Tuesday, August 19, 2014

Financial Modeling: Yet More Tools

A clearinghouse of financial models
Visualize how analysts, bankers and researchers performed financial analysis decades ago, especially if they set out to analyze a company, assess whether a company can pay down debt obligations or determine the equity value of a company.

Analysis involves financial statements, financial ratios, projections of income statements, cash flows and balance sheets, and a presentation of various business scenarios. It also involves an assessment of the financial condition of the company and often a careful determination of its value.  Decades ago analysts and bankers used pencil, erasers and paper spreadsheets to do these exercises, aided by slow calculators and rock-hard patience to complete these tasks over 1-2 days.

Today, analysts, whether they know it or now, are gifted with technology tools to perform the same tasks in just a few hours. In days of yore, financial analysts endured tedium to ensure that numbers were transferred from detailed financial reports to paper spreadsheets accurately. Balancing balance sheets was a monumental task. Because these tasks were physical and time-consuming, there were limits in what analysis could do--limits in the way company performance could be projected, limits in how many scenarios could be presented and evaluated, or limits in what growth rates or interest rates to use in assessing a company's value or creditworthiness.

Today, these exercises are conducted using elaborate, precise, sometimes complex financial models, all performed swiftly with computing assistance. Researchers and analysts no longer "do spreadsheets," as much as they tweak them, adjust them, or churn them through countless scenarios. What an irony. With vast amounts of computer power and with innumerable financial models available to perform almost any kind of financial evaluation of a company, financial analysts and associates at banks, hedge funds and private-equity firms continue to labor inhumane hours each week (and weekend) doing the work that those in a long-ago generation performed via labor and hand muscle.

Many will say in current times, the stakes are higher; banking deals are done at much larger amounts (some in the billions). Competition is fiercer, tougher.  And business demands to get the deal done right, with precision and no tolerance for failure, become primary factors that keep junior associates toiling in bank cubicles until the wee hours. Clients want answers and updates right now.  Trading and investment decisions must be made on the spot. 

Yet with all the computing power and available financial models, today's analysts are blessed with boundless resources.  Financial information is available everywhere online--sometimes free and accessible, other times purchased from special-services companies.  Analysts, traders and researchers don't need to pore through dated paper 10-K reports or hard-copy financial statements.  The tools that exist to streamline the analytical process are bountiful.

And now along come financial-services companies like Thinknum, which permit analysts to share their financial models online, accessible to anyone among the public looking for assistance, guidance or insight when it's time to analyze the financial condition of a company or assess its value. Thinknum was formed last year by banking and hedge-fund analysts, recent Princeton graduates, who thought the industry and broader marketplace could benefit from a financial-modeling clearinghouse that lets analysts pull from a virtual shelf any model or equity or debt analysis  for whatever need that suits them.

Founders Justin Zhen and Gregory Ugwi told the CFA Institute that the new company's services are "radically open." They pattern the company after GitHub, a computer-software company that allows programmers to share their coding with the public, a collaboration that helps improve software and makes it available to anyone who needs it.  Same idea for those who need and use financial models.

Thinknum acknowledges most equity research analysts present their work publicly, including the thousands of assessments of just about all publicly traded companies.  However, they present their conclusions. They don't necessarily share their detailed models. Thinknum wants to display the analysis behind the conclusions and wants to help others build their own models based on the work of others.

Take Apple, Inc., the computer giant. If an analyst seeks to determine its intrinsic corporate value, based on a projection of earnings and cash flows, she can start from scratch and develop her own financial model and incorporate projections, scenarios, and assumptions. Or she could decide to examine the work and models of others, study them, and tweak and revise them for her purpose. She may disagree with others' assumptions of growth or may decide that a rise in interest rates may have little impact on the company's fortunes.  Thinknum would permit the analyst to dial up and review others models (and projections and calculations of value) before immersing herself into the exercise.

Yes, she could copy their models and present them without adjustment or change, but those who share their work are aware their analyses might be used for any purpose. Or she could study them to gain insight--to find something new or to unearth a factor or variable she may have previously neglected. On Thinknum's site, with Apple, she can see the company valuation performed by a handful of analysts around the country, including one from a prominent business-school professor. She can explore the assumptions they used, the long-term business conditions they describe, and their attempts to project earnings and cash flow out several years.

Thinknum's founders say the forum, the sharing of models and model ideas, should reduce the labor of analysis, help analysts focus more deeply on valuation concepts, debt structures, business scenarios and management--less time on figuring out why balance-sheet items don't reconcile.

In certain industries, financial analysts already have access to private services that provide financial information, financial ratios, and ready-made spreads. But they come at a cost and typically an expensive contractual subscription. Other services, including, for example Google-finance, provide financial information and ratios, but stop far short of doing analysis or making an evaluation. Thinknum's services, meanwhile, are available as easily as it is to type " Apple" into a search box.

Will such services take off? Will they contribute to vast improvements in the work-life balance among young bankers? Not so fast, the big banks and hedge funds will say. They will argue they have privileged access to and use significant amounts of confidential information from client companies. That information, used as inputs in models and used to enhance them and make them more detailed, could never be offered to an at-large public forum. They will also argue that many models they use are proprietary and are specially designed in a way to give them an analytical edge above competitors. When Bank of America advises a client that a target company is worth X, the bank and the client will not want to convey to public markets how it derived the value X--at least not until it's necessary.

But give Thinknum the credit it's due, especially in its efforts to expose the details of how banks might determine whether a company can pay down millions in debt or how banks determine at what price a client should sell new stock or why a hedge fund might have discovered intrinsic value in an unpopular stock. There are much art, magic, intuition and mystique to deal-doing or trading, but much of it starts with a methodical, more scientific process, the process of assembling the financial numbers and getting them to tell us something about the future (future worth or value, or future ability to generate cash to meet obligations).

In some sense, banking will still be banking. The hours will still be long. Decades ago, because they were strapped with pencil and paper, bankers and analysts were satisfied with one or two business scenarios (based on growth rates, interest rates, or leverage ratios). In these times, because there is technology, two scenarios won't suffice, when a dozen or more can be performed and presented with the click of a button.

Tracy Williams

See also:

CFN:  Mastering Technical Skills, 2010
CFN:  Apple, With All That Cash, 2013
CFN:  Verizon, Big Numbers, Big Debt, 2013
CFN:  Who's Betting on Blackberry, 2013
CFN:  New Financial Technology, 2014
CFN:  The Most Popular MBA Professors, 2011

Monday, July 14, 2014

Wells Fargo: Sticking to What It Does Best

Wells Fargo:  A well-deserved Double-A rating
Give some deserving credit to the bank Wells Fargo.  It's one of the largest, most important financial institutions in the world and certainly one of the most recognizable banks anywhere in the U.S., thanks to a widespread branch network that puts a Wells Fargo office on just about every other corner in most regions of this country. 

Among regulators, the bank is deemed, like other big institutions wielding similar financial impact, a "systemically important financial institution," (or "SIFI," as they are called).  (Accompanying that tag are extra attention, potentially more capital requirements, and a requirement to pass occasional stress tests administered by regulators.) Its "SIFI" designation came about because of its size and geographic scope and because of its large customer base of both retail and institutional clients.  Wells Fargo, like its peers Citigroup, Bank of America and JPMorgan Chase, is a "trillion-dollar bank" with assets now above $1.5 trillion dollars.  A trillion dollars in deposits support a loan portfolio of hundreds of billions.

Without much fanfare and limelight, Wells Fargo has maintained profitability and market strength, while its peers continue to wrestle with financial-crisis issues and scramble for ways to generate profits investors like. The bank just reported second-quarter, 2014, earnings:  Another period of excellent performance ($5.7 billion in net income for the first quarter, $11.5 billion for the first six months). Yet some market doubters have begun to worry about revenue growth and about how the bank will be able to sustain such performance. 

In the past several years, while big banks have confronted every imaginable detrimental financial risk, from strangling new regulation to huge losses tied to imploded mortgage portfolios, Wells Fargo hangs in there from quarter to quarter with handsome returns on equity (12% in 2013, 13% in the second quarter, 2014, e.g.), a relatively clean balance sheet, and fairly basic business lines. 

Headlines about  financial institutions often scream about management shortcomings or major challenges at banks like Goldman Sachs, Morgan Stanley, JPMorgan, and Citi.  Wells Fargo, perhaps to its liking, gets crowded off the front pages.  Even those who follow the industry closely won't know its CEO by name (John Stumpf) as well as everybody knows the names Jamie Dimon at JPMorgan Chase or Lloyd Blankfein at Goldman Sachs.

What is Wells Fargo doing right? And how does it get it done?

