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    « February 2006 | Main | April 2006 »

    March 31, 2006

    3i Group to Return 500 Million Pounds to Shareholders

    Portfolio holding 3i Group PLC (III/LN) Europe's largest publicly traded buyout firm, announced yesterday plans to return at least 500 million pounds -- $870 million -- to shareholders for a second year in a row after income from the sale of investments surged.

    3i reaped 1.8 billion pounds from selling assets in the 11 months to the end of February, up from 1.15 billion pounds in the same period a year earlier, CEO Philip Yea stated during a conference call yesterday. Profit from those sales will be “significantly higher'” than last year, he added. He declined to be more specific on that before 3i reports earnings in May.

    Regular readers of this blog know 3i invests in startups that promise to grow rapidly and makes buyouts of undervalued or out-of-favor businesses. 3i is returning the money after earning more from selling than it spent on buying new ones. Rising stock markets and competition between buyout firms are boosting prices, making asset sales more attractive and new investments more expensive.

    Bloomberg reported Yea as saying the buyout mid-market space has been excellent for realizations. Remember that 3i Group’s competitive advantage is that it focuses on small-to-medium sized deals. I also like that the management team is willing to walk away from transactions -- they don’t do deals just to do them. That's the mindset that had Yea reminded analysts during the call that 3i continues being highly selective in making any new investments.

    3i invested 1.2 billion pounds in the first 11 months, up 42% on the 843 million pounds it spent in the same period a year ago. Provisions in this fiscal year for investments that may fail will be “broadly in-line'” with last, the company said.

    3i Group was first recommended on Controlled Greed last May at $12.73, adjusted for a subsequent reverse split. The shares closed yesterday at $16.58, for a gain of 30% in US Dollar terms -- not including payouts.

    One last thought. Private equity has been hot and many feel there’s a top in the cycle being reached. I don't disagree with that opinion.

    But 3i is more than simply a private equity firm. It’s also engaged in venture capital and other investments. That, plus a couple of rumored takeover offers for 3i itself in the recent weeks, has me holding onto my shares.

    March 30, 2006

    Looking to Buy

    I've been looking at two companies to add to the portfolio. One headquartered in Britain, the other in Australia. They had been dropping in price and I was getting tempted. But they've inched back up in recent days and I've held off.

    I've also got my eye on a pending IPO that will be taking place here in the US. That makes a third portfolio candidate.

    Regular readers know that I want to have 20-25 positions before the portfolio can be considered "fully invested." We've got a bit of buying to do to achieve that.

    As always, if anything happens with regards to buying -- or selling -- action in the portfolio you'll read about it here. So stay tuned and thanks for your continuing readership. Feel free to recommend this site to two or three of your friends and colleagues today.

    And in the meantime, I'm reminding myself that patience is a virtue.

    March 29, 2006

    WSJ Goes Two for Two on GM

    Today's column on General Motors (GM/NYSE) by Holman Jenkins, Jr. is the second excellent piece on the company appearing in The Wall Street Journal opinion pages this week:

    The real test is whether the buyouts will allow GM to close its notorious "Jobs Bank," where some 8,000 workers currently receive a full wage and benefits even though they aren't working. That would free up $800 million a year in dead waste. More: It would fundamentally transform GM's decision-making about how many cars to produce and how to price them.

    GM also seems to be making progress in raising cash by selling off its GMAC financing arm, and last year it wrung modest copays and other health-care disciplines out of the UAW worth $3 billion a year if the company has done its projections right. It's also trimming white-collar ranks and benefits.

    Then Jenkins writes this:

    The company is not out of the woods yet, and never will be really out of the woods. GM operates in an extraordinarily competitive marketplace, beset by hungry competitors and excess capacity. But capital is being freed up. The most interesting stage of the turnaround is coming next: How much of this capital to put at risk by investing to upgrade GM's product line, especially its lagging sedans?

