Tuesday, August 2, 2016

Yahoo Tosses in the Towel

It's been about two years since Yahoo board members and CEO Marissa Mayer huddled among themselves time and again to decide what to do with the company. Few companies, including many of its competitors all along the Silicon Valley corridor, have endured as many volatile ups and downs in its two-decade history. Yahoo's earnings, revenues and its strategic direction have bounced around like balls in an aimless path.

Mayer was hired from Google to become the CEO who would devise the strategic, pick the people, make the acquisitions, and develop the products that would thrust the company into the elites among technology companies that depend on digital advertising.  Mayer was supposed to push Yahoo to seize once again its top perch among Internet "portal" companies.
Somewhere along the way, Yahoo stepped into a blockbuster of good fortune from having invested in Alibaba, the big Chinese company that combines the best of PayPal, eBay and Amazon and issued its equity over here.  Yet Yahoo stumbled a few times. It picked itself up, stumbled again, and reached a point of not being sure what that best next step should be--except to separate the company into its Alibaba parts and its website parts and let another big company, with resources enough to take risks with it, decide what that next strategy should be.

Verizon has decided to purchase the non-Alibaba parts of Yahoo for a mere $4.8 billion. (Yahoo could have sold itself to Microsoft years ago for nearly 10-times that amount.) Verizon decided to find a partner for AOL, which Verizon acquired within the past year.  Put AOL and Yahoo together, take advantage of their millions of subscribers and tens of millions of clicks, coordinate the content they both pour through websites, reduce duplicate expenses, and make gobs of money from digital advertising.

Yahoo was not on the verge of bankruptcy or insolvency. Revenues have been flat, and earnings exist, although losses are occasional.  Mayer staged many acquisitions (Tumblr, for example), but none could help boost revenues much beyond $4 billion/year. Alibaba brought a fortune--tens of billions in unusual earnings and needed cash reserves.  It also brought bothersome levels of tax headaches.  Yahoo had modest levels of debt (to help its acquisition binge and to develop content), but dwindling cash flow meant it had little room to borrow more.

Markets, disappointed and signaling frustration in slipping stock prices, pushed Meyer and the Yahoo board toward a final move. The market, in fact, had valued Yahoo, minus its Alibaba asset, at negative values.

Mayer's rise to a top post Silicon Valley was meteoric, rapid, and not unexpected (from those who had knew her work at Google).  As a woman CEO not yet 45, she was watched, observed, and perhaps over-analyzed. Every quarterly earnings announcement (or quarterly misstep) and every large-scale, over-priced acquisition were headlined, heralded, or overly analyzed. When the desired revenue growth never appeared, her strategies were second-guessed. It's unfortunate the Verizon acquisition reduces women CEO's in Silicon Valley by one--a worrisome number in a corporate sector where women CEO's can tallied by less than two hands.

No matter what Mayer attempted, the company couldn't rocket itself to where it wanted to be, even if it head years of a head start before the Googles and Facebooks were household names.  Sales were stagnant at below $5 billion. No matter what it acquired, developed, and created, operating revenues (excluding anything related to Alibaba) never topped that $5 billion lid. Earnings and cash flow were erratic (They were losses and deficits last year).  The company spent and spent (development, administrative, and traffic-acquisition expenses), but revenue growth didn't accompany the spending sprees. Debt levels were moderate (less than $2 billion), but would have become a difficult burden if losses continued.

In the eyes of a potential acquirer, Yahoo offered some form of equity value, measured not by growing flows of operating cash, but from the metrics that technology companies with digital-advertising business crave:  subscribers, views, and clicks from a predictable core.

Just as it reasoned with AOL, Verizon likely rationalized that $4 billion and change is not an outrageous price to pay for a company that attracts enough eyeballs daily to generate a base level of $4 billion in revenues. It also likely concluded it could erase much of the billions in Yahoo expenses within a year and eliminate its debt without a flinch. Verizon may quickly turn something that is lackluster breakeven operation into something cash-flow positive. 

The challenges, however, will be (a) how to increase revenues to justify the acquisition, (b) how to mesh Yahoo's operation with that of AOL, which had its own set of financial woes, and (c) how to respond to regulators who might all of a sudden express concern about Verizon amassing enormous amounts of customer information from its combined Verizon-AOL-Yahoo data bases in its efforts to sell the most-targeted form of digital ads.

Tracy Williams

See also: 

CFN:  Verion Acquires Vodafone, 2013
CFN: Why is Dell Going Private? 2013
CFN:  Verizon Rescues AOL, 2015
CFN:  Will Yahoo Ever Rebound? 2015
CFN:  Who Calls the Shots in Silicon Valley? 2016

Friday, July 15, 2016

Who Attracts the Best Talent?

Financial institutions are scarce on LinkedIn's new talent-attraction list, but Goldman Sachs slips in at no. 27 on its U.S. list
Which companies around the globe attract the best and the brightest?  Where do the most talented want to work?  What are the coveted places for those who are select their employers, before employers select them?

LinkedIn used its stockpile of data from over 400 million users and took a stab at creating a list. It used data analytics and data science. It tapped intuition and made assumptions (many of them). Here's one:  Companies that attract the best talent are companies that get the most job requests in LinkedIn or garner the most attention in LinkedIn updates or communications. 

In early July, it presented the results of the project, its first such effort. Its data and models produced a ranking of top companies or financial institutions it contends are successful in attracting the best talent. Some of the familiar names (Apple, Google, Amazon, Facebook, e.g.) led the top of the list.  Financial institutions were few in number, and there might be reasons.

Be mindful that a broad survey or analysis of the kind LinkedIn led could lead to possible false impressions or misrepresentations. (What is the real definition of "talent"? Aren't many talented people recruited without their making inquiries in LinkedIn?)

Yet the final list included names we would expect in 2016, names of companies that pay well, that have ambitious plans to grow and make a societal difference, that offer pleasing perks, and that present interesting problems for smart people to find solutions in their first few days on the new job.

Up front, LinkedIn needed to define top talent and best talent.  It then assembled a set of assumptions to define what it means to attract talent.   Are the companies at the top of its list attracting employees who sported the highest GPA's, who performed beyond expectations during internships, who have in-depth levels of skills in technical areas, and who have demonstrated qualitative skills (drive, energy, work ethic, leadership, etc.) in previous work assignments? Are they MBA's from top business schools, those who lead class discussions in investment analysis or chair the finance club?  Are they mostly computer science whizzes from elite engineering schools?

There's a global list and a U.S. list. Apple, Salesforce, Facebook, Google, Amazon, Microsoft, Uber, Unilever, and Coca-Cola and Oracle appear on both lists.  In the U.S. compilation, you see Uber, Stryker, Netflix, Under Armour and Tesla. Are we not surprised? Don't talented people want to work at companies making a mark or sitting on the cusp of extraordinary growth? (Many of the companies on the global list are Consortium sponsors.)  Few financial institutions appear on the list, and we might be able to rationalize why.

LinkedIn explains the criteria clearly, even if many will argue about the flaws (as there are in just about all lists published and promoted widely).  LinkedIn has access to voluminous data--from companies, recruiters, employees, industry leaders, potential hires, students, etc.  It culled the data, deciphered trends, clicks and activity from its users, put together a set of rules and used results to present a list.

Its premise for talent-attraction is based on (a) reach and clicks (how well known the company and its brand are) (b) engagement and interaction (how often LinkedIn users connect with the company in some form), (c) job interest (how often LinkedIn users explore or seek employment at the company), and (d) staying power (how long do employees remain at the company).

Some filtering of data must have been necessary, because those who lack required skills or talent are also clicking and exploring and pursuing job opportunities at many of the same companies.  And often the best are discovered and tapped in other ways or through other channels.  They need not spend much time completing job applications discovered from an exploratory moment in LinkedIn. But LinkedIn asserts, if thousands are exploring employment opportunities at Google, then Google's chances of hiring the best increase.

Now what about financial institutions?  Why don't they crowd or dominate the list in the way they might have in the 1990's or mid-2000's, when art-history and music majors expressed interest in gaining a spot in an investment-banking class at, say, Credit Suisse or Lehman Brothers?