1.  A bread-and-butter business.  The bank sticks to its niche, for the most part, and that seems to be basic commercial banking: deposit-taking and loan-making. Profits come from a shrewd management of interest spreads, maintaining loan quality and managing costs carefully.

Its peers long ago ventured into far-ranging activities such as investment banking, institutional sales and trading, derivatives and financial engineering of all kinds (and did so successfully until the crisis and until regulators decided to put straps on all that activity).

The bank has now reached a trillion dollars in deposits, which accrue low or no interest expenses.  Over 75% of the these low-rate deposits (no rates, in some cases) support a vast loan portfolio, now exceeding $800 billion (but not growing as fast lately as some investors and market-watchers would like).  (Because of the deposits, net-interest spreads exceed 500 basis points.)

2.  A clean balance sheet.  Like all big banks, Wells had to scrub its balance sheet to manage through or get rid of bad corporate loans, defaulting mortgages and trading assets, while raising capital and reducing risks. (Over $175 billion in equity capital anchors that balance sheet.)  The clean-up exercise, however, didn't lead to billions and billions in settlements and reserves, as other banks incurred. Some banks are still suffering from the recession, still paying settlements to investors and regulators (Bank of America in recent months), and still trying to shake off the crushing blows of the crisis.

Despite the many ways mortgage abuses and incompetence in managing mortgage risks led to billions in losses, Wells Fargo emerged as a leader in mortgage banking, devoting even more capital to this business line than ever, but likely prudent in what it does and how it does it.  Mortgages today comprise a large portion of its $800-billion loan portfolio; mortgage-servicing contributes about 11% of total net revenues.

Marketable securities and trading assets comprise about 20% of all assets, suggesting the bank is still vulnerable to market volatility and still maintains a big trading operation.  Yet in 2014, it hasn't had to grapple with big trading losses, nor is it entrenched in the trading activities (fixed-income, derivatives, e.g.) that are pummeling other big banks.


3.  Few thorns from the Wachovia merger. Wells Fargo had to digest Wachovia in recent years.  Wachovia had not been healthy financially in the late 2000's, and Wells Fargo was even nudged to make the acquisition.  Years after acquiring it, Wells Fargo doesn't appear to have had regrets in the way Bank of America and JPMorgan Chase are second-guessing themselves on acquisitions of Countrywide, Merrill Lynch, Bear Stearns and Washington Mutual.

Either Wachovia was in far better shape than the quartet Bank of America and JPMorgan purchased, or Wachovia and Wells Fargo complemented each other more perfectly than expected.

4.  Less temptation to get too fancy.  With regulators pounding their doors, many banks have retreated, too, to more basic banking activities to comply with tough new rules and to find ways to be profitable.  Wells Fargo, it could be argued, has had an easier time, because it didn't have an aggressive global investment-banking and trading operation and it never seemed tempted to expand beyond what it is comfortable doing.  Think Wells Fargo, and you think of mortgages booked in North Carolina and not exotic derivatives traded in Singapore.

5.  Ability to prepare for regulation.  The bank is well prepared for the Basel III and Dodd-Frank.  It has already begun to meet capital requirements for 2014-19, and Volcker Rules prohibiting proprietary trading won't have the impact it has had on, say, Morgan Stanley and Goldman Sachs.  Equity capital has grown steadily with earnings (about 11% the past 15 months). 

6.  Strong ratings from ratings agencies. The ratings agencies like Wells Fargo, too.  It has one of the best ratings among large financial institutions (Aa3 by Moody's).  Compare to Baa2 at Bank of America, Morgan Stanley and Citigroup, several notches below, or A1 at JPMorgan and Baa1 at Goldman Sachs.  It's not just the clean balance sheet it likes, but stable, consistent earnings in easily understood business segments help, too.

Are there worries?

Investors (and the equity markets) will push for more.  They want assurance the bank can generate 12-13% returns on equity from quarter to quarter and evidence that every quarter going forward will result in more than $5 billion in net profits.  They'll want to see earnings growth from steady increases in the loan volume. But loan volume is a function of other factors, as well, including limits on customer demand, economic cycles, and a long list of competing banks that won't give in. Wells Fargo will strive to push volume without sacrificing loan quality and taking desperate steps. 

For now, slap its back and applaud the San Francisco-based institution for showing how plain-vanilla activities can achieve good returns, strong ratings from credit agencies, and a nod of approval from regulators.

Tracy Williams

See also:

CFN:  JPMorgan: Is $13 Billion a Lot of Money? 2013
CFN: Morgan Stanley: Can It Please Analysts? 2012
CFN:  Why Was Citi's CEO Asked to Resign? 2012
CFN:  Basel III: Becoming Real, 2013
CFN:  UBS Throws in the IB Flag, 2012
CFN:  What About Corporate Banking? 2010
CFN:  Today's "Bulge Brackets," 2013

Thursday, June 26, 2014

JPMorgan's Refined Regulation Strategy

 Thousands of pages of regulation upcoming
Banks have a monumental task before them these days. Almost from scratch, they must redesign their operations and organizations to embed a new, more burdensome  regulatory-compliance structure. Processes related to all aspects of compliance (data accumulation, rules interpretation, reporting, etc.) must be meshed into almost every bank activity. The task is far more complicated than it sounds.

There was a time when regulatory compliance, even for the biggest of financial institutions, was managed by a modest-size staff within a silo detached from most bankers, traders, sector leaders, and research analysts. Quarterly compliance with bank capital requirements was always "someone else's" responsibility, the job functions of others less attuned to core bank activity.

Bankers understood the importance of compliance, but they conducted business without much regard to the gory details of SEC or OCC rules--unless they were kindly tapped on their wrists to be mindful of the capital that was required to book new loans or new trades or expand business units. Reserve requirements (for deposits) were monitored by "others" (compliance officers). In good times before the crisis, most profitable banks presumed they could manage requirements without much fuss.

These are new days and times. Compliance and building the complex structure to ensure banks comply today and in the years to come are top priorities for regulators, board members, and bank leaders.

In years past, JPMorgan's CEO Jamie Dimon ranted against the reams of new regulation crash-landing in the lobbies of banks in the late 2000's. New regulation and rules were imposed on banks as long-term penalties for what happened in 2007-09. New rules would be so restrictive, he and some of his cohorts argued, that banks will operate with arms in slings and hands tied to perform the most basic services. To comply, banks would need to jettison product lines, pare down to basic activities, and increase prices across the board just to achieve below-average 10% returns on equity. Regulators, for sure, haven't had an issue with the industry's back-to-basics reorganization.

This year, Dimon in his state-of-the-industry letter to JPMorgan Chase shareholders presented no raging argument, no rant that new regulation is overwhelming banking. It is what it is. And some of it, he admits, is good for the industry and the financial system.

Instead he offers a logical presentation of what it will take for a major financial institution like JPMorgan to comply with thousands of new rules and requirements. JPMorgan, he promises, will spare no expense or investment to ensure compliance. He says JPMorgan will be a model citizen for compliance. Expenses are increasing $2 billion annually just for compliance, and the bank will invest over $600 million in systems and infrastructure to keep the compliance machine running properly.

Shareholders must understand the true impact of regulation. He explains to shareholders (and to the public at large) that the task is arguably more challenging than, say, the most daunting, most complex bank merger. And bank mergers are usually always difficult, cumbersome, and frustrating.

After a nightmarish year with regulators and law-enforcement officials and after billions in settlements, JPMorgan insiders may have decided it serves no purpose to step on a pedestal to agitate about the burdens of regulation. Regulators, too, likely wanted to see nothing of the sort and may have conveyed their expectations on how banks should behave in public.

Let's examine the scope of the burden outlined by Dimon, who didn't whine much about those additional expenses to the bottom line. Dimon reminds readers often there are hundreds of pages and thousands of rules. All those pages and lines of rules apply to--at least at JPMorgan--to dozens of its subsidiaries and operations around the world.

New laws and requirements will be enforced by several regulatory bodies, including the familiar overseers such as the Federal Reserve and the SEC. Most industry followers know the well-known Dodd-Frank, Basel III, and Volcker regulation or at least have a big-picture understanding of what that is intended to do. Banks started a few years ago reorganizing their operations and raising new capital to meet requirements that become more restrictive in the next few years.

But there are batches of other regulation, too, including rules related to "Living Wills" (Recovery and Resolution, which forces banks to outline a plan for orderly liquidation or wind-down, if that scenario is necessary) and rules related to something called "CCAR" (which requires large banks to pass periodic stress tests to show they can survive worst-case scenarios).

