Thursday, July 31, 2008

CEO and Chairman Out at Alcatel-Lucent

CEO and Chairman Out at Alcatel-Lucent

On July 29, shareholders in telecommunications equipment giant Alcatel-Lucent (ALU) finally got what many have been demanding for months: the resignations of Chief Executive Patricia Russo and Chairman Serge Tchuruk. Russo, the former boss of Lucent Technologies before its 2006 merger with Alcatel, said she'll step down before the end of the year, while former Alcatel chief Tchuruk will leave Oct. 1. "The company will benefit from new leadership aligned with a newly composed board to bring a fresh and independent perspective," Russo said, in announcing the changes, which will include a downsizing of its 14-member board.

The telecom gear maker's latest quarterly results, also issued July 29, underscore just how tough a job the new leadership team will face. Alcatel-Lucent posted a $1.7 billion quarterly loss, including a $1.3 billion writedown on the North American wireless business inherited from Lucent. Quarterly revenues were down 5.2% year-on-year, to $6.5 billion, and the company warned that spreading economic malaise in Europe could further dampen sales. "We may see some weakness in spending" by fixed-line phone and broadband operators, traditionally a strong business for Alcatel-Lucent, Russo said in a conference call with journalists and analysts.

Alcatel-Lucent shares, which have sagged 60% since the merger, remained largely unchanged in July 29 trading after the news. The $27.5 billion company hasn't posted a profit since the merger.

A Tricky Transatlantic Merger

What went wrong? Can it be fixed? And if so, who can fix it? Although Alcatel-Lucent characterized the departures of Russo and Tchuruk as the end of a "transitional phase," the move reflects deep disappointment in a merger that both promised would create a global powerhouse. "We were not very keen on the rationale behind the merger in the first place, and we've been disappointed with the progress management has made in executing it," says Richard Windsor, a London-based analyst with Nomura International.

Or, as French newspaper Le Monde succinctly put it in a front-page headline on July 29: "The resignation of Alcatel-Lucent's top executives signals their failure."

Like other makers of telecom equipment, Alcatel-Lucent has been clobbered by slowing economies—as well as by brutal price competition from newcomers such as China's Huawei Technologies. But it has been further handicapped by the difficulty of carrying out a tricky transatlantic merger (BusinessWeek, 6/18/08).

Hinting at Board Changes

New management and a revamped board won't improve the overall market situation. But industry-watchers predict the company will bring in a CEO and new board members with few ties to either Alcatel or Lucent. That could help clear away the entrenched interests and Franco-American politicking that have weighed on the company. "It is clear something fundamental has to happen," says a top European telecommunications executive who knows Alcatel-Lucent well.

Although the company didn't give details, it hinted at forthcoming board changes in announcing that Henry Schacht, a former Lucent chairman and CEO, would immediately step down. Until now, the board has been carefully balanced between ex-Alcatel and ex-Lucent representatives.

  • A Tepid Welcome for AIG’s Boss
  • Jobs: The Slump Stretches into Summer

    Jobs: The Slump Stretches into Summer

    The U.S. labor market likely remained in the doldrums in July. The government's employment report for the month, scheduled for release Aug. 1, looks poised to extend the patterns of the first half of the year.

    Both Action Economics' own forecasts and the median forecasts of economists imply a near-repeat of the June nonfarm payroll figures. We expect nonfarm payrolls to fall 60,000 (vs. economists' median forecast of a 65,000 decline), while the unemployment rate holds at 5.5% (median 5.6%), average hourly earnings rise 0.3% (0.3%), and the average workweek is unchanged at 33.7 hours (median 33.7).

    The mix of payrolls by industry should continue to show weakness led by goods-producing industries, with restrained gains in service sector employment.

    Still Weak, but Little Further Deterioration

    Looking at the other labor-market reports that inform our forecast, the ADP employment survey released July 30 revealed a 9,000 rise in private payrolls in July that signals some upside risk for the July employment report. But, given the enormous recent overperformance of the ADP figures relative to payrolls, the upside ADP surprise is hard to interpret.