Why are Goldman Sachs (no. 27 on the U.S. list ) and Morgan Stanley (no. 40 on the U.S. list ) the only two large financial institutions on the list?  Do financial-service companies (banks, funds, institutions, insurance companies, and asset managers) not attract top talent annually from undergraduate and business schools or from other industries?  Are this generation's brightest choosing careers mostly in technology, new ventures or less-bureaucratic and less-hierarchal organizations?  And are work-life-balance issues factors?

What implications can we make from LinkedIn's efforts to highlight the paths that talented people take in pursuing opportunities or employment?

1) Investment banking might still be a lure.

Goldman and Morgan appear on the list, partly because of the continuing attraction of investment banking.  They are no longer "pure investment banks." (They are officially bank holding companies.) But in some circles, they are considered major investment banks before they are labeled commercial banks.

Wells Fargo, Citi, or JPMorgan Chase with similar brands and, in some cases, strong financial results might easily have supplanted Goldman and Morgan.  With Goldman and Morgan Stanley, there is the apparent direct tie (and heritage) to investment banking, where compensation packages are still lucrative and deals, transactions and trading still cause surges of adrenaline.

2)  The steady transformation of financial services (including the impact of regulation) can be daunting.

With new regulation keeping banks strapped in many ways, talented people might be restricted from being creative, expanding on bold ideas, and coming up with new products.  Regulated financial institutions have restrained balance sheets and thousands of pages of new rules to adhere to. 

3)  The survey, with some flaws, could still have omitted some institutions or miscalculated "talent attraction."

Let's consider that banks such as Wells Fargo, hedge funds such as Bridgewater and Citadel and private equity firms such as KKR, Carlyle and Blackstone indeed attract the financially talented.  How do they not appear on the lists? In some cases, they aren't household brands (one of the criteria). In other ways, they identify talent in stealth ways and hire in limited numbers.  And they may have a limited presence in LinkedIn.

4) The fintech revolution might, in fact, even its early unproven stages, be enticing talent that might otherwise have gone to work at Charles Schwab or Bank of America.

New companies that fit the mold of "fintech" didn't ease onto the lists. A few notable ones (Square) did. Others might show up on lists in the years to come. SoFi is a prominent example. But the wave has come and is far from peaking. They have affected talent retention at banks, which are suffering anxiety trying to determine a counter-strategy:  Beat them or join them or invest in them?

An MBA graduate (of a Consortium school?) with a concentration in finance and an extensive background in computer science is just as likely to want to explore working for a transformative, business-model-breaking fintech company as she would want to start out as an associate in project finance at Deustche Bank.

So the list is out, slowly slipping onto the digital screens of young professionals (and those more experienced).  It will likely be an annual LinkedIn roll-out, and no doubt it'll polish and update the criteria next year.

One special note:  Microsoft, which just announced its planned acquisition of LinkedIn, appears on the list.  LinkedIn list organizers unabashedly said they will keep the new parent on the list this year. For now, at least.

Tracy Williams

CFN:  The Fintech Revolution, 2016
CFN:  Financial Technology and Opportunities, 2014
CFN:  Bitcoins:  Embrace or Beware, 2014
CFN:  High-Frequency Trading:  What's Next? 2014
CFN:  Fortune's Best Places to Work, 2016

Sunday, July 3, 2016

Another Round of Stress Tests

Global banking these days is so much about building capital bases and passing complicated stress tests.
First there was "Brexit," the U.K.'s referendum leading to a surprising, planned departure from the European Union. Then came the big banks' stress tests, graded by Federal regulators.  In the days after Brexit, there couldn't have been a better time to announce the 2016 results of the annual bank-holding-company stress exams. 

Banks have mountains of new regulation for which they must adhere to between now and 2019. Along the way, they must pass yearly stress tests administered by the Federal Reserve Bank and falling under the more expansive title, "Comprehensive Capital Analysis and Review," referred to more often as "C-CAR."

In the wake of Dodd-Frank legislation, regulators want banks to have sufficient amounts of capital to withstand shocks, losses and surprises during the ordinary course of business and to endure the worst possible scenarios, those that lead to unexpected losses.  The capital guidelines are detailed and complex. The formulas used to calculate precisely the amounts of capital to act as worst-case cushions are as complicated as a graduate-school statistics course. They aim to compute expected and unexpected losses.  They consider such factors and variables as 99-percent confidence levels (for worst-case scenarios), correlation, loan default probabilities, concentration, market volatility, market sensitivity and market shortfalls. 

But even after data accumulation and calculations and after banks report they have far more than the minimum amounts, U.S. regulators require the stress tests. They want to cover all bases. They want to make sure they haven't overlooked other negative influences--like a Brexit-type event, oil prices deep-diving toward $20/barrel, or a global recession appearing from nowhere.

So the exercise is this: 

Banks first address Basel III requirements.  They routinely tally up all their risks (credit, market, operational, contingent, and off-balance-sheet), perform the calculations to assure regulators they have enough capital (the sum of equity and some forms of long-term debt) and assert their capital totals will tolerate massive losses, including that arise about once a century (like those from the period of 2008-09). 

The risk tally sums up to a total of risk-weighted assets (RWA). A bank's loan to, say, investment-grade companies like Home Depot or John Deere is "risk-weighted" downward, compared to the bank's loan to a struggling, non-investment-grade borrower like, say, Sears, Valeant, or now-bankrupt Sun Edison. The minimum capital requirements (Common Equity, Tier 1, Tier 2, Total Capital), tied to RWA, are stipulated by Basel III rules. 

And then, oh, by the way, after all those calculations, come the stress tests.  Regulators require yet another vigorous shake-up to balance sheets, bank operations and the financial system to see if banks can still survive with ample amounts of capital.

Hence, the latest stress tests.

Every U.S. bank passed this time, although one bank (Morgan Stanley) was put on what might be called regulatory probation, a conditional watch list. (Two subsidiaries of foreign banks ran into trouble:  Deutsche Bank and Santander.)  Citi, which fumbled the test the last time, was determined to be a leader of the pack this time.  Its stress test showed how the worst of all worst-case scenarios could lead to the bank suffering over $34 billion in losses over an 18-24-month period. Yet it proved (and regulators agreed) it would still have ample capital resources to remain sound and viable--not just barely solvent. Its equity "cushion" would still exceed $150 billion. (Most of those losses would come from loan losses on its consumer and corporate-lending portfolio.)

In the latest test, regulators presented the following scenario:

1) U.S. unemployment rates would rise above 10%. That would have impact on consumer loan and residential-mortgage portfolios and would have eventual impact on corporate borrowers that depend on thriving retail markets.

2) The U.S. dollar appreciates substantially. That would have impact on global corporate loans and U.S. borrowers with substantial exports. It would affect U.S. banks with big balance sheets abroad. (Some would argue that banks' currency-trading units, which thrive on volatility, might have income upswings to offset other losses.)

3)  U.S. Treasury securities will trade with negative yields (as many Euro-issues have done in the past year). That would have a detrimental impact on bank earnings (net-interest margins) and might encourage banks to take out-size risks to recoup negative earnings on Treasuries they may have held for liquidity purposes.

4) "Flight-to-safety" capital flows would occur and would like result in rocky, strangely behaving markets.  That would result in financial institutions dumping riskier assets for safe-haven instruments (sovereign debt, high-rated bonds, or even U.S. Treasuries with negative yields), likely causing a collapse in a range of assets (equities, commodities, lower-rated corporate bonds, mortgages, etc.). This would replicate 1998's Asian and Russian crisis, when flights to safety led to a sudden widening of bond spreads, as investors dumped mortgage bonds and any asset that smelled risk for U.S. Treasuries.

Regulators this time hadn't really identified a Brexit, didn't predict it, or at least didn't specify such a case in the detail they described for scenario possibilities. But stress tests are supposed to capture the risks of Brexit-like occurrences. 

The tests aren't conducted as easily as they appear.  While it is straightforward to describe a stress scenario, all bank activities, assets, loans, trading positions, liabilities, and legal entities are subject to these downside cases. All results must be quantified with reasonable precision.

Out spills a grand total of possible losses over a defined time horizon. The losses are subtracted from current capital totals. Regulators then access whether the bank, after all, still has sufficient loss-absorbing capital to meet Basel III requirements.

Banks that pass can exhale. The exercises, however, don't go onto a shelf or get buried in electronic files in a compliance department.  Banks gear up and prepare for the next test or take measures to ensure on an ongoing basis they can pass the test any time its administered with a different, but similarly outrageous, but realistic list of extreme market characteristics.