There are other new acronyms: "SIFI" (which will impose requirements on "systemically important financial institutions"--including big banks and some insurance companies) and "AML" (an old, updated rule that requires banks to implement practices to discourage money laundering). "MiFID" regulation will be enforced in Europe.

Overall, bank regulation in the U.S., Europe and Asia will have impact on the following activities and balance-sheet items (broadly speaking) at JPMorgan: capital, loans, derivatives, trading, clearance, liquidity, leverage, mortgages and securitizations.

This is exponentially more complex than it appears here. For example, there are capital-requirement rules that apply to many JPMorgan entities and operations. Yet some of the same operations are subject to different capital rules from different regulators in different countries. Dimon even suggests there could arise conflicting cases, where the bank attempts to comply with a capital or leverage rule by one regulator, but breaches, say, a liquidity or trading rule by another. ("Unintended consequences," he explained and outlined three years ago.)

Check the personnel requirements and the level of detail those bank officers must immerse themselves in to ensure ongoing compliance. Stress testing (CCAR, or Comprehensive Capital Analysis and Review) has 750 requirements, Dimon points out; about 500 people at JPMorgan will be involved in some way to gather data, devise models, conduct tests and prove compliance.

Rules related to liquidity and funding (Liquidity Coverage and Net-stable Funding) have 250 lines of requirement, and about 400 people could be involved in related compliance (including data gathering, accounting, cash management, funding management, etc.). Derivatives trading and clearing will be overhauled entirely. There are 2,000 pages of new rules, requiring 700 people to help build a new derivatives operation.

Regulation tied to stress tests (SIFI, Recovery and Resolution) evaluates whether banks have a sufficient capital cushion to survive market crashes, unexpected market events, or any other debilitating scenario. Some call this regulation for financial institutions "too big to fail." Whatever, JPMorgan must adhere to requirements and says 35 separate subsidiaries are subject to the test.

Anti-money laundering procedures have been in place at the bank for over a decade, but with even more onerous requirements for diligence, JPMorgan now says over 8,000 people will be involved in related compliance in some way.

Economists, politicians and now financial historians blame the financial crash of the late 2000's on mortgages (including mortgage practices and mortgage trading). It's no surprise, therefore, that rules related to mortgage underwriting, servicing, and securitization now exceed over 9,000 pages.

Dimon showed that compliance, at least at JPMorgan, is no longer a bullpen operation.  It's as important an activity as leading a billion-dollar syndicated loan for a Fortune 500 company or advising GE in its next overseas acquisitions. Still not glamorous. Still not an attractive hub for glory-seeking bankers. But sufficiently vital to bedazzle officials at the Federal Reserve and the OCC. And probably vital to ensure the institution will be in superb shape for generations to come.

Tracy Williams

See also:

CFN:  Is $13 billion a Lot of Money at JPMorgan, 2013
CFN:  Jamie Dimon's Regulatory Rant, 2012
CFN:  Dimon's State-of-the-Industry Message, 2011
CFN:  Letters to Shareholders of Financial Institutions, 2010 

Saturday, June 14, 2014

Krawcheck's Pivot Move


Krawcheck unveils a new index and fund
There might have been a time when industry analysts would have bet it was just a matter of a few years before Sallie Krawcheck would climb into the CEO's seat at a major bank.

Her rise through the ranks at Citi was swift and included a stint as CFO.  She subsequently held senior roles in asset and wealth management at Bank of America. But in both places she crashed upward into a ceiling, shoved aside from senior, sector-leading roles after being just steps away from the CEO's front door. She was not yet 50.

Some who followed her career might not have wagered that she would become the next CEO at Citi or Bank of America, but many might have bet that a known regional bank would have asked her to leave New York's financial cauldron and lead a smaller institution in banking's regulation-challenged new era.

Her days at Citi and Bank of America are apparently done. And since then, she has not shied away from reflecting upon her experiences in why she might have been dismissed and wondering whether Wall Street is still reluctant to let women lead major financial institutions. Many major banks have had women in significant roles. JPMorgan Chase, Citi, BankOne, Morgan Stanley, and even Lehman Brothers had or have women in CFO spots.  Bank of America has had women in roles as Chief Risk Officer and Chief Marking Officer. JPMorgan had women as Chief Investment Officer and has a female CFO and head of wealth management. Nasdaq recently rehired a senior woman executive, who some speculate could run the exchange one day.

Yet something seems to happen--a dismissal, an unexpected downturn, a financial crisis, a bankruptcy, a different CEO and his new team--to get in the way of women rising and settling into the top spot.

In the past year, Krawcheck has assumed a different leadership role, preferring now to lead efforts to find pathways for women to seize important roles in not only in financial services, but all of global business. Hers is a different approach from Facebook COO's Sheryl Sandberg's Lean In strategy that encourages women, more or less, to look into the mirror, change some of their ways, and forge ahead aggressively.

 Krawcheck has adopted a take-action approach, ready to bang on corporate doors to force companies to do better about women in their corporate ranks. Last year, thanks in part to comfortable severance packages from her old employers, she bought out the women's finance network "85 Broads" and is using that as a platform to make the industry uncomfortable. She is preaching about industry's sluggish efforts to make the sheltered circle of financial services--at its highest levels--more welcoming for women.

Just days ago, she announced the formation of an industry scorecard, a new index along with a new fund, that will report publicly to investors and business leaders which companies are walking the walk. The financial index, the Pax Global Women's Leadership Index, will include companies that have significant numbers of women on their boards and significant percentages of women in senior roles. The index will highlight companies, she contends, that should be revered (and promoted) because women are in visible, impactful leadership positions.

The fund, the Pax Ellevate Global Women's Index Fund, will invest in companies that appear in the index. Krawcheck says companies that are successful in "gender diversity" have a track record for producing good returns for investors.

(Krawcheck, after acquiring 85 Broads, changed its name to "Ellevate," partly because of the old name's ties to Goldman Sachs. Goldman's old headquarters were located at 85 Broad Street in the Wall Street area. She wants to expand the network beyond its investment-banking roots and its Goldman Sachs birth, and some might have advised that "Broads" in reference to improving the business prospects of women might not work well in Dubuque.)

As the index and fund are launched, what's the current scorecard with some major financial institutions--for women and for those in other under-represented groups?

For the past couple of decades, the industry had taken token steps. You could always count on major banks, broker/dealers, insurance companies, and asset managers to have one or two women and one or two minorities on boards of directors. You could probably count on the same institutions to have a woman leading a small fraction of a bank's major business units or acting in a one or two major corporate-staff roles. But you couldn't count on financial institutions to promote regularly a woman into the president's or CEO's office, and you don't see boards of directors where more than half comprise women or minorities. As the index and fund are launched, few financial institutions have met the initial qualifications to be included. (US Bancorp is one bank that will be included.)

Let's take a peek at the leadership landscape at selected financial institutions today. What do the board numbers look like in 2014?

1.  Goldman Sachs. Ruth Simmons, president of Brown University at the time and an African-American woman, served on its board until 2010.  But as she was departing, certain factions attacked Goldman for haven chosen a university president not experienced in the complexities of capital markets, derivatives and corporate finance, especially in midst of the financial crisis.

Nonetheless, she brought many other important experiences, skills and judgment to board discussions. Remember, Brown has an endowment in billions, and Simmons managed a large organization with several silos of departments led by smart, stubborn professors, populated by thousands of smart students. Sounds somewhat like Goldman. So why wouldn't she have been qualified at Goldman?

The criticism might have influenced Goldman in selecting other board members, but the firm later appointed another woman college president to the board (Debora Spar of Barnard College) and--to its credit--didn't seem to be moved by voices assessing who was and wasn't qualified to serve on its board. 

Goldman's numbers are adequate, at best.  Two women and one black (Adebayo Ogunlesi, who once held senior positions at Credit Suisse) serve on the board.

2.  JPMorgan Chase has two women on its board and has had a history of having one or two African-Americans (including long-time board member, the late Congressman Bill Gray).  In recent years, it has had women in CFO roles or women managing large business units.  But when people dare to speak of CEO Jamie Dimon's successor or those on the short list to lead JPMorgan in the 2020's, no woman appears to be a front-runner. 


3.  Bank of America has better representation. Four women serve on the board. Although Krawcheck left under unhappy circumstances, women have had major, visible roles the past decade (e.g, in risk management, wealth management, and marketing). 

3.  Applaud Wells Fargo, because its board ranks include at least five women, one African-American and two Hispanics, unusual representation for a financial institution that large. The bank chose the eight or more because of their experiences and leadership, but don't discount how much Wells Fargo, a major commercial bank with footprints in diverse communities, values the business it does with these groups.

4.  Richard Parsons, an African-American, once served as Chairman of Citigroup. Hence, it has had its significant first.  Three women serve on its board today.