    His bit about GM never really being out of the woods is true. The company is in a tough, capital-intensive business that includes Toyota -- probably the best-run auto company in history. But overcoming or matching Toyota in North America isn't part of my rationale for owning GM stock. Now let's get back to Jenkins' column and the question about what GM will do with its freed up capital:

    The answer will tell us what kind of turnaround CEO Rick Wagoner, with new board member Jerome York at his elbow, is shooting for. Will he play it safe, going for incremental upgrades and matching innovations already introduced by competitors? Or will he go for broke? Not an easy choice given that GM's reputation with auto shoppers may not support the premium products and prices that GM would dangle in front of them. Even more so because the company will continue to be in the news in unflattering ways for the foreseeable future, including over late-breaking accounting scandals (though these may not amount to very much in the end).

    Mr. Wagoner has struck many as the right CEO to see GM through tortuous negotiations with labor and the political class, and to suss out the complicated financial tradeoffs in managing its giant fixed labor burdens. Is he the right guy to greenlight product gambles that may ultimately decide whether all his efforts pay off and GM rights itself for another decade?

    Here, Jenkins actually avoids the current journalistic fashion of dumping on Wagoner:

    Over the years Mr. Wagoner, a product of GM's finance department, has been a reliable voice of balanced caution, noting GM's need to minimize capital risk while issuing safe, commodity products that can be relied upon to generate cash flow to meet GM's crushing income and benefit guarantees to the UAW. Though Mr. Wagoner reportedly was a strong backer of Cadillac's gutsy turnaround, he worried publicly that it "ate up a lot of capital." Last year he told Barron's: "It's true that in a portfolio like ours, trying to hit a wow!-type product is a risk, so part of our strategy is to build good cars that are pleasing, but are not at the edge."

    Then he points out that Toyota, despite what many think, has produced remarkably few "wow!-type" cars over the years. Jenkins says there's a second bottom line here for GM -- getting rid of the Jobs Bank. Why? Because the Jobs Bank gives GM the incentive to underinvest. Equally bad, it also gives the company the incentive to overproduce, to churn out cars commanding just enough market price to meet GM's fixed labor costs even if they fail to generate profits.

    Don't underestimate the importance of this factor. Dumping these cars on the market, especially through cheap fleet sales, undermined the pricing and image of all GM cars, then undermined it again when these fleet vehicles reappeared on used-car lots a year or two later. Optimizing production volume under GM's crazy labor guarantees was such a puzzle that an economist in the company's R&D department even published a research article on it in 1995. A year earlier, GM had actually found itself hiring temps and paying overtime to meet demand for hot cars even as it paid 8,300 UAW workers at other factories to stay home.

    Jenkins' piece ends with this:

    As the company began to spell out in a briefing Monday, unwinding its jobs-for-life commitments would enable GM to alter this basic approach to the car business. Bluntly put, GM would be able to build fewer cars and charge more for them.

    That, of course, is no substitute for having cars on hand that can reasonably compete in the marketplace on style and features, but it would give GM a flexibility -- normal for most businesses -- that it hasn't enjoyed since the Jobs Bank was created more than 20 years ago.

    P.S. For a thoughtful consideration on whether or not GM could make it on having 20% market share in North America, see this from Doug McIntyre's blog.

    Jim Grant's "Tokyo's Day" Makes Mine

    I started buying Japanese stocks in 1998, the same year James Grant began helping to manage some money invested there. He discusses he views of the country in his latest Forbes column:

    Is dawn breaking at last over the long-slumbering Japanese economy? "Yes" is my emphatic, admittedly unobjective, answer. Whether or not you have money invested there, Japan is calculated to intrigue. Here is a living laboratory in what the learned economists call "behavioral finance." In their propensity to sell low and buy high and to perceive risk where there is actually reward, Japanese investors strongly resemble their American counterparts. That is, they are only human.

    Then further down the piece:

    With the Nikkei 225 index quoted at 43 times trailing earnings, the Tokyo market is not precisely cheap on an earnings basis. And gone are the days when hundreds of Japanese companies were valued at less than their net current assets.