Some big banks this year proved to have so much ample capital they proved to the Federal Reserve they could pay higher dividends and resume stock-repurchase programs. They proceed with such shareholder rewards, confident they will continue to generate earnings quarter after quarter.

Ever since Dodd-Frank and Basel II and III rolled onto the financial scene, banks know well they must continue to keep those capital bases swelling and growing. And they want to the headlines that come with having fallen short of expected capital requirements or having failed a stress test.

Tracy Williams

See also:

CFN:  Basel III Becoming Real, 2013
CFN:  JPMorgan's Refined Regulatory Strategy, 2014
CFN:  Big Banks:  The Dreadful Downgrades, 2012
CFN:  Bank ROE's: Stuck at 10%, 2015
CFN:  Banks and Living , 2016
CFN:  Banks and Their Energy Loans, 2016
CFN: When Does a Bank Have Enough Capital? 2015

Monday, June 20, 2016

Was LinkedIn for Sale All Along?

Out of the blue, LinkedIn made itself available for sale.  Microsoft reached out.
Did anybody see it coming?

Did anybody know Microsoft had its eyes set on acquiring LinkedIn? Yes, this is the LinkedIn almost all professionals are familiar with, the website that presides over business networking, permits its hundreds of millions of users to post their resumes' online, and is a gateway for corporate recruiters to sift through data on those who work in the most junior positions to those who have roles on a floor C-Suite.

There hadn't been rumors floating around about LinkedIn searching for a suitor or buyer. Not much whispering about its board members adopting a strategy to convince shareholders the company would benefit from a merger. The merger announcement, on a late-spring Monday morning, emerged from around the bend.

Microsoft has announced it plans to acquire LinkedIn for $26 billion.  The acquired company, after another year of losses when it had actually turned the corner toward profitability two years ago, had decided that its best bet was a merger. 

Too much risk and uncertainty loomed if it opted to push ahead, find clever ways to boost sales, and figure out a way to generate predictable streams of income (which it hasn't yet done). Too much uncertainty loomed if it thought its current business model, strategy and financial results could thrust the company to valuation levels (above $100 billion) that could reach the class of Facebooks or Googles.

Might there have been clues the past few months that LinkedIn had put itself up for sale?

A few clues.  Last year's performance. This year's first-quarter outlook and performance.  And the implosion in its stock price in February when an unfavorable outlook presented by the company led to a decline by almost 50%.

Had the board decided that the company's valuation, as an independent company, right now was as high as it could possibly get?

Unlike some ventures in Silicon Valley that were launched in the late 1990's and early 2000's and that eventually went public, LinkedIn had begun to eke out small profits or at least get near break-even. But the company last year sagged and reported losses. 

Revenues were growing at rates Silicon Valley followers covet. The company now boasts of sales of almost $3 billion, about three times revenues from three years ago.  New users, new services, and more interesting and useful items that cascade through its version of a newsfeed helped to generate more fees and advertising revenue. 

But expenses across the board surged. The more it has grown, the more it has spent to spur growth or find ways to make LinkedIn special in complex sphere of social and business networks.  Revenues show signs of flattening out, and the company was on a pace to lose about $250-300 million this year.

The balance sheet has a modest amount of debt (about $1 billion), and the operations actually squeeze out some cash flow, despite recent losses. Much of that cash flow has been siphoned toward new investments and capital expenditures. 

In other words, as a relative new company in a technology arena, the company was doing what it thought it's supposed to do to grow and remain relevant, interesting, and hip. Like many new Bay Area companies, it hasn't even thought of paying dividends yet.

With revenues apparently topping out, with it perhaps having run out of ideas for how to push usage on the site and with stock values gyrating in sometimes unexplained ways, LinkedIn figured its best bet was a sale.

So now the ball is in Microsoft's court. How does LinkedIn fit in? What will it do to or for the company? How realistic are the reported synergies between Microsoft's strengths and LinkedIn's purpose?

Despite some equity analysts and market watchers squirming after the announcement, Microsoft has the heft and might to do the merger.  Its market value exceeds LinkedIn's by 10-times. LinkedIn's sales will contribute, at least for now, less than 3 percent of the combined company. Despite some who lament Microsoft being an old-school, behind-the-times technology company, it still can still be counted on to generate over $10 billion in profits (and over $20 billion in operating cash flow). Like Apple, it has over $50 billion of cash sitting on the balance sheet waiting to prey on a new investment opportunity. (It's those kinds of cash-flow numbers that permit credit-rating agencies to rate it AAA.)

LinkedIn, therefore, would only cause a slight scratch in Microsoft's numbers, if the merger fails.  Somehow, however, critics and pundits might be right in wondering how the two fit together. Will professionals using Excel spreadsheets really seek advice or input from their connections in LinkedIn?

Tracy Williams

See also:

CFN:  Who Calls the Shots in Silicon Valley? 2016
CFN: Twitter's Turn for an IPO, 2013
CFN: Why Did Dell Opt to Go Private? 2013
CFN:  Google Reorganizes as Alphabet, 2015

Monday, May 23, 2016

Taking a Bite Out of Apple

Warren Buffett likely gave a nod of approval before Berkshire decided to invest $1 billion in Apple

To the surprise of many who figured Buffett and his Berkshire Hathaway investment company always steer far from investments that sound and smell “technology,” the group announced in May it would invest $1 billion in Apple stock. 

In the days before the announcement, Apple’s stock had tumbled a bit following what it deemed a lackluster first-quarter performance (a slight decline in revenues for a company that had hardly experienced bad-news earnings the past decade). In the moments after the announcement, its stock price bounced upward. A Buffett stock-purchase gesture will do that for you. 

Some analysts responded in the media this signaled a step toward retirement for Buffett, now 85--a hint that he is allowing others to lead the company’s investment decisions and that might have spurred the decision behind the Apple stake.

On the other hand, no matter how many detect Buffett is permitting others to make investment decisions, a billion-dollar investment in Apple or Coca Cola or any major company likely required Buffett’s nod of approval. The next generation of decision-makers at Berkshire will likely have sought Buffett’s input and sign-off. He might have not have come up with the idea or might not have immersed himself in the research that usually accompanies a Berkshire stake. Others performed the analysis and industry research and presented a legitimate case to invest; Buffett, no doubt, okayed it.

What did they see, as they researched and reached a decision that must have conformed to the company’s decades-long investment principles? The  principles form the backbone of investments in companies that will show consistent, stable and sustainable performance for a long time. 

Buffett and his Omaha crew for ages have preached investments in

(a) businesses they know and understand and businesses with readily understood operating models,

(b) industries that will be important for a long time to a large buying market, 

(c) companies that have groomed leaders to be astute, shrewd business managers, 

(d) companies that hit certain measurable objectives: good, stable returns on equity (book value), most notably, 

(e) companies that have “intrinsic” values that far exceed the values calculated by emotion-swamped and flighty short-term shareholders, 

(f) companies that have cost control and exhibit some signs of growth (after a modest amount of tweaking by the same experienced management team), 

(g) companies that may occasionally experience downturns or slumps, but will be granted time to recover and even soar.

And yes, companies that pay steady dividends from predictable streams of cash flow, aren’t burdened with too much debt and aren’t daring to venture into non-core, exotic activities or activities that appear to be CEO “hobbies.” 

Does Apple qualify? What could have swayed them, beyond Apple’s decades-long performance of stunning levels of operating cash flow? 

Take a peek. 

a) Market values that fall shy over “intrinsic” values, even if Apple hasn’t yet unveiled the next gadget of the decade.

Apple now has a market value that now exceeds $510 billion, even after the stock price cascaded downward from above $130/share to the mid-90’s today. Berkshire analysts may have concluded after a slight downturn in earnings (“down” to $10 billion in the first quarter), equity markets might have over-reacted. Has the market been too concerned about Apple's product line, uncertainties about an Apple watch product and slippage in revenues warrant declining values? 

A recent P-E ratio computed to 10, for a company operating in a still-growing industry where normal P-E’s range above 15. A P-E ratio hovering about 10 suggests markets aren’t willing to give value to uncertain levels of growth. 

The Omaha team may have concluded the market is under-estimating future growth. They are confident Apple management (under Tim Cook, as CEO) can still crank out operating cash flows continually in a $10-15 billion range each quarter. 

b) Cash reserves, which rest visibly on its balance sheet. 