5.  Some companies, powerful and profitable in the industry, conduct much of their business transactions out of the public (or individual consumer's) eye. They might not be attuned as others are about diverse representation at the top levels.  

Blackstone, the private-equity firm, roams the top in its sector. Big, powerful, successful, it conducts much of its business in private, out of the headlines, or often in the back of the business pages in the media. It doesn't advertise its services in TV commercials or online ads; it doesn't need to or want to.  It has only two women and no African-Americans on its board.   

Lazard, the boutique investment bank with major corporate clients, has no women and one African-American (Richard Parsons, formerly of Citigroup and recently announced as the top executive of the Los Angeles Clippers). To its credit, Lazard has had African-Americans in senior banking roles.

6. Count on Kenneth Chenault, CEO of American Express, who happens to be African-American, to ensure his company sets examples for all major financial institutions. And it does.

Many bank leaders will say privately they welcome women and those from under-represented groups, but can't find them. Chenault and American Express seem not to have had that issue.  Its board includes three African-Americans and three women.  Other institutions usually (a) don't see this as a priority, (b) don't make concerted, painstaking efforts, and/or (c) are so mired in other issues (regulation, business downturns, slow growth, or challenges from shareholder activists) they overlook the importance of broad representation.

7.  Capital One, AIG, and eTrade have two women board members each.  Notice a pattern? JPMorgan and Goldman also had two.  These financial-services companies seem to have stopped at two. Since it's 2014, many will likely ask themselves, "What's good enough? What's appropriate?" Two seems to be that number and, unfortunately, has been that number for about two decades.  (Some of the same institutions have had two women and one or two African-Americans or Hispanics on their boards since the late 1980's.)

Krawcheck's campaign (managed by her organization, the new fund, and the new index)  hopes to push companies to do better.  Companies, she would contend, need to get beyond settling for a number and patting themselves on the back.  Companies must recognize there are women and members of under-represented groups who are qualified to serve and lead (from vice president to managing director to CFO and CEO and board membership).  Financial institutions should open their doors, Krawcheck suggests, or else....

Tracy Williams

See also:

CFN:  Fighting the Gender Fight at Harvard Business School, 2013
CFN:  Muriel Siebert, Wall Street Pioneer, 2013


Friday, May 30, 2014

Finance MBA's Face a Complex Landscape

Michigan's Ross (above) and 18 other Consortium schools welcome 405 new MBA's
In a week or two, over 400 new MBA students will journey to Austin, Tex. for the Consortium's 48th annual Orientation Program. Like other OP sessions, they will meet each other and share cocktail, networking moments with business-school deans and large throngs of corporate representatives. They will attend special sessions related to industries and job functions. They will discuss hopes and expectations of a current generation of MBA graduates.

For this moment, they'll celebrate reaching a fork in the road that opens up to bright opportunities. And for right now, they'll dismiss worrying about the burden of coursework they confront in the fall.  Nineteen Consortium institutions, all prominent business schools with rigorous programs, will welcome them in Austin and then escort them back to the MBA experience in the fall from California to New Hampshire.

Of the 405 Consortium students of 2014, about 100 have indicated an interest in finance or financial services, hoping to land jobs in a range of positions from M&A investment banking to real-estate private equity.  Many in this group endured the grueling times of the financial crisis.  Some were undergraduates during those years (2008-2010) trying to make sense of a financial system on the verge of collapse. They must have asked themselves:  Could they envision themselves as role players in the industry in years to come?

The landscape has changed in many ways, and most new MBA's know that. It's complex. Financial institutions, encountering limited revenue opportunities and mountains of regulation, struggle to figure out, every day, what they want to be and how they are going to get there.  They ask themselves:  With thousands of rules to adhere to, with strapped balance sheets, with enormous requirements to maintain large capital cushions, and with none of the chances as before to do just about what they wished, how will they generate revenues and sufficient returns on capital?

If it's complex for financial institutions (including banks, broker/dealers, boutique investment banks, insurance companies, hedge funds, asset managers, and private-equity firms), then it might be overwhelming for MBA students in finance.

These times, nonetheless, are not the terrifying months of the financial crisis and recession.  These same institutions have cleaned up their balance sheets, siphoned off distressed assets, shut down non-performing operations, injected new capital, and sliced off much of what was proprietary trading. They have also rationalized every single business line under the CEO and continue to hunt desperately for ways to generate new forms of revenue to help find new earnings for all the capital they must now maintain.

This new class of MBA's in finance will have abundant opportunities to explore, spread out across many functions and regions. But gone are the days when a Consortium grad could study corporate finance, do an internship at Morgan Stanley, and then hop on board at Merrill Lynch and spend the next 20 years rising to the top negotiating with clients while doing deals.

What will this class encounter?

1.  Investment banking has been a long-time favorite destination of many finance MBA's from top schools.  The industry is in flux. Challenged by new regulation after having  been bowled over in the aftermath of the crisis, some banks have withdrawn from full-scale emphasis (UBS, Barclays, e.g.)  Others have decided to re-deploy resources, capital and talent toward commercial and corporate banking (Wells Fargo, e.g.).

The big bulge-brackets (JPMorgan, Goldman Sachs and Morgan Stanley) have doubled down, will continue to hire large numbers, and are prepared to bang heads with each other chasing down many of the same headline deals, but willing to work arm in arm in transactions if they must.  Big banks will cross the country in search of new MBA associate, as long as the deal environment is brisk or predictable.  

2.  But the boutique banks continue to make their marks.  Big banks aren't threatened by them, although they certainly squeeze themselves into numerous advisory mandates. The roster of boutiques changes from time to time. The favorites these days are Lazard, Evercore, Greenhill, Moelis, Weinberg Perella, Soundview, and a handful of other small, but still relevant shops (M.R. Beal, Williams Capital, e.g.). 

They look for MBA talent, but their relationships with top schools are often limited and fleeting. Think in terms of founding partners focusing primarily on the few schools they attended when recruiting season rolls around. They covet MBA's from top schools, but won't jet across the country recruiting them.

2. Banks are facing a debt and commodities crisis this year--not from having highly leveraged balance sheets, but in managing debt-product units that are struggling to be profitable.  Debt sales & trading and many activities in the realm of what the industry now calls "FICC" (fixed-income, currencies, and commodities) are ransacked by regulation, low interest rates, and low profit margins. An MBA interested trading bonds on a debt is headed toward a dead end. 

M&A units are smirking these days.  It's as if they've found gold in their back rooms. What they've found are company CEO's and CFO's now confident enough to contemplate a strategic acquisition. They've found companies now willing to spend cash they wouldn't touch after the haunting, crushing blows of the crisis. M&A activity, however, fluctuates and swerves, and all MBA graduates should be forewarned.  For new MBA's, this might be the optimal time to secure a spot at a major bank or boutique.

3.  Few MBA's in finance head off to business school with an ambition of becoming legal, regulatory and compliance officers at major banks. And financial institutions have done a poor job in explaining the role or convincing students to consider these now visible, important functions.  However, banks everywhere are hustling to fill roles. They are tossing millions into budgets to build a long-term infrastructure to manage every aspect of compliance--from data accumulation, regulatory reporting, regulatory compliance, capital allocation, and risk-capital computations.  The functions exist far from the front lines of client banking, yet are getting maximum attention from senior managers and boards. 

4. New MBA's, especially those interested in proprietary trading, investments, and equity research, will aim for hedge funds, private equity, and venture capital at firms big and small.  But they'll learn quickly after they attend the first corporate-recruiting reception that the road to Blackstone, Carlyle, Citadel, Bridgewater, or Sequoia is far more treacherous than the road to Goldman Sachs or JPMorgan.

Opportunities will exist, because these are the best of times for venture-capital firms and favorable times in private equity. They all need finance associates to crunch numbers, run models, value companies, perform research and present conclusive findings. Every deal requires these exercises.

Meanwhile, hedge funds have stumbled in clumsy ways the past year or two. Some large ones have closed.  Hedge funds will still persist and will always be happy homes for market traders in all asset classes who insist they can out-perform broad markets.  They'll welcome MBA talent that in years past might have spent early years in apprentice roles on equity, debt, and emerging-markets desks at big banks.

5.  The corporate-finance function at non-financial institutions thrives, especially in a post-recovery setting where companies are finally confident about deploying cash that has sat dormant for years. They appear ready to use idle cash to expand, grow, and perhaps acquire a company or two.

In the past, pursuing a career in financial management or corporate finance at an industrial company or Fortune 500 corporation wasn't a preferred route for some MBA's at top schools.  MBA graduates chased the fanciful, more lucrative opportunities on Wall Street.  But after late-2000's turmoil, working as a financial analyst at places like IBM, Eli Lily or Pepsico was more attractive and offered a more stable, more sane existence.