    The weekly initial jobless claims data and continuing claims figures have been affected by auto-industry retooling in July, though the four-week averages imply a sideways trend in job market conditions since June. The labor market is still in a weakened state relative to where it was before financial market turmoil began last August, but claims imply little further deterioration in recent months. Overall, the 50,000-60,000 rise in initial claims since the middle of last year is much smaller than the 100,000-150,000 rise that would normally be expected in a recession.

    The Michigan consumer sentiment survey and the Conference Board's consumer confidence survey have both bounced in July, with gas prices finally subsiding following the record run in the first half of the year. The June Michigan survey dropped to the lowest level since May, 1980, while the June Conference Board survey dropped to the lowest level since March, 1992. Thus, the bounce in July still leaves this series at historically depressed readings that have only been seen previously in recession.

    Other Employment Numbers Down

    As such, these figures probably still suggest weakness in payrolls, as confidence declines historically are correlated with a weakening labor market. Soaring gasoline prices and recent declines in the stock market are likely the primary drivers of plummeting confidence in recent months.

    The employment components from the various factory sentiment surveys have deteriorated further in July. The Empire State employees index came in at -6.3 from 1.2, while the workweek fell to -8.4 from -2.3. The Philly Fed employees index fell to -7.3 from -6.9, while the workweek fell to -12.5 from -8.9.

    The Chicago purchasing managers' employment index will be released ahead of the July employment report on July 31, while the Institute for Supply Management employment index will be unveiled after the jobs report on Aug. 1. Of particular concern is the drop in the June nonmanufacturing ISM employment component to 43.8 from 48.7, which marks a new all-time low for the history of the series (dating back to July, 1997).

    Expect the Fed to Keep It Steady

    As for the impact on the Federal Reserve, the August jobs report should prove weak enough to prevent the central bank from significantly boosting its disproportionate focus on inflation risk at its Aug. 5 policy meeting, and we continue to expect policy to remain on hold through the November elections. Yet, the report should not be weak enough to prevent Fed inflation hawks from continuing to highlight inflation risks in public statements, leaving ongoing pressure on the FOMC to take back at least some of the recent jumbo easing moves at some point soon after November.

  • AT&T Earnings Give Hope to Telcos
  • Beijing Olympics: The Buildings

    Beijing Olympics: The Buildings

    National Stadium lies beyond Beijing's Fourth Ring Road, at the northern end of the imperial axis that cuts through Tiananmen Square and the Forbidden City. But it can be seen almost everywhere in the capital. Billboards, magazines, television ads, soda cans, clothes, hats, and ashtrays bear the likeness of Herzog & de Meuron's woven-steel building, reflecting the propaganda, marketeering, and pure fascination that surround the city's Olympic centerpiece. In a place where architectural feats tend to attract puzzlement, if not ridicule (locals use "The Egg" with a derisive tone when referring to Paul Andreu's National Performing Arts Center), the $423 million stadium has become a rare architectural celebrity. Everyone calls it the "Bird's Nest," which in China means it is something much prized, an expensive delicacy eaten on special occasions.

    Jacques Herzog and Pierre de Meuron, along with their project architect Stefan Marbach, developed the stadium's distinctive design in close collaboration with a number of key Chinese players. Artist Ai Weiwei, a provocateur who famously shattered a pair of ancient Han Dynasty vases in one work, showed the architects how he manipulates old and new, and contributed ideas throughout the design process. "We learned how radical Chinese art has become," recalled Herzog at a lecture at Columbia University in May.