Apple still sits on billions in cash, even if in recent years, the company has elected to reward shareholders with dividends and not hoard it all. Beyond dividend pay-outs and stock repurchases, it still has about $40 billion to “play with”—for new investments, new projects, an occasional acquisition. (Another $30-40 billion resides in operating units overseas and unconsolidated subsidiaries, targets for many who claim the company keeps that cash there to avoid tax obligations.)

A few years ago, shareholder activists protested that some of the cash reserves should be siphoned off to equity-holders in the form of dividends, if only to boost an already astounding ROE’s (returns on equity). 

Apple complied, started paying dividends for the first time and instituted a stock-buy program. It replenished much of the stockpile from new cash from operations and from proceeds of new debt. (Apple continues to pay out about 15% of operating cash flow in dividends.) 

Activists pushed for stock buy-backs, too, and begged for a capital structure that welcomed cheap debt, less equity. A little financial engineering, so to speak. Apple has obliged and has conducted occasional stock repurchases the past three years or so. 

c) Operating cash flow 

Even if it claims it experienced a “bad” first quarter (unsuitable for its standards), the company is still generating sustainable (predictable) cash flow (after capital expenditures) from operations of about $15 billion a quarter, over $60 billion a year, reliable streams that get Berkshire analysts excited.

Berkshire analysts could have concluded that operating cash flow won’t surge to $80 billion a year soon, but the market may be under-valuing a company that will likely continue to generate at least $40-50 billion cash from profits, even in the toughest years. 

d) Book-value returns. 

Buffett has often said they assess performance based on a company’s ability to generate earnings on book value. Apple produced an ROE of 44% last year (31% last quarter). Getting comfortable with low-cost debt (as it has done the past few years) has enhanced returns. High profit margins (22% ROS) on products peddled to consumer public has helped. (Remember, iPhones have $500-plus price tags affixed to them.)

Buffet is attached to companies with operations that result in returns (ROE) that exceed expectations and cost-of-capital requirements. 

In the end, the team of analysts concluded sustainable cash flows and sound returns on capital offset the label of Apple being a “technology” company. They crunched the numbers and felt comfortable the right management is in place for a long time. And Cook and his corps of product creators will develop new products that will keep piles of cash flooding its doorsteps. 

Buffett and team are less worried about whether Apple’s watch didn’t usurp the iPhone in popularity, not too concerned because one or two quarters fell short of fabulous earnings in previous years. They may have beamed they could swoon in and grab a piece of a $500 billion company they think—with cash flows and predictable streams and a business culture that finds a way of producing the next new thing—is really worth $600-700 billion. 

Tracy Williams

See also:

Thursday, April 21, 2016

What's This About "Living Wills"?

Bank regulators, including the FDIC, gave failing grades to some well-known banks in the recent "living wills" test

U.S. financial regulators delivered another blow toward big banks in mid-April, 2016. Some analysts and equity markets considered it a benign one because bank stock prices hardly budged.  It provided easy fodder, however, for the bands of critics (including a presidential candidate or two) who wage arguments that big banks must be broken up.

This time the FDIC and Federal Reserve announced its list of banks that didn't pass its latest test to assure the public that tax-payer funds won't bail out the next Lehman or Bear Stearns. A slate of banks (including JPMorgan Chase, Bank of America, Wells Fargo, and State Street) failed the "Living Wills" test.

This requirement is not arbitrary or recent. Dodd-Frank, the U.S. legislation that spells out much of bank regulation after 2010, permits regulators to establish rules that require big banks (especially the ones deemed "too big too fail") to show how they will wind down their vast operations in the event of extreme distress (at or near bankruptcy) without putting us through what the globe endured in 2008.

In other words, if a bank like JPMorgan or Wells Fargo in control of over $2 trillion in assets in all parts of the globe is in jeopardy of going out of business (perhaps because of mounting loan losses, extraordinary asset concentration, gigantic trading losses, insufficient capital, or fraud), can it manage an orderly liquidation of the business? Can it do it without hurting depositors and causing wreckage in capital markets?

And can it do so without the U.S. Government having to intervene? Can it do it without the Government feeling obliged to inject new capital to keep markets at peace and avoid jeopardizing the existence of the financial system? Can that orderly process occur with only shareholders (and maybe subordinated debt-holders) bearing the inevitable billions in losses?

In 2015, regulators requested banks to complete this  exercise.  After assessing the "living wills," they would decide which banks passed or failed--regardless of how well those banks are performing today or how well the banks meet current regulatory requirements for capital, leverage and liquidity.

The banks got their report cards recently, and they accepted their wrist slaps in stride, suffered a little embarrassment and promised to redesign their respective liquidation plans.  They must present improved presentations of  "living wills," and they are taking this seriously.

Why did JPMorgan, a bank cushioned with over $200 billion in book capital, fail this test?

How could the big behemoth, with $20 billion-plus annual profits and with its hands entangled in about every form of financial transaction that exists, have not passed?  JPMorgan management is blaming technicalities.  And it might have a case (although that won't convince regulators to change their grade).

Regulators examined a hypothetical scenario where the bank's credit ratings have been downgraded to near-default status (or the ratings have been withdrawn) and where the bank's parent company is in or on the verge of bankruptcy. They argued a JPMorgan liquidation process, as catastrophic as that seems, has short falls that require immediate attention. The bank has the rest of this year to redo the will. A catastrophic-sounding wind down, regulators insist, must have minimal impact on the rest of the financial system.

In reality, if JPMorgan is about to implode and if rumors of bankruptcy abound and even if its problems and woes are isolated, it's likely other big institutions will be fumbling (or failing) because of similar issues.  Big banks have similar businesses,  strategies, balance-sheet content, and ways of managing risks. They often interface, compete, or aggressively manage markets in similar ways. Paraphrased, they often copy each other, if only to compete and grow. If JPMorgan is going down, then it's likely Goldman Sachs and Citi are suffering similar financial anxiety.

The goal of a "living will" is to ensure an orderly, safe liquidation that follows a regulatory-approved "playbook."  The implied goal is to assure all of us the financial system won't suffer a repeat of 2008.

Explaining in clear communication, regulators directed JPMorgan to clean up lingering issues with liquidity management, complex legal structures, and derivatives exposures.  To their credit, they outlined the problems in layman's detail.

Bank overseers say the bank's liquidity plan has weaknesses.  The bank has vast amounts of cash reserves (to meet short-term obligations), but the bank is over confident its ability to summon up cash that might be trapped in subsidiaries, particularly regulated entities.  Regulators want the bank to assume that parent cash deposited at a major subsidiary might become "ring-fenced," trapped overseas, blocked by other rule-makers or encumbered by third parties, unable to be funneled back to the parent.

They also remark the bank's parent entity presides over a sometimes inexplicably complex legal structure, one that would with certainly impede an orderly liquidation. They recommend the bank consider aligning legal entities with business activities.  No doubt regulators are aware big financial institutions create hundreds of legal entities, often to separate regulated activity from non-regulated activity, sometimes to extract exotic, difficult-to-value assets from trading units that seek a high-grade credit rating.

Regulators also want to see a better plan for recapitalizing some of those entities, if and when necessary. And they are pushing for a stronger outline for how it would wind down billions in derivatives exposures.

The strikes above result partly from the bank's size (cash reserves residing on balance sheets around the world, vast numbers of unexplained legal entities, and exposures in nearly every kind of derivative that is traded).  That explains why it can be harder for JPMorgan to pass a "living will" test than it would be for a   domestic, medium-size bank, even one that isn't growing or is barely profitable.

However, it's a strike, and it's a new era. The bank's legal staff, compliance officers and financial managers will hastily respond and resubmit a stronger liquidation plan, even if the probability of a such a bankruptcy is low and unimaginable.

Tracy Williams

See also:

CFN:  Banks and their Energy Loans and Losses, 2013
CFN:  JPMorgan's Regulatory Rant, 2012
CFN: Credit Suisse Makes a Big Move, 2015

Monday, March 28, 2016

Best Work Places: Financial Institutions?

