrial average (last one month)

Links:
Airline Video –
http://www.youtube.com/watch?v=Q-nX6g148mA

Airline CEOs sign joint letter to frequent fliers -http://www.stopoilspeculationnow.com/uploads/An_Open_letter_to_All_Airline_Customers.pdf