    Another important guide was Li Xinggang, the chief architect of China Architecture Design and Research Group (CADG), the local design institute with which Herzog & de Meuron worked. At their first design meeting in Basel in 2003, Li suggested that the Swiss architects move away from the delicate facades for which they had first become known. "Until then, the entire architectural discipline had the impression of Herzog & de Meuron as the ‘skin' architects," said Li. "In my opinion, if they had submitted this kind of design for the competition, they would have been denied by the Chinese people," he said. "China wanted to have something new for this very important stadium." The architects weren't interested in repeating the past either. "We don't want to be typecast," stated Herzog, "so we are always trying to escape our biography."

    The design team began by studying Chinese ceramics. "We wanted the stadium to be a collective building, a public vessel," explained Herzog. But they also wanted it to be "porous," open to its surroundings. So they explored the idea of a bowl with no skin, which eventually led them to the nest scheme. At the time, Herzog & de Meuron was starting to build Allianz Arena, a soccer stadium in Munich with a translucent ETFE (ethylene tetrafluoroethylene) envelope that wraps around an elliptical frame. For the Olympic stadium, the architects went in the opposite direction, using an exposed structure, rather than a dramatic skin, to define the building's form.

    Although the stadium's curving steel nest grabs the most attention, the building actually combines a pair of structures: a bright-red concrete bowl for seating and the iconic steel frame around it. Sight lines from the seats to the playing field helped determine the form and dimensions of the concrete bowl, while the need to include a heavy retractable roof (a requirement in the competition brief) informed the giant crisscrossing steel members on the outside of the building. Because the architects disliked the massive parallel beams necessary to support the retractable roof, they developed a lacy pattern for the other steel elements to disguise them. In the process, they created a structure that seems random and nonrepetitive. "We're interested in complexity and ornamentation," said Herzog, "but of the kind you would find on a Gothic cathedral, where structure and ornamentation are the same." For Michael Kwok, the director at Arup in charge of the project, the design was gratifying. The structure may seem complicated, but it "expresses the engineering beneath it," explained Kwok.

    View the BusinessWeekslide show of innovative structures built in Beijing for the 2008 Summer Olympic Games.

    With reporting by Clifford A. Pearson.

  • China’s Pre-Olympics Media Clampdown
  • Sunday, July 27, 2008

    They Know What's in Your Medicine Cabinet

    They Know What's in Your Medicine Cabinet

    That prescription you just picked up at the drugstore could hurt your chances of getting health insurance.

    An untold number of people have been rejected for medical coverage for a reason they never could have guessed: Insurance companies are using huge, commercially available prescription databases to screen out applicants based on their drug purchases.

    Privacy and consumer advocates warn that the information can easily be misinterpreted or knowingly misused. At a minimum, the practice is adding another layer of anxiety to a marketplace that many consumers already find baffling. "It's making it harder to find insurance for people," says Jay Horowitz, an independent insurance agent in Overland Park, Kan.

    The obstacle primarily confronts people seeking individual health insurance, not those covered under an employer's plan. Walter and Paula Shelton of Gilbert, La., applied to Humana (HUM) in February. They were rejected by the large Louisville insurer after a company representative pulled their drug profiles and questioned them over the telephone about prescriptions from Wal-Mart Stores (WMT) and Randalls, part of the Safeway grocery chain, for blood-pressure and anti-depressant medications.

    Mental Health Is a Red Flag

    Walter Shelton, a 57-year-old safety consultant in the oil and gas industry, says he tried to explain that the medications weren't for serious ailments. The blood-pressure prescription related to a minor problem his wife, Paula, had with swelling of her ankles. The antidepressant was prescribed to help her sleep—a common "off-label" treatment doctors advise for some menopausal women. But drugs for depression and other mental health conditions are often red flags to insurers.

    Despite his efforts to reassure Humana, the phone interview with the company representative "just went south," Walter recounts. He and his wife remain uninsured.

    "I want to know what's in there if there's a black mark against us," Walter says. Paula, 51, adds: "We can't get health insurance because we're taking medications that were prescribed by our doctors. I don't think that's right."