Why aren't financial institutions on this list in greater numbers?
Fortune magazine just published another list.  Lists sell print copies.  They attract views and readers online.  Starting with the Fortune 500, Fortune's lists--from top global companies to its power and diversity lists--get the attention its editors crave.  Lists spur dialogue and discussion. They at least encourage the larger population to talk about the subject, even if many disagree lists are subjective.

Lists can be disconcerting and controversial, especially the criteria on which most lists are made.  Criteria are often too subjective and permit list-makers to exploit statistics, data, numbers and surveys in the way they might want lists to appear.  Fortune's 500 list, it happens, might be one of the least-subjective lists around.  They are based on public company's disclosed, audited sales totals.

(BusinessWeek's and USNews' lists of top business schools are subjective and can change significantly by tweaking one variable among many in a list of criteria. Such lists can be helpful, but should viewed with caution. Should business-publication editors get to decide what business school is "better" than another one?)

Fortune's latest list is its list for the best companies to work for.  Remember, this is not a "500" list. Companies appear based on a set of subjective criteria, surveys, interviews, and evidence of perks, special benefits, and hear-say.

The net worth, market values or profitability of companies is not a primary factor, although some of the "best companies" on this list attract top talent because they have proven results and strong financial performance.  Vice versa, strong companies are able to invest in perks and benefits to attract top talent and keep the talent for years because of such benefits.

The usual names appear at the top of this year's list:  Google/Alphabet, Salesforce, KPMG, EY, Pricewaterhouse, IKEA, Whole Foods, and Deloitte. Even GoDaddy, Mars (Candy), and the Cheesecake Factory made the list. (Many, in fact, are Consortium sponsors.)

But what about financial institutions:  banks, broker/dealers, asset managers, insurance companies, hedge funds, mutual-funds companies, securities exchanges, etc.?  Do they appear on the list? If not, why? And how has this trend changed in recent years?

First, let's check Fortune's criteria, at least the way the publication organized and presented the criteria in 2016. Remember, this isn't a list that measures size, bottom-line metrics or a company's ability to generate tens of billions in sales, although many on the list are big and generate returns that keep investors smug and satisfied.

Happy, talented employees contribute to strong performance, no doubt. And employees are generally happy when companies eagerly provide perks, nurture sane work environments, and maintain common sense about employees' own lifestyles and family constraints. Fortune's criteria revolve around just that:  benefits, rewards, and attractions that help retain employees for the long term.  They include childcare, sabbatical privileges, flexible workdays, healthcare, and exercise gyms.

What financial institutions appeared on the list?  Some names are familiar. American Express, for example, no matter recent performance issues it has had to deal with, is still a favorite place for employees--thanks, still, to the leadership of its CEO Kenneth Chenault.

A few are scattered on the list--some insurance companies (Nationwide, e.g.) and a handful of banks and regional broker/dealers (CapitalOne, Edward Jones, American Express, Robert Baird, e.g.). Goldman Sachs doesn't  make the top 50.  Major banks or institutions such as Citi, Blackstone, JPMorgan Chase, and Morgan Stanley aren't listed at all.

Why don't financial institutions appear on these lists in large numbers?

There might be some an assortment of reasons.  Large size and unwieldy organization structures might be factors.  The volatile, unpredictable nature of financial markets could be a contributing factor, too.  That many financial institutions are the results of a series of clunky mergers shouldn't be minimized.  But let's try to tackle a few common reasons:

1)  Regulatory requirements and related priorities. 

Financial institutions are deeply immersed in a complex web of financial regulation.  Compliance is difficult, laborious, expensive, and critical.  As much as they are attentive to financial performance (shareholder returns, revenue growth and cost-cutting), they are wading through thousands of pages of new regulation and playing catch-up even when they catch up.  (Bank regulation continues to evolve and expand each year since the crisis.)

Meeting capital, shedding trading desks, reducing leverage, and passing stress tests with top grades become priorities. Gifting employees with free perks and caring about work-life balance issues get thrust into the back seat.

2)  Still haunted by the financial crisis.

The financial crisis has receded into financial history, but financial institutions today take business steps and adopt strategy with one foot pointed ahead and the other anchored down by debilitating risks that caused a near collapse in the financial system.

Banks, hedge funds and broker/dealers are not necessarily risk-adverse at all hours of the clock. But they operate in anxiety, pushing buttons to ensure they don't slip back into a setting where all markets are slamming their balance sheets, capital bases and earnings reports. Nor do they want to make an errant, rash decision that might result in hundreds of millions in litigation years from now.

3)  Less able to attract the best talent.

In recent years with a surge in interest in technology, entrepreneurship, and new business models, financial institutions may no longer be the most desirable destination for undergraduates and for those with professional degrees (JD, MBA, e.g.).

Banks know that and have worked hard to redefine the experiences and growth paths in their institutions. Some are "creating" interesting roles to attract not only those who adore capital markets and investment management, but those interested in computer science, engineering, and international relations.

It's a tough sell. Some interested in financial services may turn first to opportunities in "fin-tech," or financial-technology start-ups and related new ventures.

4)  Fewer benefits, perks and special attractions.

Financial institutions are bogged down with capital requirements that increase every year (as rules are amended to ensure they can stand down the next crisis).  They are steadfastly focused on containing or cutting costs to reach profitability objectives.  The best way to achieve an ROE that pleases shareholders, when revenue growth is limited, is to wage aggressive cost-cutting campaigns, the kinds of campaigns that cut into the core of a business operation. If abolishing tuition reimbursements for employees helps cut costs, then so it goes.

Large banks have cut their costs or managed them well in recent years.  The expense numbers prove it, and the profit margins in recent years show it. (Just this month, Credit Suisse announced bold efforts to cut cuts even more.)  But what gives and what goes away?  Employee benefits, employee perks, long-term or contractual compensation, and many of the factors that might help put banks on best-work-place lists.

5)  An industry still in flux.

The industry of financial services is evolving quickly.  Regulators are concerned about institutions being "too big to fail" and have imposed restrictions on activities like proprietary trading and on balance-sheet leverage.  Smaller start-up companies, not yet constrained by regulation, have begun to tread on bank territory to provide payments and lending services. Securities exchanges have sprouted all over the place electronically.

What financial institutions from banks and broker/dealers to exchanges and futures dealers could do years ago might be prohibited or limited today.  What they could do years ago might make little economic sense today. How they do things (processing securities and making payments, e.g.) is changing rapidly.

Uncertainty in some industries can present opportunities.  Uncertainty in financial services presents opportunities, as well, but can also discourage talent, if the talent is unsure what the role of large financial institutions in 10 years will be.

6)  Fluctuating, unpredictable patterns in compensation.

Compared to many industries, financial services continues to pay well, especially in areas like investment banking, investment management, research, private equity, and hedge funds (when they are doing well).  The old guard might complain that the era of star bankers and stratospheric, guaranteed compensation is over, but head-shaking compensation packages still exist.

Sometimes, however, compensation--no matter how lucrative--varies significantly from year to year and is too often be based on subjective criteria. The best employee is not always assured of being paid fairly or commensurately.

7)  Working under a constant threat of lay-offs, reductions, and firings.

Within the industry, there have been precedent and patterns since the financial crisis.  Financial professionals no longer join the industry confident they can spend 20 years or more doing well on the job and be handsomely rewarded and aptly promoted. The days of such comfort are gone.

Companies, banks and firms in financial services nowadays make critical decisions on businesses, geographies, products, balance sheets, and profitability. Unfortunately people are affected. That has led to a work environment, unlike decades before, where employees say they work under a cloud that "this day could be the last."

Staff reductions and dismissals exist in all industries.  Yet the aura of "the last day" and ongoing efforts by employees to look for omens (little signs that lay-off-related announcements are looming) persist often in financial services, because of what has occurred regularly in the past decade.

8)  Lack of attention to professional and management development.

The industry does an outstanding job in providing experience and expertise to junior staff about products, markets, clients, services, and systems.

The industry focuses first on "closing the deal," "booking the best trade" or "providing the most lucrative advice" and ensuring that everybody involved is equipped with market information, data, or financial models.

The industry, however, falls short in helping develop new professionals to become shrewd, compassionate managers of businesses, sectors, and people. And much of that is due to fierce, ironclad attention toward the market place and to regulatory compliance, while professional development is overlooked as a priority.

9) The hours.

Stories about "the hours" working in a financial institution are legendary:  the so-called 100-hour work weeks, the sudden demands from higher ups to cancel weekend plans, the Sunday-afternoon conference calls, beach vacations spent in front of a laptop, etc.