    But plenty of Japanese companies continue to hoard cash, as plenty of American companies would if they had been through a decade and a half of rolling recession. These asset-rich businesses are ripe for restructuring. Small wonder that merger-and-acquisition activity is strong (2,713 transactions last year, the most on record) or that Western private-equity investors are circling Tokyo in expectation of a new wave of dealmaking. "Japanese capitalism used to be static," the general manager in the business development division at Bank of Tokyo-Mitsubishi was quoted as saying at year-end. "Now we are learning about dynamic capitalism. We will see more spinoffs and restructurings."

    Actually, my memory is that Japan was never really cheap on an earnings basis. It was always a cash-rich, asset play. But that's a very small quibble. This is another fine piece by Grant -- long the best writer of words in financial journalism. ("Just plain words writing," as John O'Hara once said of F. Scott Fitzgerald.)

    And reading his thoughts on Japan this morning makes my day.

    March 28, 2006

    Another Call for Wagoner's Ouster

    Paul Ingrassia, President of Dow Jones Newswires and former Detroit correspondent for The Wall Street Journal, wrote this about General Motors (GM/NYSE) CEO Rick Wagoner in a column in yesterday's Journal opinion page:

    Which means the clock is ticking on the young CEO, as surely it should be. Look for the board to oust him this summer, at the latest, and thus complete a sadly ironic cycle. Mr. Wagoner first came to prominence in an earlier boardroom revolt -- the company's epic upheaval of 1992. In the fallout from the forced resignation of then-CEO Robert Stempel, Mr. Wagoner was vaulted ahead of several others to become GM's chief financial officer at just 39 years old.

    And just as Mr. Stempel was off in Asia when his board started to stir against him, so Mr. Wagoner was visiting Korea and China in mid-March when GM's board called a special meeting to demand a probe into the newly found accounting errors. Perhaps it was best that Mr. Wagoner was thousands of miles and many time zones away. The special meeting can't have been pleasant.

    Ingrassia then recaps the moves GM has been making. Selling part of its GMAC financing unit. The Board holding a special meeting Sunday afternoon to further discuss selling more parts of GMAC. Offering early-retirement incentives to all of its US hourly workers and most of those at Delphi Corp., a total of 131,000 eligible workers. And slashing hundreds of white-collar positions from the company payroll.

    But despite the mess at GM, Ingrassia sees a hint of hope. Why?

    Well, precisely because of all these painful steps and, more importantly, the reason behind them: a newly alarmed and energized board. The catalyst is Jerome B. York, former chief financial officer of both Chrysler and IBM, and agent of investor Kirk Kerkorian, who holds nearly 10% of GM's shares. "Jerry," as he is known, joined the GM board on Feb. 6.

    The GM board has other strong members, such as former Clinton White House official Erskine Bowles and John Bryan, retired CEO of Sara Lee. But they and the others all are part-timers who really don't know the auto industry, or the key questions to ask about management's explanation of events.

    Mr. York, in contrast, spent most of his career in the car business. And as our Monica Langley reported last week, he is clambering all over GM these days, poring over engines, machinery and financial reports with equal intensity. For Mr. York, unlike any of the other 11 GM directors except Mr. Wagoner, GM is a full time job. Which is only fitting, since Mr. York is charged with protecting Mr. Kerkorian's $1.7 billion investment. Mr. Bowles, for one, says he's "thrilled" Mr. York is around.

    Ingrassia then brings up Bob Lutz, who worked with York at Chrysler, and who -- as commenters here and at Seeking Alpha have pointed out -- hasn't exactly set GM on fire:

    But Mr. Lutz has been surprisingly ineffective at GM, as if mired down like a raisin stuck in oatmeal. Developing distinct vehicles for eight different brands, far too many for a company with less than 25% of the market, is a task that exceeds even Mr. Lutz's talents. GM has neglected trimming its brand lineup for far too long, and it will take a new CEO to tackle that task. Mr. Lutz, at age 74, is too old for the job, and Mr. York, himself 67, doesn't want it.

    The column ends with Ingrassia speculating on who might take the reigns of GM. This is hugely interesting piece -- and I should have posted about it yesterday. But the day got away from me and I didn't see it until last night.