Furthermore, the same companies have become shrewd and begun to bring more of its corporate-finance and corporate-strategy work in-house before they reach out to investment bankers to do some of the same.

5. The asset-management industry also presented itself as an oasis of stability, predictable revenue streams, and growth.  The industry welcomed MBA's and has successfully recruited them over the past decade.  Yet even this sector must fend off challenges.

Investors have low-cost options now, especially after the explosive growth of ETF's.  Some investors and experts question the value of hiring advisers to manage funds to try to beat market performance.  Why pay high fees when investors can push assets into a low-cost ETF's or similar portfolios that match the market? Why pay high fees when it is possible that managers' performance will fall shy of market returns, as they have done at many hedge funds the past year or two?

Asset managers won't concede.  They work hard to convince investors (individuals and institutions) that they have analytical tools to out-perform market indices and to reallocate funds quickly among different asset classes when market conditions encourage a reshuffling.

6.  Financial institutions that once thought they could escape the grasp of regulation must also adapt and comply with new requirements. Federal regulators, for example, can now parachute in, tap the front doors of non-bank institutions that had little to do with Dodd-Frank or Basel III, and wrap them under new rules.  Insurance companies like Prudential and AIG have been designated "systemically important financial institutions," or "SIFI's," institutions that have roles and market positions too large in financial markets not to be supervised like big banks.

New MBA's shouldn't fret.  The environment is not discouraging; it's merely complex, evolving. The industry harbors many forces, including forces that want substantial regulation and oversight and forces (applied by banks and hedge funds, for the most part) that don't want to be strangled too much in their desperate efforts to maintain earnings and returns.  The jockeying, pushing and pulling have been going on the past few years and will continue.

In an improved business environment, there's still room for the new deal, new client, new financial model, new investment, new discussion to acquire or merge or new financing to support new product lines--all promising signs for a new MBA in finance.

Tracy Williams

See also:

CFN: Consortium OP, Getting Psyched, 2012

CFN: Consortium OP, Alumni are Welcome, 2011
CFN:  Consortium OP, June is OP Time, 2010
CFN:  Finance, Still a Popular Destination, 2014


Wednesday, May 14, 2014

On Deck: Alibaba's IPO

Alibaba's IPO will be executed in the U.S.
Pay attention. Alibaba has made a landing on American soil in U.S. trading markets. Until recently, Alibaba was a far-flung concept, a fast-growing e-commerce business that had made technology splashes with torrent waves in China, where a stunted version of the Internet still languishes in its early rounds and still hasn't reached millions of households. (Or billions?)

Alibaba, we learned a few years ago, was China's version of Amazon with a business plan of peddling goods online to a Chinese market of tens of millions. Now Alibaba has made a virtual splash into the U.S., not by attempting to supplant Amazon, but in choosing to issue stock in an IPO in the U.S., of all places. Alibaba is on its way to becoming household-familiar in the way Amazon, eBay, and Google are.

Alibaba is planning to go public in one of the biggest stock offerings ever, upwards to $20 billion, selling goods online to the Chinese, but offering stock under American rules and protocol. (That very act is not unusual, as other Chinese corporations have issued stock here or are contemplating it.) And in finance circles, it figures.  From nowhere emerged a band of banks willing to lead that offering--whether stock will be offered in one big offering or in several stages. Banks have already assessed that the total market value of the company could reach $200 billion, rivaling many big-name companies in the U.S.

Alibaba, led by CEO and founder Jack Ma, portrays itself not as the Amazon of China, but as an Amazon with eBay, Google, and PayPal features. There is a Yahoo wrinkle, as well, as a struggling Yahoo made arguably its best strategic move ever by investing in a significant stake in Alibaba, when many weren't taking the Chinese company seriously. That stake will reap over $10 billion in cash for Yahoo, when the IPO occurs. 

Why would a Chinese company accustomed to Chinese markets, consumers and products choose to issue stock publicly in the U.S., subject to the rules and disclosure requirements of the S.E.C.? Alibaba claims it wanted to issue the new stock in Hong Kong, but regulations there wouldn't permit the founders to maintain a controlling interest in the company. U.S. laws and rules will permit company founders to retain controlling voting powers.

But there must be corollary reasons. A gravy train of benefits will inevitably come with Alibaba's decision to step onto U.S. soil. Let's first explain Alibaba's business model in a few sentences.

1. Alibaba is Amazon without the large, regional warehouses for product distribution and without the risks of financing and maintaining large amounts of inventory. Alibaba is like Amazon in that they are led by visionary founders (Ma at Alibaba and Jeff Bezos at Amazon), who tend to act as the corporate and long-term strategy department embodied in one being.

2.  Alibaba is eBay, because it allows individuals to sell whatever they choose in an electronic market, often in an auction environment. Alibaba also has an attached marketplace that allows companies to sell new, branded products directly to consumers.

3.  Alibaba is PayPal, because it, too, has a payments-systems affiliate.

4.  Alibaba is Google, because it runs a search engine to permit consumers to search products and product details and subjects them to product advertising, based on their searches.

It hasn't been articulated anywhere in glowing detail using the jargon of consultants--not in securities prospectuses, not in analysts reports, and not in media summaries. However, wouldn't Alibaba have plans to expand aggressively into U.S. markets with U.S. consumers? Does it envision consumers in Iowa benchmarking the website www.alibaba.com?

Is it contemplating a wholesale transfer of a successful market strategy to the U.S.? Is an IPO a first step in global expansion? Will the U.S. also be the added source of growth shareholders will demand, as it they try to rationalize high stock-market values or high price-earnings ratios?

Perhaps an IPO in the U.S. is a "test the waters" step in a long-term strategy.  The IPO and the public trading of its stock (replete with analysts' commentary and continual coverage of the stock) are ways to promote a brand, a way to slip through the doors of a familiar club of technology companies Google-Amazon-Facebook-Apple. In some ways, Alibaba is already in this club in terms of market size, market valuation, and total revenues. The company will top $6 billion in sales this year, and it has been reported that it has profit margins that would cause Amazon to blush or Amazon executives to scratch their heads.

Alibaba, for now, is presenting a calculated growth strategy, focusing mostly on the potential for untapped markets in China and claiming it must manage fierce competition among companies in its own land that appear to be the Googles and eBays and PayPals of China.

On the banking side, underwriters have certainly swarmed the potential deal like locusts. Everybody wants a finger on this transaction, just as banks besieged Facebook and Twitter, when those companies prepared for IPO's. The bank roster includes the usual names for high-profile technology deals:  Morgan Stanley, Goldman Sachs, JPMorgan, et. al.

Alibaba indicated it wants to play fair and is not showing favorites, listing the banks in the SEC prospectus in alphabetical order (not in order of importance or in order of underwriting commitment) and convincing companies to accept a below-market IPO fee of 1%. It awarded underwriting roles, for the most part, to banks that have helped them in debt financing in the past (including those that  participate in an existing $8 billion facility).

Banks will earn their fees on this deal, because nobody wants to be associated with a fumbled, headline-blaring technology underwriting, similar to what happened with Facebook.  Furthermore, underwriters will need to explain clearly how growth will be achieved (although it has been taken for granted that China has only snipped a few layers of the surface of the potential for new consumers and Internet users). Underwriters will need to convince investors that reported profit margins (exceeding 30-40%) are real.

Banks, investors and research analysts--not just now, but on an ongoing basis--will need to grapple with an assortment of matters that aren't plain-vanilla, since they must tell a business story where the scenario is China, not Silicon Valley.  For example, stock-buyers will need to understand differences in reporting, business disclosures, and accounting methods.

Investors, analysts and banks will also need to understand or appreciate consumer behavior and trends in China. Don't discount at all, too, the impact of Chinese macroeconomics, political risks, and the patriarchal role of the Chinese government.

Banks and media reports estimate the value of the company, at the time of its offering in months to come, ranges from $135-200 billion, a range that is so wide that it suggests that much more due diligence and financial homework are necessary, but a range that considers the possibility of upcoming fluctuations in overall markets and sentiments for technology stocks.

Alibaba and banks will also have the opportunity to learn from the big stock roll-outs at Facebook and Twitter. There must binders of lessons learned in the past few years (not to mention countless lessons learned from the dot-com stock crumbles in the early 2000's).

Now if Alibaba is preparing for America, are Amazon, eBay and Google huddling to devise a counter-strategy?