Long hours exist in other industries, too. Management consultants, computer programmers, and entrepreneurs work similar hours and have the same level of demands. Those who work for banks, hedge funds, and private-equity boutiques don't complain as much about the long hours as much as they screech about the lack of control over the hours they work.  Few who choose the industry mind the deals, transactions, trading, and research they do.  Many enjoy the thrill of the deal, trade, client closing or investment find. Yet many will say the uncertainties and sometimes the whims of supervisors or clients are too hard to tolerate.

Let's not lampoon the industry without highlighting its attractions and explaining why, despite all, thousands of graduates swarm toward Wall Street or its regional equivalents every year.

Why would or should a financial institution appear on the list?

1) Technical innovation and changes in the industry.

For good or bad and despite demands and clamors from regulatory authorities, the industry is in the midst of constant change.  Technology helps drive that. Entrepreneurs and a new-venture spirit contribute.  The impact of technology over the past 15 years has been extraordinary. The way securities are traded and cleared is swift, efficient and less cumbersome (although some say more improvements are necessary).  They way payments (institutional and retail) are made are similarly swift and smooth. Loans (including small-business and student-related credit) have hopped this electronic, swift-approval bandwagon.

Such constant innovation, much of which has helped to spur growth and cost-efficiencies and much of which has sparked the formation of new companies or partnerships with big institutions, can attract talent into the industry.  The computer expert who might have fled to Silicon Valley to join an interesting new venture might choose to accept Goldman Sachs' offer to build a trading model that might reduce the market risks of billions of dollars of derivatives.

2)  Capital resources: breadth and size

Critics from all over argue loudly financial institutions (banks and insurance companies) should not get too big. With their lists of who's too big and who's not, regulators worry, as well. Substantial size leads to significant systemic risks and "contagion" within the system. We've heard these argument lines regularly since the crisis, and many offer valid points, while regulators obsess in what else they can do.

Capital resources and size, however, typically mean big institutions can take on big, bold projects and make big investments that can have important impact.  Big institutions can also preside over big transactions and deals (loans, underwritings, trades, etc.) or operate across the globe if they choose to do so.

The ability to capitalize on size, scale and resources can be attractions to those who like to work on headline transactions, big deals, or financings that have widespread impact.  Size and resources in the industry make it easier to get things done in capital markets or with clients with operations around the world. The MBA finance graduate, newly arrived from Dartmouth-Tuck, can work on a $5 billion equity offering on the first day on the job or help arrange the merger of two large pharmaceutical companies the next week.

3)  International presence.

Large financial institutions have a global footprint. They operate just about in every major locale, where there exist vibrant capital markets or bustling business activity, where there exists a groomed financial system.  This often means banks, insurance companies, and asset managers will station themselves in New York, Chicago, San Francisco, London, Paris, Brazil, Tokyo, and Singapore at the blink of an eye.

Opportunities to work around the world amidst different culture and environments or having an impact on emerging markets are attractions to talented, diverse employees.

4)  Compensation benchmarks

Even if it is volatile and unpredictable and even if it comes with fewer other perks and special privileges, compensation within the industry is still more than satisfactory. In certain institutions or financial-sector niches, opportunities to increase rewards (via stock and incentive plans or investments) continue to be favorable industry attributes.

5)  And, yes, the thrill of financial and capital markets

In the end, the industry will always be attractive to those who understand the significant, varied contributions of financial companies (as traders, as intermediaries, as market-makers, as advisers, as researchers, as asset managers, and as innovators of new financial instruments).

Financial markets can be a thrill to follow, to dissect, to analyze and explain. Financial instruments offer vast amounts of funds sources that spur investments in new products, industries and regions.

And those who are enamored will be willing to step in to do the analysis, do the trade, do the investment, do the research, nurture the client, help the customer, and close the transaction.

Tracy Williams

See also:
CFN:  Summertime, Summer Internships, 2010
CFN:  Work-life Balance:  The Discussions Continue, 2014
CFN:  Delicate Balance:  Long Hours and Personal Lives, 2010
CFN:  Finance:  Still a Popular Destination? 2014
CFN:  Is I-Banking Still Hot? 2011CFN:  Diversity:  Black Enterprise's Top 40, 2009
CFN:  Diversity Top 50, 2012
CFN:  Fortune's Best Places, 2013
CFN:  Affinity Groups in the Work Place, 2011

Sunday, March 20, 2016

Banks: Energy Losses Now, Not Later

Some big banks have decided to take their expected losses in energy loans now

In recent weeks, oil prices have inched upward, and seldom have markets and investors felt good about that.

After the precipitous, steady slip in prices over the past year, the oil-and-gas industry drooped toward turmoil, and banks braced themselves at the start of 2016 for a rough year of loan losses from lending to hundreds of companies that have ties in some way to slumping prices of oil.

Once prices dipped below $30/barrel and companies started to disclose sour results and whined that losses could continue through the year and perhaps into the next, bank shareholders and analysts began to react. They tapped their calculators and ran their computer models to determine how many billions banks will lose in the next few years.

Many dumped bank shares and pushed prices downward. JPMorgan Chase share prices in the mid-60's had slid suddenly into the mid-50's, at least until the market could learn the gory details about what's vulnerable in their portfolios of energy loans.  Pessimistic equity markets in the midst of a wild, volatile first quarter could easily have inferred that billions in bank loan losses will be sufficient to trigger the next Great Recession. 

In the past month, banks, likely with some urging from regulators, jumped ahead of the guessing games and decided to compute their expected losses. 

(For banks, "expected losses" are a function of probabilities of default, which in the industry certainly rise when prices are declining. They are also a function of recovery rates after default.  Factors such as collateral, third-party support, guarantees, loan tenor and loan seniority increase the likelihood of recovery.)

With Wells Fargo and JPMorgan taking the lead, big banks have decided to

(a) report details of the total amount of loans they have in the energy sector,

(b) act conservatively and reserve for possible losses at amounts far more than they actually expect to lose and

(c) remind market watchers of the huge capital bases they now maintain (thanks, in part, to new regulation) to act as a comfortable cushion against actual losses in the years to come.

They counted up their energy-related exposures, including those to companies that supply the industry and build its equipment and even including amounts that have not yet been borrowed under committed revolving-credit arrangements.  They tallied the amounts that have collateral.  And they declared they are taking the bulk of expected losses now. 

JPMorgan increased energy-related loan losses by $500 million; Wells Fargo took  provisions of $1 billion.  (The biggest banks are reporting total exposures in the tens of billions, not the hundreds of billions.)

They helped prove such conservative gestures won't damage the viability of big banks with capital bases that exceed $150 billion (as both JPMorgan and Wells Fargo possess).  Energy-industry exposures still comprise less than 10% of all loan exposures. The expected losses are still less than 10% of total bank equity capital.

Regulators, for sure, likely applauded these moves or might have coerced banks to do the same if they banks had sat still. Post-crisis regulators are intimately involved and influencing behavior.  They frightened many big banks last year with their exhaustive, comprehensive stress tests and weren't reluctant to report who passed, who failed, and who received an incomplete assessment. This year, regulators could choose to crunch numbers and come back to report which banks they believe couldn't pass a new stress test tied to a prolonged slump in oil prices.

The loan-loss gestures of JPMorgan and Wells Fargo, however, are isolated and don't necessarily account for what has haunted banks to no end in the past decade:  correlation.  What happens in one loan sector (in one industry) might cause horrors in other sectors.  Problems in the oil industry might lead to problems in other industries--equipment manufacturing, transportation, or even consumer products in the long term. (To its credit, in its compilation of oil-industry exposures, Wells Fargo even reports consumer loans to employees in the industry.)

The exercise is far from over. Banks will continue to watch and worry about oil-and-gas exposures and review portfolios almost daily. Many will have already initiated steps to reduce risks in other ways: 

a) hedging by purchasing credit-default swaps (before they become too expensive),

b) arranging to reduce loan outstandings while they can,

c) cancelling lines of credit where they can legally, selling loans to other institutions that have the risk appetite or like the loan returns (given the high risks), 

d) requesting more collateral,

e) renegotiating terms, and

f) postponing new business at least until oil prices to trickle back up to a certain level.