    P.S. To restate something I've explained to commenters regarding Bob Lutz -- I don't think Lutz is a silver bullet or will be the savior of GM. I simply give him as an example of a good move by Wagoner. GM needs to get smaller in North America. Hot cars will be nice, but getting smaller is the key.

    March 27, 2006

    Barron's on The Little Book

    Joel Greenblatt's The Little Book That Beats The Market is the subject of a feature piece in this week's Barron's.

    The verdict is that The Little Book is a sound investment guide, but that readers shouldn't expect their portfolios to grow at triple the market's rate of return. Fair enough. In fact, Barron's devotes most of the article not questioning the validity of Greenblatt's approach, but looking at how back-tested  investment results are calculated:

    Why is there such variance among the back tests? For one thing, there are differences among the U.S., European and Japanese economies. And there are also differences among databases -- including those from Compustat and Bloomberg -- that ostensibly document the same economy. Each uses different accounting adjustments: Compustat standardizes results more than does Bloomberg, which tends to enter numbers "as reported." The vendors also include different populations of stocks, with Compustat best documenting industrial corporations and Bloomberg better covering financial companies. Compustat data are widely used; Haugen's Bloomberg database is only used at his company.

    And even though those databases look large, there's actually a scarcity of historical data in relation to the complexity of the patterns that financial researchers like Greenblatt are trying to test. Physical scientists can repeat an experiment over and over, to generate data on hundreds of independent trials. Our financial history happened only once.

    My problem with "back-tested" results is that the human factor is removed. By that I mean an investor has to make decisions on buying and selling in real time. Do you pull the trigger or don't you? I've posted before about times I knew I should buy -- such as when Disney was trading at roughly $13 a share a few years ago -- and I didn't. "Back-testing" my value approach means I bought the stock, yet the reality is quite different.

    But don't get me wrong, The Little Book is EXCELLENT and deserves to be the best seller it has been since last November. I noticed it's still being displayed prominently in the Barnes & Noble I frequent. If you haven't purchased it yet, you can get it here as well as Greenblatt's previous book, You Can Be A Stock Market Genius.

    March 25, 2006

    Italian Job Coming on GM's Wagoner?

    This from Saturday's BreakingViews column in The Wall Street Journal Europe comparing General Motors (GM/NYSE) and Italy's Fiat:

    Two years ago, Fiat the wreck of the car industry. Its absorption into General Motors looked preordained. How things have changed. Today Fiat's market cap is nearly $15 billion -- a fifth greater than GM's. Aside from savoring this stunning reversal of fortunes, is there a lesson the Italians might provide GM and its investors?

    The column then points out that GM's troubles mirror those of Fiat during its darkest hours. Sales are plunging, market share is eroding, factories and workers are idling and the business is burning cash. All that, and the stock has plummeted, the dividend has been slashed, and the debt is rated junk.

    Fiat surmounted these obstacles by jettisoning assets not central to its industrial focus on cars, trucks and heavy machinery. But it also cut closer to the bone, not only selling most of its financing arm but a chunk of its crown jewel, Ferrari. It swapped debt for equity, sold new shares and wangled $2 billion from GM for giving up the right to force it to buy Fiat Auto. That allowed Fiat to reinvest in its area of expertise, cheap and cheerful cars. Last year, Fiat snapped a 17-quarter run of losses. The stock has surged 80% in a year.

    Then the piece continues with this:

    GM's playbook is not too far off from Fiat's. One notable distinction is the slower pace at which GM's board appears to be moving. It halved the dividend instead of eliminating it, for example. And management appears unwilling to part with ancillary brands, such as Hummer and Saab, something its new, hard-nosed director Jerry York sought.

    And, in the end, GM in general and CEO Rick Wagoner in particular can't catch a break from the BreakingViews editors as they note two differences between the Detroit auto giant and Fiat:

    Fiat had nothing like GM's long-term health-care and pension liabilities. These may be insurmountable without a bankruptcy filing. Oh, and Fiat's board did something else that GM hasn't -- it fired four chief executives before it found the right turnaround artist in Sergio Marchionne. If GM studies Fiat's lesson closely, that can't be far behind.