Tracy Williams


See also:

CFN: Facebook's IPO:  What Went Wrong? 2012
CFN: Facebook IPO:  The Lucky Underwriters, 2012
CFN:  Now It's Twitter's Turn to Go Public, 2013
CFN:  What Can Morgan Stanley Do to Please Analysts? 2013

Monday, May 5, 2014

Vista's Smith Found a Way

Smith started Vista after leaving Goldman

Much has been said or written about how difficult it is to crack barriers at venture capital and private-equity firms. Quite a lot--enough to discourage some MBA graduates in finance with genuine interests in long-term investing from even bothering. Similarly much has been said and written about the scarcity of women and under-represented minorities in important roles in private equity--as investors, fund managers or principals and founders.

Most in finance, however, know the impressive rewards that are reaped in private-equity investing, conducted at such big names as Blackstone, KKR, Silver Lake, and Carlyle. Many gasp at the cascade of wealth generated by venture funds scattered about the Bay Area on the West Coast.

However, the story of Vista Equity Partners is hardly known, and perhaps it should be. The private-equity industry is aware of Vista, because the big firms and their leaders and the big investors keep an eye out on each other. Major banks know Vista and all the other firms, because banks sit side by side with them in the big deals they all seek to do.  The principals of Vista aren't likely those who rejoice in telling their stories broadly, unless they do so in front of prospective investors when they organize a new fund.

Maybe it's time its story is told more prominently and thoroughly. The firm seemed comfortable allowing the New York Times  in April to report its unique business to a wide business audience.

Vista is one of the few large private-equity firms founded and led by an African-American, Robert F. Smith. Smith was a banker in mergers and acquisitions at Goldman Sachs, when he decided to move on from a blazing career in technology investment banking to help found a new private-equity firm in 2000, a daring move for someone who had reached a comfortable perch at Goldman.

Smith had taken challenging, but conventional steps before he had the idea of starting a new firm. They were tough, methodical steps in a process that helped him understand the mechanics of private investing, understand at expert levels a sector of the technology industry, and meet certain movers and shakers among investors.

He went to Cornell to become a chemical engineer and got work experience at Kraft General Foods before he pursued finance and the MBA at Columbia. Attracted to his credentials and the academic milestones he racked up at Columbia, Goldman Sachs brought him on board and inserted him on a career trek that could have eventually thrust him into the most inner management circles at the top of the firm.

But right near the peak, he slipped away from Goldman's privileged banking club and decided to do what might have been the impossible in 1999-2000, when the dot-com bubble burst and the technology industry was running in circles trying to determine what would happen in the second chapter of the Internet: He started a private-equity company focusing on business software.

Fourteen year later, Vista is a player, managing $10 billion-plus across several funds, regularly attracting large institutional investors and proving that it can generate sound, consistent returns. Smith, in fact, told the Times that investor returns have exceeded those at Warren Buffett's Berkshire Hathaway.

(The Times tried to get more specific details about those investment returns, but verified that Vista's returns rank among the best in the industry. Buffett might rebut that achieving higher returns are harder when you manage a capital base 30-times higher and must respond to a more fickle group of investors, who happen to be public shareholders.)

Vista ought to be better known beyond private-equity circles, a little bit to broadcast the successes of a black CEO of a large private-equity organization, a lot to show how Vista has proceeded on a different course.

Those not familiar with private-equity investing might reason that success comes from accumulating massive amounts of investor funds and spraying them across industries, wherever growth opportunities peek out and wherever strokes of luck and fortune might rain down.

With offices in Austin, San Francisco and Chicago, Vista has a more disciplined, defined approach. Like most private-equity firms, Vista has a management company that oversees investments across several funds.  Vista is currently organizing its fifth fund. Investors are typical large institutional investors:  pension funds, school endowments, other asset managers, etc.  The Vista funds invest only in technology companies involved with "enterprise software," basically companies that create, develop, sell and/or license software to other client corporations to use to run their businesses. Each fund has slightly different investment approaches and timetables that match investors' objectives.

Vista's investment portfolio hardly strays from "enterprise software." It invests in few companies, not an army of software firms. It prefers to have a majority stake in a company and to be the only outside investor to avoid clashing with other big-stake investors and to have greater impact on operations and strategy. It uses ownership leverage to have a seemingly intrusive, but strategic role in operations. Companies, with sales in a range from $100 million-$1 billion, are typically still growing, looking for new markets, and might be encountering operations hurdles.

Vista just doesn't invest, appear at board meetings and provide occasional advice or guidance. It immerses itself in a company's operations, implementing detailed financial requirements and goals, coaching and training management, expediting "follow-on" acquisitions that enhance the business, and even inserting itself into recruiting new employees.  While it has consistent success, some detractors have, of course, complained that Vista, in its role, has dismissed unproductive managers and reorganized businesses without purpose--common responses to actions taken by private-equity investors with large stakes.

Because of its greater operations immersion, Vista will likely maintain ownership and control of a company over a longer term than other private-equity firms that aim for a swiftly arranged IPO or sale.  Some examples of Vista investments follow:   Mysys provides software for financial institutions for banking functions, trading, risk management, and portfolio management. Accruent offers software solutions in the real-estate industry for building construction, development and facilities management.


MicroEdge has a client base of foundations and non-profit organizations to which it sells software for grant-making, management and monitoring. Newscycle Solutions peddles software for news media to manage circulation, content, and customer relationships.

How did Smith do it? How did he find a way? A combination of factors might explain it.

He amassed expertise in finance--from tools he learned in business school and from the experience of hundreds of deals, transactions and difficult client negotiations while at Goldman. At Goldman, he participated in some of the largest, most complex deals of that period.

He gained expertise in the technology industry--with experiences in engineering, physics, computers and quantitative analysis from his engineering degree and business-school training, as well as Goldman banking experiences.

Confidence with clients, in business negotiations and in business challenges grew from responsibilities and experiences at Goldman. Such confidence and a reputation for accomplishment likely helped him assemble a talented team when Vista launched. At Vista, Smith is the lead principal, as CEO, but he doesn't do it alone. He manages a team with relevant expertise and backgrounds. A handful came from Goldman.

At Vista, Smith and team have shown discipline by sticking steadfastly to a tried-and-true investment regiment. They have not been teased by industry sectors not familiar to them, nor to they tread on territory beyond their comfort zones.

Just as important as any other factor, it helped that investors were willing to take a chance with Smith and his firm, willing to take risks and buy into the firm's parochial philosophy.

And then all these factors had to fall neatly in place in timely fashion.

If Vista is like most private-equity firms, it seeks not to attract too much media attention, if only to discourage others from copying its philosophy or chasing after the same investment gold-mine findings (which bids up acquisition prices). But Smith doesn't mind broadcasting one off-shoot he and Vista sponsor, a special venture called Project Realize.

The project is intended to help managers and owners in small companies in big cities. Smith, with Vista support, selects a small business, typically with less than $25 million in revenues and engaged in a processing business. Project Realize coaches its managers as part of a formal growth program. Participants are shepherded through all facets of finance, marketing and operations. Vista helps them achieve targets in revenue growth, operations efficiency and funding.

Some might see this is as an "incubator" for established small companies operating in various industries.  Smith sees this as an "adoption" of a company for which Smith and his Vista network provides priceless consulting services in management, strategy, operations and finance. In some ways, the services they provide are far more invaluable than if they had provided investment funds and captured board seats.

It's probably not an accident that Smith, the one-time chemical-engineering major, selected Cedar Concepts Corp., a chemical-manufacturing company, as its Project Realize's current project.

Tracy Williams

See also:

CFN:  Horowitz and his "Latest Venture," 2014
CFN:  Knocking Down Doors in Venture Capital, 2012
CFN:  Venture Capital Diversity Update, 2011

Tuesday, April 22, 2014

Buffett: 2014 Take-Aways

Buffett:  Ignore the bark of daily stock prices, he recommends
Each year Warren Buffett's Letter to Shareholders is a remarkable feat. His discussions of business lines, operations and performance are conventional. But Buffett, as Berkshire Hathaway CEO, intersperses passages about profitability with stories and lessons for investors of all types and ages.


Each year you wonder how is it possible for Buffett to top himself. What more enlightenment about long-term investing could he possibly share with shareholders and even investor novices?

Each year, nonetheless, he picks a couple of business topics, sometimes controversial, sometimes complex. He wrestles with the topic, explains it in simple terms, ties it to real business experiences (often his own past success stories) and  offers a special lesson for long-term investors. His audience includes long-term investors.  He seems to have little time, tolerance or patience for short-term traders. 

This year after reviewing Berkshire Hathaway's activities in railroads to insurance companies , Buffett told a couple of stories--one about a Nebraska farm and another about a retail store near NYU--investments he made a long time ago.