Some are revamping energy-banking units to focus, as well, on other energy projects and related companies--sustainable and green energy, wind and solar projects, natural gas, etc.

The most experienced bankers understand how the oil industry is intermittently volatile and how booms, busts and oil cycles occur with near certainty. 

Tracy Williams

See also:

CFN: The Collapse of Oil Prices: Painful for Banks? 2016
CFN:  Banks' ROE's:  Stuck at 10%?
CFN: When Does a Bank Have Enough Capital? 2015
CFN: Credit Suissie's Big Move, 2015

Wednesday, February 10, 2016

Who Calls the Shots in Silicon Valley?

Of all the board members of the top 150 Silicon Valley public companies, 87% are male.
Silicon Valley, some will argue, has grabbed the heart of American commerce.  It's the unabashed global seat of technical innovation and creativity. Other regions in the country and around the world wish they could replicate at least a small portion of its entrepreneurial successes and its contributions to value in global markets and consumer satisfaction.

It's the home base of companies like Facebook, Apple, HP, Oracle, Alphabet/Google, Intel, Dropbox, Salesforce and eBay.  It's where the next new things are dreamed, groomed and designed.

But the Valley has fallen flat on its face when it comes to diversity.  And to its credit, it knows it.

The statistics tell the story, and so do casual glimpses of its board rooms, its venture financiers, and its popular tech-crunch conferences, where technology good-'ol-boys hang out, trade industry stories, and promote glistening new products.

Lonergan Partners, an executive-search and talent firm based in the Bay Area, recently presented its findings from a research project to determine who's who in Silicon Valley and who runs all the shows that make Silicon Valley soar. It focused on board membership at major Silicon Valley companies, what it calls the "Silicon Valley 150." With help from nearby Stanford Business School, it compiled statistics, summarized its findings, and made careful attempts to draw conclusions.

Its findings reaffirmed what most already suspected, what most had already observed.

The SV150, a moniker to rival the S&P 500 or Fortune 500, includes the top 150 publicly traded companies headquartered in Silicon Valley. It includes many companies with familiar names that went public within the past decade (Facebook, Twitter, LinkedIn, e.g.). It includes, also, companies that helped give birth to the region as a technology center of the universe (HP, e.g.).

It includes companies in assorted industries: IT, Internet, semiconductor, biotechnology, clean technology and consumer products.

It doesn't include recent start-ups and the dozens of companies classified as "unicorns," private companies that have been valued at $1 billion or more, but haven't yet decided to leap across the private-public divide into IPO land.

Apparently it would have included the best-known unicorns (Uber and AirBnB come to mind), if it could.  But for survey and research purposes, Lonergan wanted reliable, updated data, information that can more easily be obtained from public companies or at least from their annual reports and public filings (information public companies can't hide or camouflage).

It also doesn't include much of the finance sector, the venture capitalists who surround the industry prominently with promises of rounds of funding and who set the agenda for which companies will have the best chances to thrust themselves toward billion-dollar market valuations.

Nonetheless, the reliable results from a data pool of 150 public companies are informative and meaningful.  By examining the make-up and membership of the boards of directors of these companies, it could determine, based on data and not hearsay or hunches,

a) Who are the people who run the big Silicon Valley companies?

b) Who are the people who have influence at many companies in an industry?

c) What are the backgrounds, experiences and education of people who run these companies?

d) Are women represented in board rooms and in senior-management positions in meaningful numbers?

e) Are there board members in significant numbers from under-represented minority groups?

What did it find? And did it recommend solutions and next steps for an industry that sells products and services to the masses around the globes, but for which its core of leaders tend to be a cozy neighborhood of well-connected men?

Men run the show, for certain--as founders, as visionaries who get their projects funded, as private investors, as senior engineers and designers, as founder-CEO's, and as board members.

The SV150 tally shows an astounding number of male board members.  That's not shocking; the numbers reinforce what we already knew.

Of the 1,156 board members of the top 150 companies, 87% (as of August, 2015) are male, who at an average age of 59 are not as young as fables suggest and who tend to have had established business and board experience (about 7 years of board involvement). Board chairs are 97% male.

Not surprisingly, board memberships are interlocking, where members are typically selected from those already established within the network.  About 20% of the board members serve on other SV150 boards.

Over a quarter of the boards (42 or 28%) have no women.  How much does Silicon Valley trail all other top global companies? The Valley's 13% women board composition lags the S&P 500 (19%).

Well, what about new, young companies, more recently founded and perhaps more likely to be conscientious and progressive about board representation.  Lonergan research shows for companies that have gone public within the past five years, only 12% of board composition are women. Hardly any different from older, established companies.

The results aren't too sour. Some companies deserve applause.  Google, Symantec, Netflix and Cisco are among the nine companies with at least three women board members. The number of women CEO's is now up to eight.

Researchers tried to compile trends and numbers for minorities. They acknowledged challenges because they couldn't determine with certainty who fell into which groups, because they were not relying on (and likely couldn't rely) on companies self-reporting information by race and ethnicity.

As best as possible, they were able to conclude that among total employees, minorities (blacks, Latinos, and Asians) account for about 35% of the total.  Among board members, minorities comprised only 5%, most of whom were Asians (South and Pacific Asians).

The lists of reasons why the numbers are abysmal in 2016 are long and have been analyzed relentlessly. Solutions aren't always implemented well or aren't prioritized. Technology companies, especially those struggling to remain solvent or respond to pressing demands from venture investors, dance around or neglect the topic. Often they just aren't motivated to ensure leadership is as diverse as the users of their products.

The usual "excuses" include a scarcity of women and minorities in the "pipeline" for leadership roles and the low numbers of women and non-Asian minorities interested in or pursuing engineering. The real reasons are often tied to a lack of urgency or emphasis on the issues and tied to the tendency for busy people to appoint whom they know or hang around with or hire those with degrees or experiences they share.

Hewlitt-Packard is one company deserving a pat on the back, even if financial analysts have criticized the company's financial performance almost non-stop the past decade. In the midst of making a strategic decision to split up a company whose founders are often called pioneers of the Valley, HP announced the two new companies would have a set number of women and minority directors.  And it came through.

That it already had a woman CEO (Meg Whitman) might have been why it took bold, immediate steps.  The company now exists as two independent public companies (HP and HPE), but their boards now include at least three African-American women:  Pam Carter, a former Cummins executive, Stacey Mobley of DuPont, and Stacy Brown-Philpot, the COO of TaskRabbit.

In a club whose members can likely be counted on one hand (and maybe half of another), black board members among the 150 include James Bell at Apple and Robin Washington and Colin Powell at Salesforce.  Hector Garcia-Molina at Oracle is the only confirmed Mexican-born board member in a state where Latinos are at least 38% of the population (20% of the Bay Area).

Take a look at Facebook, whose hundreds of millions of daily users include huge numbers of women, blacks, Latinos and Asians.  Its board is small (only eight members).  Its membership includes, besides CEO Mark Zuckerman and COO Sheryl Sandberg, a predictable small club of Silicon Valley legends, (Marc Andreesen, Reed Hastings, and Peter Thiel).

If one reason for the lack of women and under-represented minorities in senior roles or positions in Silicon Valley is the tendency to appoint those who share the same degrees and schools, statistics prove it.  Over 20% of SV150 board members have a degree of some kind from Stanford.

There is indeed a core of favorite schools from which companies hire to populate the pipelines that eventually lead to appointments as senior managers and board members.  The Lonergan research showed that most board members and company senior managers (CEO's, CFO's, COO's) were graduates of just a handful of top schools:  Stanford, Harvard, Princeton, Berkeley, Yale and Michigan (undergraduate) and Stanford, Harvard, Berkeley, Penn, UCLA, Carnegie Mellon, and Cornell (graduate, including MBA's and including degrees from Consortium schools).

(Consortium business schools in California include USC-Marshall, UC-Berkeley-Haas, and UCLA-Anderson.)

Over 50% of the 150 women board members have an MBA, most from the list of top, favored schools.

The Valley has a long way to go. A long, long way.

Statistical research helps because it shows trends (and progress, where it might exist) and confirms notions we already have had.

However laudable such findings and research may be, they don't offer solutions or a game plan that would force board leaders and senior managers (including the clubs of founders, visionaries, and highly networked, well-contacted people that decide what's next in the Valley) to act now instead of "when the time is right."