    I've stated before that I am not down on Wagoner like many. I may be crazy but there you go. Yes, he's been CEO for several years. But the problems at GM date back at least four decades and turning this company around is like turning a huge supertanker at sea. It won't turn on a dime. What's more, there's no way to know whether or not Wagoner and York/Kerkorian are playing a "good cop, bad cop" routine regarding the painful cuts needed. Maybe York is dragging Wagoner and the Board kicking and screaming. Maybe Wagoner is secretly cheering him on. One thing we DO KNOW is that they've been talking -- that's how York got put on the Board.

    Whether this ultimately results in a Boardroom "hit" on Wagoner remains to be seen.

    P.S. Even if Wagoner is fired, no one can say he made a mistake bringing Bob Lutz in. Lutz is the first real "car guy" GM has had supervising car design in ages.

    P.P.S. Doron Levin, Bloomberg's auto columnist, calls for GM's Board to "step up" and make a change at the top in this piece.

    March 24, 2006

    Land of the Rising Shareholder

    Nikko Cordial (NIKOY/OTC) may buy a 50% stake in Tokyo Star Bank, valued at about $1.2 billion, to become the first Japanese securities firm to acquire a commercial lender, according to reports such as this one from Bloomberg on Friday:

    Much of the stake will come from Lone Star Funds, according to the four people, who have direct knowledge of the plan and declined to be identified ahead of a statement. The Dallas-based investment firm owns 68 percent of Tokyo Star, according to data compiled by Bloomberg. Shares of the Japanese lender surged.

    The acquisition by Nikko Cordial, Japan's third-largest brokerage, may herald more financial mergers in Japan as banks and securities firms vie for the nation's $12 trillion in household savings. Tokyo Star has more than 30 branches and 1.3 trillion yen ($11 billion) of deposits. The talks were reported in the Nihon Keizai newspaper earlier today.

    Regular readers of Controlled Greed know that the corporate governance climate in Japan has been getting increasingly shareholder friendly. That's true for the country in general, and in the financial services sector in particular. But this purchase by Nikko, if it happens, marks a milestone in the Land of the Rising Sun.

    And I'm not the only one feeling that way:

    "This deal signals a new phase in the consolidation of Japan's financial industry,'' said Neil Katkov, the head of research in Asia at Celent LLC, a U.S.-based financial technology consulting firm. "The past few years have seen the megabanks building up brokerage businesses. Now it's the big brokers' turn to move onto their turf.

    ''Nikko Cordial Chief Executive Officer Junichi Arimura, 56, is expanding the firm's retail brokerage to take advantage of Japan's biggest share rally since 1972. Buying a bank would also enable the company to make property loans after commercial land prices in 2005 rose in the nation's three largest cities for the first time in 15 years.

    "The next game in Japan will be taking care of personal financial assets,'' said Alexandre Tavazzi, who helps manage about $1 billion of Japanese stocks at Geneva-based Pictet & Cie.

    The Bloomberg report also contains a nice overview of Nikko Cordial:

    Nikko Cordial last week forecast profit will double to a record 94 billion yen in the year ending March 31, after posting net income of 77.2 billion yen in its first three quarters. Stock brokerage commissions soared to 30.1 billion yen in the three months ended Dec. 31, from 12 billion yen a year earlier as a 19 percent gain in the benchmark Nikkei 225 Stock Average doubled daily trading in the quarter.

    The firm also profits from its 26 percent stake in Monex Beans Holdings Inc., Japan's second-largest online brokerage by accounts, which boosted third-quarter profit to a record 4.72 billion yen, from 1 billion yen a year earlier. Funds under management rose to more than 9 trillion yen at Nikko Asset Management Co., the brokerage's money management unit, which will be sold in an initial public offering.

    Nikko's ADRs were first recommended here at the split-adjusted price of $8.64 each on May 26. I posted about taking partial profits on the stake last week. The company continues to be a large holding (actually the second-largest holding in the portfolio) and the ADRs closed Friday at $16.55.