In both cases, he boasted about having almost no involvement in either one. He has never bothered to visit the farm and the store (maybe once or a forgotten second time), but both have been successful, thriving investments, based on simple principles. Buffett sums up:  Corn will always grow on his Nebraska farm. Students will always be around and about NYU and will always need a place to buy clothes, snacks, supplies and groceries.

Buffett abhors the fears and panics induced by daily stock-market volatility. For years, he has encouraged investors to avoid staring at daily stock prices and indices. He has advised investors that the best times to buy stocks is when markets have plunged. Yet he knows, no matter his wisdom and his experiences, investors will still watch market upswings and downturns, still be swayed by pundits on CNBC, still be influenced by Wall Street Journal headlines, and still be tempted to follow the masses when determining when to buy and when to sell.

In this year's letter, he offers a story about his Nebraska farm to explain why investors should shut off their ears and eyes to daily stock-market emotions.  Consider the scenario (his shared experience) where, he says, your Nebraska farm is well-managed. It produces corn consistently year after year and distributes produce widely, resulting in stable profits annually, because people eat corn and will continue to do so. Now imagine if a man (or groups of men) stands at the boundary at a fence and barks and screams prices for which he will offer to buy your farm—every day, all day long, non-stop. Imagine, as well, the man's fluctuating offering prices—surprisingly high offers, inexplicably low offers. Prices and prices, echoing across your cornfield.

What an annoyance that can be, Buffett suggests. The man screaming numbers at your gate interferes with the day-to-day requirements of running a thriving business. When it’s time to sell the farm, you’ll know. It just so happens that Buffett hasn't bothered to sell. He still owns his farm, still reaps the benefits of increased cash earnings each year,  and boasts that, except for reviewing operating performance, he never needs to be involved or be present.  He says the annoying, barking man is like the annoyance of stock-market tickers that get in the way of operating a business or presiding over an investment.

Inevitably, in a Buffett letter to the public, some themes repeat themselves. He doesn’t necessarily forget what he wrote in years gone by, but he seems to want to emphasize some points, perhaps points that weren't digested thoroughly in previous shareholder messages. For example, he refers once again to his invaluable security-analysis tool book, Graham & Dodd’s Security Analysis, the comprehensive investment-management text he absorbed while in business school at Columbia many moons ago.

Buffet once again devotes passages to explain the insurance business, seeming to want to convince readers and investors how an apparently aged, dull industry can lead to promising investments if companies do the following: (a) Manage expenses carefully, (b) be realistic and conservative about expected losses, and (c) price premiums carefully.  And once again, he rallies and cheers for his company’s ownership in the popular insurance company Geico, a company in which he has had a stake for decades.

Buffet and his troops have always been shrewd risk managers, preparing for difficult times or exploiting difficult times to find investment bargains. This year, he mentions in passing “liquidity risk management” at Berkshire, discussing briefly a company policy to maintain billions in cash reserves and minimize short-term debt to avert the risks of rising interest rates, to be ready to pounce on any opportunity, and to not be caught off guard in managing liabilities and other debt. Berkshire doesn’t despise or avoid debt; it just prefers it long term.

What else is on Buffett’s mind in 2014?

He tosses out a phrase “circle of competence” to instruct investment analysts to forecast operating earnings based on what they know and what they can grasp.

He mentions some of his favorite blue-chip stocks, investments anybody can step up to purchase, not merely significant investment vehicles like his company. American Express, Coca-Cola, IBM, and Wells Fargo are current favorites, and he explains why: Growing revenues, stable and sustainable profits, managed risks, global operations, and reliable products and services.

“We much prefer owning a non-controlling, but substantial portion of a wonderful company to owning 100 percent of a so-so- business,” he writes. “It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.”

So what are other take-aways from Buffett’s 2014 finance lecture. His lessons are straightforward, easy to digest, sometimes hard to accept how simple they are. Some lessons are principles to abide by when managing companies and investment portfolios.

1. He reminds all that you don’t need to be an expert to achieve satisfactory returns.

2. Keep things simple, he says. “Don’t swing for the fences.”

3. In assessing the value of companies, focus on future production, recommending that historical numbers should be shunted aside (although a peek at history of performance may tell a story about the competence of management or the potential for assets to generate profit).

4. Focus on the “playing field” (operations, products, costs, industry dynamics), he writes, and not “the scoreboard” (stock prices, stock indices, technical market analysis, market momentum).

The vagaries and emotions of stock markets enveloped his mind this year. He reminds readers how much they enjoy their Saturdays and Sundays without paying attention to stock prices and advises them to enjoy their weekdays, too, by ignoring the crawl of market prices on CNBC or the wails and headlines about market trends from business journalists.

Tracy Williams

See also:

CFN:  The Word from Buffett, 2013
CFN:  Merger Mania, Boom Times Ahead? 2013
CFN:  Shareholder Letters at Financial Institutions, 2010
CFN:  Jamie Dimon's Shareholder Letter, 2011

Friday, April 4, 2014

Lewis' Back-door Move

Lewis takes on black-box traders
Talking about the blind side.  Best-selling author Michael Lewis, who wrote the book Blind Side about football and the book Moneyball about baseball, slipped through the back door this week and published his new book Flash Boys about electronic stock trading. Right away, the publication stirred the world of stock markets, exchanges and high-frequency trading.  Lewis had spent a year or so studying, learning and asking questions about electronic trading and the dynamics of high-frequency trading, the lightning-quick activity conducted by a small circle of black-box firms that explains most of the trading volume in equity markets in the U.S.

Lewis draws conclusions in the book. He claims a band of high-frequency traders have rigged markets, slicing bits of profits (measured in morsels, or cents per share) from billions of trades from innocent and often unknowing participants--mutual funds, pension funds, and, yes, moms and pops.

In the wake of sudden appearances on CBS-TV's Sixty Minutes and PBS's Charlie Rose, Lewis's book, his claims and conclusions have spurred loud voices on both sides of the looming questions:  Is the market rigged? Do high-frequency traders serve an important role?

When Lewis speaks (or has something to write about), a financial audience will pay attention. His track record gives him an audience each time he publishes something new. He often tackles intriguing subjects and asks questions many don't know how to pose.   His The Big Short a few years ago explained how traders and hedge-fund investors reaped billions in complex credit derivatives by betting on the demise of mortgage markets.  His book Liar's Poker, now decades old, still ranks among the most popular books ever about Wall Street trading floors. 

And now all of a sudden, Flash Boys will become a spring-time must-read, if only for market participants to decide if Lewis' claim is fair or if only to permit outsiders to understand the revolution in the way stocks are traded and market values are determined. Contrast today's stock market (or markets, since trading occurs on dozens of venues) with the old vignettes of humans (Wall Street specialists) wrestling for space in the Great Room of the New York Stock Exchange, amidst mountains of pieces of paper.

Those days are gone, although specialists and traders still show up at the Exchange and still go through motions pretending they influence markets.  These days, it's the hum of computers and black boxes and the atomic-swift movement of data through fiber optics and microwaves that dictate volume, activity, and volatility in equity markets.

Lewis' book portrays the experiences of a head equity-desk trader, Brad Katsuyama, at RBC Capital Markets in Toronto and New York. Katsuyama's team, puzzled about not getting orders filled at prices they hoped for, went on an investigative hunt and concluded that high-frequency traders were "front-running" their orders on electronic exchanges, taking advantage of RBC's expressed intent to buy or sell stocks.  The traders exploited that advantage, forcing RBC to buy or sell at less-than-optimal prices, even if just a few cents a share.

Lewis, as the interested bystander on this journey, tries to explain electronic trading and the amorphous, varying role of high-frequency traders.

Already, many in the industry say there is little new in the book. What's new to most is that Katsuyama at RBC eventually decided to beat back high-frequency traders by joining them.   He decided to set up his own exchange and is implementing techniques to change protocol. His exchange, he says, will discourage high-frequency traders from rushing ahead of the pack. It will slow them down. It's "trust" he says he is selling, as he encourages asset managers, funds, and investors to send their trades his way. He formed his exchange, IEX,  and seeks to match buyers and sellers without the involvement or  intervention of brash, bold electronic dealers.

The issue is complex.  Lewis and cohorts show how markets might be rigged.  But the big stock exchanges themselves--from Nasdaq to BATS to the New York Stock Exchange--enable such traders, encourage their activity, and even invite and induce them with pay-outs or reduced fees to boost volumes and liquidity on their respective platforms.

These are different times. In old days, stock exchanges were few. They were non-profit marketplaces, overseen by members and member institutions, run by tight rules and regulation, operating within comfortable 9-to-4 time frames, and respectful of gentlemanly ways and traditions.