Tracy Williams

See also:

CFN:  Venture Capital and the Pao Lawsuit, 2015
CFN:  Harvard Business School and Gender Diversity, 2013
CFN:  Horowitz and His Latest Venture, 2014
CFN:  Venture Capital Diversity Update, 2011
CFN:  Sally Krawchek's Pivot Move, 2014
CFN:  Muriel Siebert, Wall Street Pioneer, 2013
CFN:  Knocking Down Doors in Venture Capital, 2012

Monday, February 1, 2016

Collapsing Oil Prices: Painful for Banks?

Will the steep drop in oil prices haunt banks and their loan portfolios?
Last August, we endured the pain of wild swings in equity markets.  At that time, we blamed it on China, its boiled-over economy and its government's desperation to find quick solutions via currency manipulation and temporary shut-downs in the market.

In early 2016, we are enduring pain again, but from a different source:  the continuing collapse of oil prices.  How can this be?

Economists in years past have tried to show that slight, steady declines in oil prices can prompt slight, steady boosts in GNP.  A decline in the price of oil barrels is supposed to be kind-hearted to consumers, airlines, manufacturers, and auto-makers. A decline in the price of fuel and energy should bring joy to consumers and manufacturers, helping to boost confidence in capital markets and encourage consumers to get out and about and companies to invest and grow.

This time, however, markets are in disarray. The decline in prices is producing a far different effect, an impact that has sent shudders among stock investors before the new year can even get off its feet.  The woes of depressed oil prices have caused problems (and declining revenues and losses to be reported in the periods to come) for countless participants in the energy sector--from exploration companies and drillers to oil traders and powerful, big-name companies. (We'll see for sure in the weeks to come as big oil companies, announcing 2015 earnings, report substantial earnings declines.)

How steeply have prices declined?

Just two years ago, oil prices hovered about $100/barrel. This month, they slipped below $27/barrel. And yet world supply continues to increase in ways that puzzle many market watchers, which suggests the likelihood that prices will continue to fall.

Market analysts are examining the phenomenon in countless ways--global and regional supply, global and regional demand, U.S. energy policy and strategy, the impact of natural gas, the impact of fracking,  Middle Eastern politics and geographic tension, OPEC's intentions, OPEC's bluffs, and now Iran gaining the privilege of entering the world market.

In finance, what impact will depressed prices have on financial institutions--the banks that provide funding for exploration and drilling, the hedge funds that trade energy stocks and derivatives, the dealers that trade the bonds of energy companies, and the fund companies that bundle energy stocks into ETF's?

Inevitably it won't necessarily be positive. Negative impact at financial institutions implies loan losses, trading losses, and balance sheets bulging with concentrated, unhedged risks.

Banks do significant business with companies in this industry sector. They lend money, arrange financing, syndicate loans, provide advice and underwrite stocks and bonds for big oil companies like Exxon and Chevron and for companies involved in exploration, drilling, refining, and distribution. They also make markets in bonds, securities, and commercial paper issued by companies in the sector.

Until Dodd-Frank came along and until Volcker Rules became a reality, some banks dared to leap into the industry to become not arrangers or financiers, but "players," institutions that made markets in commodities like oil (and other energy components) and traded for their own accounts, speculating like hedge funds and buying and owning refineries.

New regulation has either prohibited banks from continuing down these paths or discouraged them by imposing onerous capital requirements.

Banks and other financial institutions continue to do significant business with the sector.  Take JPMorgan Chase, for example. In a corporate loan portfolio that totaled about $204 billion in Dec., 2014, about 9% is extended to oil and gas companies, companies now confronting a market where the price of one of the primary products they sell has declined 75% over the past 18 months, contributing to devastating impact on revenues and earnings.

At the end of 2014, JPMorgan's total credit exposure to the industry was reported at $19.2 billion, a total that includes loans outstanding, loan commitments, letters of credit, and derivatives activity. No doubt risk managers at the bank, along with the regulators camped within, have huddled to devise a risk strategy to address the risk of losses from doing business with this sector.  That likely means having to decide the right amount in loan reductions, loan sales, hedges, and loan-loss provisions in earnings. And it will possibly mean prohibiting overall loan growth for now.

In fact, when the bank announced its record-breaking 2015 earnings (over $24 billion), it cautioned investors that it had already begun to account for loan losses to energy companies. (It increased loan-loss provisions to its oil-and-gas sector in the fourth quarter.) And perhaps more will come.

Overall, the unfavorable aspects of depressed oil prices on banks can fall in the following categories:

1.  Loan portfolios

Banks with significant concentration of loan and credit risks to the sector are likely addressing concentration risks right now and getting set to identify non-performing loans and reserves for potential losses and allocate more capital for unexpected losses.  Bankers are also deciding how best to hedge (which credit-default swaps to purchase) and are sitting through many "portfolio reviews" to determine where else they might be most vulnerable.

Regulators, this time around, are hovering in the background to ensure banks are calculating expected and unexpected losses and allocating more capital for sector risks.

2.  Client relationships

Banks have significant client relationships with big energy companies.  Many relationships date back decades (even during the times of other energy-industry crises).  Some banks have files and cases of lessons learned that go back to industry troubles in the early 1970's and the early 1980's.  Bad loans during those periods led to the outright demise of big-name banks (Remember Continental Illinois?).

Long-term relationships must be managed tenderly, carefully. Client CFO's and senior managers, for some reason, tend not to forget how their banks treated them when they endured difficult periods. The same client for which the bank knocked down lobby doors to win a lead-underwriting role may now be one for which the bank must decide whether to reduce loan outstandings or demand more collateral and to postpone a debt offering.

3.  Corporate-bond yields

Banks and funds make markets and trade in corporate bonds, including those issued by energy companies.  All of a sudden, because risks loom indefinitely, bond yields are rising to account for the increased possibility of default by oil and gas companies.  A bond trading in the 90's and rated single-A by a major rating agency could suddenly trade in the 80's after a ratings downgrade to BB-.

If the bonds are already in a trading portfolio, higher yields imply bond-trading losses, unless the banks have hedged against these potential losses already.

4.  Energy-related derivatives, credit-default swaps

This includes many kinds of financial instruments:  oil futures, oil forwards, other energy-related futures and forwards, related derivatives traded and settled on exchanges and markets around the globe, often on behalf of energy-related companies or other speculators and hedgers.

This might include, too, credit-default-swap contracts and indices related to participants in the industry, for which hedgers and speculators may want to protect themselves against the possibility of a default by a company (or companies) in the sector or want to speculate that a company is about go beyond a cliff's edge.

Banks have limited roles in dealing and trading nowadays, but they are still smack in the middle of activity, standing in between trades, arranging each side, making markets for client-investors, clearing trades, and more. In these times, they'll want to ensure they are not handling trades for counter-parties that are over-exposed to the industry or simply don't know what they are doing in this sector.

5.  Commodity prices

There are oil prices and related volatility. There are also prices for other energy products that might have some correlation with or that might be influenced by oil-price fluctuation:  natural gas, ethanol, coal, and electricity, e.g.

Banks, traders and hedge funds are likely examining the impact of oil-price declines on these and other commodities, too, as they examine their trading portfolios, as well as the clients and counter-parties that have significant exposure to the other commodities.

6.  Clients that do business with energy companies

One sector overlooked in examining current risks is that which includes the companies that may not be energy-related, except they sell products (tools, real estate, drilling equipment, raw materials, etc.) to oil and gas companies.  These companies could be vulnerable, too.  And banks and financial institutions that do business with them will incur more risk, as well, if oil-related companies can't buy supplies in similar numbers from them anymore.

Hence, as they conduct their reviews of risks and vulnerability, banks will try to identify borrowers that fall in this group.

As we go through this unique, different type of "crisis" (a mini-crisis, we hope), hedge funds, because they aren't regulated, will take their lumps (as they have been doing so the past year or two). Equity investors in the sector will have a rocky road for a while.

As for banks?  Regulators, meanwhile, will intrude and are hopeful the strenuous capital requirements and risk-management rules they've imposed since the days Lehman collapsed will protect banks if large numbers of energy-related borrowers default, disappear, or collapse.

The new year is not yet 60 days old, but already financial institutions have a big risk item to manage in ways regulators hope they will do so with prudence, without much ado, and with no risk of banks failing.

Tracy Williams