    Recapping Sherman's March

    Here's an interesting article recapping how Bruce Sherman and Private Capital Management pressured Knight Ridder into putting itself up for sale:

    On July 19, the board of directors of Knight Ridder, the   country’s second-largest newspaper chain, held a most unusual meeting. It was at the Ritz-Carlton Hotel atop San Francisco’s Nob Hill, and it was unusual because, as the 10 board members convened, representatives of Knight Ridder’s three biggest shareholders were camped outside the door, waiting to air their gripes about the company’s stock performance.

    This meeting would mark the start of an insurrection that ultimately would force the board to put Knight Ridder up for sale, threatening the future quality of its journalism and causing tremors throughout the newspaper industry. One restive shareholder in particular, Bruce S. Sherman of Naples, Florida, was the instigator and ringleader.

    Sherman (or rather, the institutions and rich individuals   whose wealth he manages) owned about 19 percent of Knight   Ridder—a huge stake, far larger than anyone else’s. He had   been accumulating it for five years, starting with less than a million shares and adding more as his investment group   attracted clients.

    Then further down the piece:

    It’s a bear market for newspapers, in any case. Following the news of Sherman’s raid on Knight Ridder, financial analysts wondered aloud why anyone would want to buy a newspaper company. A writer for Fortune magazine asked rhetorically how Sherman had gotten himself “mired in newspapers, a business that seems destined for dreary decline.” Conrad Fink, a former journalist who teaches newspaper management at the University of Georgia, says he’s never seen such panic over newspaper stocks before. The pessimism is due to shrinking circulation and a strong fear of   advertisers defecting to the Internet.

    “The perception is that somebody invented Google and so you’d better get the hell out of newspaper stocks,” says Fink.

    I don't know much about Sherman and PCM, and this a lengthy article. But it's well worth spending a few minutes reading. So enjoy.

    BreakingViews Skeptical on GM, GMAC

    Just in case any new readers suspect I'm looking at General Motors (GM/NYSE) through rose-colored glasses, rest assured I'm not. I've linked to goodness knows how many GM-related articles since launching this blog last April -- the majority being negative on the auto company.

    No surprise there. The VAST majority of news on GM has been negative. Some even downright hostile.

    But like any reader, I appreciate even-handed columns and news reports. Even when they're down on companies I'm invested in.

    One column I respect immensely is the BreakingViews column appearing daily in The Wall Street Journal Europe. This morning's piece (scroll down) comments on the partial sale of GMAC announced yesterday:

    The news flow from General Motors has come thick and fast of late -- for a change, much of it good. On Thursday the world's biggest auto maker clinched the sale of a larger-than-expected stake in the commercial-mortgage subsidiary of its finance arm. It also reached an accord with unions that could lead to tens of thousands of voluntary layoffs. This shows progress. But it's not yet sufficient to avert death by a thousand cuts.

    For starters, the sale of GMAC Commercial Holding to private-equity investors led by KKR was already in the price. The sale brings in over $1.5 billion in new cash and frees up another $7.3 billion on GMAC's balance sheet. That money may help GMAC in funding its obligations, and some proceeds could flow up to the parent through dividends.

    However, it's not clear how good a deal GM got for the business, as the company did not provide financial information such as the unit's stated book value. This would be helpful in handicapping the success of GM's auction of a controlling stake in GMAC itself.

    Then the BreakingViews editors move on to GM and Delphi:

    Similar concerns bedevil GM's attrition plan. The deal likely averts a strike at Delphi, its former parts manufacturer now in bankruptcy proceedings. And it could save up to $870 million in wages, according to Deutsche Bank. But the company has yet to give its best estimate of the costs associated with the layoffs and the possible reductions in the company's pension and health-care liabilities, which are the biggest long-term worries for GM investors.

    The column ends by crediting the auto giant with making progress, with the inevitable "but":

    But until there is greater clarity about how these advancements will affect the bottom line, it will be hard to judge them as anything more than small advances in a losing battle against insolvency.

    Sometimes when you invest in an unloved company you believe is undervalued, you have to be willing to face the headwinds. I've definitely felt the headwinds owning GM. I just hope my portfolio position doesn't get blown away.


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