Today, exchanges are abundant (at least a dozen in the U.S.). Regulation NMS from the mid-2000's facilitated the new environment.  It permitted (or encouraged) the formation of new exchanges and instructed brokers, traders and investors to roam exchange platforms in search of the best price and the best, quickest execution. 

Exchanges in these times, profit-seeking enterprises, generate revenues from brisk activity.  Therefore, they must be creative in attracting volumes of share activity from traders and investors--any legal way to lure volume to generate fees.  High-frequency traders, therefore, become their best pals, favorite participants for whom they offer privileges, advantages, a slight edge (vs. all other participants) to ensure sufficient levels of activity at all times.

So here is how the high-frequency traders and explain their side of the argument. (Over the past decade, they have included such firms with names like Getco, Jane Street, Allston, Quantlab, Sun, and Jump.)


(a) They provide market liquidity, active markets, and ready buyers and sellers.

(b) They provide "price discovery" with bids and offers updated continuously during the trading day.

(c) They provide "best prices," opportunities for buyers and sellers to search venues to find the best price for a particular stock.


But here is how factions like Lewis, other asset managers, and Katsuyam's IEX frame the issue:

(a) Unlike the stock specialists in the past, they disappear when markets become too volatile, too slow, or too boring. There is no moral (or legal) commitment to participate or make markets. They balk or refuse to participate at certain times. 

(b) They don't always provide honest, good-faith bids and offers. Sometimes they show their hands and wander away before execution (fake orders, or orders they cancel as quickly as they show their hands). 

(c) Skipping from venue to venue (exchange to exchange) with less-than-sincere bids and offers, they often try to trick or deceive markets to gain information advantages--advantages that extract profits from retail- and long-term investors.

Flash Boys elevates the debate to the front pages of the business media and encourages market overseers and regulators to move faster, if they have been investigating market practices. Some suggest if the rules changes, high-frequency traders won't disappear. They'll simply tweak their boxes, recalibrate the economics of trading, and proceed accordingly.

For Lewis, Blind Side and Moneyball eventually became popular movies.  Is a movie version of Flash Boys on the horizon?

Tracy Williams

See also:

CFN:  High-Frequency Trading, 2012
CFN:  Dark Days at Knight Capital, 2012
CFN:  Financial Technology, 2014


Thursday, March 27, 2014

Horowitz and His Latest "Venture"

Horowitz:  Fighting to open doors
Many MBA students and graduates who covet careers in finance perceive venture capital as closed-door clubs whose members operate by making quiet, stealth financial movements:  first-round funding, mezzanine funding, second-round investments, and then--bang!--the IPO.

Members of the club fight fiercely to determine and support the next new thing. They prefer to locate in offices near each other, the better to watch each other's steps and moves. They respect each other and occasionally band together to do deals or share ideas.

To those on the outside, the doors to the club appear bolted, opened only to outsiders who bring influence, contacts, funds, and technology patents. It is arguably the toughest network in business or finance to penetrate.

Andreessen Horowitz is one of the most acclaimed names in venture capital in Silicon Valley.  At Andreessen Horowitz, Marc Andressen is the better known name of the two.  He is the one out  front, the prodigy entrepreneur who helped create the popular Internet browser Netscape back in the 1990's. After a series of glowing entrepreneurial successes, he decided he preferred to invest in new things instead of running or operating them. From a Valley perch, he gets to decide what that next new thing will be.

He and Ben Horowitz formed their venture-capital group in 2009 after they "retired" from the life of managing the struggles and swirling phases of new companies (including also Loudcloud and Opsware).  They still dabble in new ventures and sweep across the landscape to decide which ones are worthy of their mentoring and money. They ditched their days of spending every waking hour building a new company and now run investment funds exceeding $2.5 billion. They were first-round investors in Twitter, Groupon, Zynga, and Facebook.


Andreessen is the one the business media go to for quotes and perspectives on the Valley and opinions on matters related to California's fragile economy, social media, and technology innovation. He has been a news item for much of 2014 with his spats regarding investments in Skype with investor Carl Icahn. Just this month, he declared Warren Buffet too old to understand technology investments. 

Ben Horowitz is the "other" guy, the other name on the door, although he doesn't shy away from media attention. In fact, he has written a popular blog to share his thoughts on topics ranging from  technology to business strategy, management challenges, and human resources. Sometimes he tackles accounting topics and world politics.  He shares lessons he learned in running companies that stumbled now and then on their way to financial health.

With a new book just published (The Hard Thing about Hard Things) and a Fortune magazine cover, he isn't avoiding publicity. Of course, he wants to sell  the new book, but he claims he wants to open up bolted-down doors of venture capital and technology entrepreneurship to those who have been shunned, those who were discouraged, and those who haven't benefited from the bundles of wealth that new ventures sometimes spawn. This includes those from under-represented minority groups--blacks, Latinos, and women.

Horowitz, as a successful mentor in a second phase of adulthood, is pushing the door slightly ajar, hammering a few cracks to permit others to take a peek and perhaps rush in. In recent years, besides presiding over a portfolio of investments with meteoric returns, he has devoted substantial time in roles as mentor, teacher, or coach to show those who never dreamed of starting a company or working in venture capital they might have the knack for it.  For new entrepreneurs, he lays it out: How to get the company going, how to keep a company growing and solvent. And he tells the truth: It will be hard.

Stories are widespread about Horowitz's ties to the black and Latino communities in Oakland and Los Angeles, his attraction to hip-hop culture, and his nose for finding entrepreneurial talent in areas outside the cloaked venture-capital huddles in the Bay Area.


His new book is a guidebook for those on both sides, those inside the right circles and those outside.  He offers advice on how to manage the toughest aspects of starting a new company and keeping it alive. He provides lessons from his own hiccups and failings when he was a CEO, mostly at Loudcloud, where he harnessed the company through periodic tumbles and upturns before it was finally sold.

This is not a book of romantic reflections in building a company, nor a storybook of tales of how a product idea results in easy profits and returns. It's nuts, bolts, and late-night worries of how his company will generate cash flow to make payroll. It's about what managers should do to dampen debilitating office politics. And it's about about difficult decisions entrepreneurs will inevitably encounter to keep companies alive:  Do you sell the company, sell a unit, lay off staff, seek another round of capital or transfer out an ineffective manager?

Venture capital and private equity reside on the periphery of entrepreneurship.  Venture capitalists and private-equity investors sit in the middle of the ring to help managers in strategy, funding, hiring and product distribution.  This appeals to many business-school students, including Consortium MBA's.

However, the pathway to a prominent firm is tricky, uncertain, not neatly outlined.  The firms don't usually have close relationships with business schools. Many prefer to hire and recruit based on their own needs, schedules and whims.  And most are indifferent to general diversity hiring practices or objectives. Many support diversity initiatives, believe in them, but don't make it a public priority.

Unless MBA students have an entree, somebody they know, somebody with whom they went to school, a previous tie, acquaintance, professor or contact with a senior principal, then an entry-level spot in a major firm is almost impossible to garner. Nonetheless, it's the in-depth experience in deals, transactions, industry, corporate finance, and firm valuation that new graduates covet and need--and don't get if the doors are shut.

Signs indicate that with support from respected people like Horowitz, people who bark and insist that opportunities be made available to a wider community, some of these venture-capital doors might crumble. Horowitz, by the way, has announced that his portion of the proceeds of the book's sales will go to women's programs.


Consortium students and graduates for years have expressed interest in venture capital and private equity, even if they know they will encounter obstacles in getting inside.  They know they can't raise hands, express an interest, prove talent and experience, and then expect job offers to flow in.

Some have gotten the chance to work at big-name firms (Carlyle, Kleiner Perkins, Sequoia, and Blackstone are examples of "big names"), regional firms or firms that specialize in an industry niche or geography (real estate, manufacturing, consumer goods, the Sun Belt). Because of obstacles or because they were discouraged, others simply decided to pursue more welcoming and more familiar sectors in finance.

And then some try the boldest of tactics. They have gone off on their own to form their own small private-equity or venture-capital companies. (Capital A Partners and Romherst Capital are examples of private-equity companies launched by Consortium graduates.) They opted for the toughest road with the greatest challenges, but possibly with the best experiences and maybe with superb performance and returns--and a chance one day to bring others like them into the fold.

Horowitz, needless to say, would be pleased with these kinds of efforts.

Tracy Williams

See also:

CFN: Venture Capital Diversity Update, 2011
CFN: Knocking Down Doors in Venture Capital, 2012
CFN:  Making Demands on Diversity, 2013
CFN:  MBA Diversity:  A Constant Effort to Catch Up, 2012