    A spokesman for Humana says the company uses "data regarding pharmacy history as part of our assessment process." But he adds that the insurer has a policy of not commenting on particular cases, such as the Sheltons' failed application.

    FTC Investigation

    Traditionally, applicants have been asked to provide insurers with a description of past illnesses. About 30% are deemed uninsurable because of their histories, according to industry veterans. Prescription profiles could add another hurdle, making it especially difficult for the 47 million Americans who lack insurance to acquire coverage. Some 18 million people are now covered by individual policies.

    Most consumers and even many insurance agents are unaware that Humana, UnitedHealth Group , Aetna (AET), Blue Cross plans, and other insurance giants have ready access to applicants' prescription histories. These online reports, available in seconds from a pair of little-known intermediary companies at a cost of only about $15 per search, typically include voluminous information going back five years on dosage, refills, and possible medical conditions. The reports also provide a numerical score predicting what a person may cost an insurer in the future.

    An investigation last year by the Federal Trade Commission found that the two companies supplying these pharmacy profiles—MedPoint and IntelliScript—violated federal law for years by keeping the system hidden from consumers. But the FTC has merely required disclosure if prescription information causes denial of coverage or some other adverse action; the agency imposed no penalties. MedPoint and IntelliScript say they are now fully complying with the FTC's order.

    Two-thirds of all health insurers are using prescription data—not only to deny coverage to individuals and families but also to charge some customers higher premiums or exclude certain medical conditions from policies, according to agents and others in the industry. Some carriers are also using the data to charge small employers higher group rates. Separately, some 20% of life insurance companies are relying on prescription histories when reviewing applications, according to experts in that business.

  • Big Pharma: What Safe Haven?
  • Wal-Mart, Your Friendly Drugstore
  • Doctors Under the Influence?
  • Reverse Logistics: From Trash to Cash

    Reverse Logistics: From Trash to Cash

    There's no place on a company's balance sheet for garbage, so most executives don't think much about it.

    But with oil and other commodity prices surging, some companies are reconsidering trash. They recognize that used-up products are the sum of their raw materials, energy, and labor: With another wring of the sponge, more value can be extracted. So they're essentially running their supply chains backward, a process called "reverse logistics."

    Genco, a privately held company in Pittsburgh, has lately seen brisk reverse-logistics business. It helps retailers such as Best Buy (BBY), Sears (SHLD), and Target (TGT) find buyers for products that are returned as defective or broken and would otherwise be landfill fodder. A recent KPMG study suggests companies can recover up to 0.3% of annual sales this way. (That's $100 million in the case of Best Buy.) Genco has even spun out a reject-pile brokerage business, called Genco Marketplace, that connects sellers and buyers with $5 million a day in junked goods.

    Some companies are keeping the efforts in-house. Carpet makers Interface and Shaw Industries collect used-up materials to feed back into production. The hurdles have been numerous, they say, but both expect to enjoy cost advantages over others that produce from scratch.

    Outdoor gear maker Patagonia is one of the most ambitious reverse-logistics pioneers. Its Synchilla Vests consist of fiber recaptured from old fleeces and T-shirts—even those sold by rivals. Customers drop worn duds at a Patagonia store or mail them to a distribution center. A subcontractor turns them into new fibers. More than 90% of the fabric is spun into new clothing, says Patagonia; the rest becomes a cement additive.

    Patagonia concedes that its process costs more than virgin polyester, but there's an environmental mandate from Yvon Chouinard, Patagonia's founder and majority owner. "[He] really wants us to plan for the end of oil," says spokeswoman Jen Rapp. For most companies, though, it's all about money. "The real value of reverse logistics is turning trash into cash," says Curtis Greve, a Genco senior vice-president. There's a clear spot on the balance sheet for that.

  • Finding Strong Stocks in a Sickly Market
  • AT&T Earnings Give Hope to Telcos

    AT&T Earnings Give Hope to Telcos

    Concern over how big a toll the U.S. economic slump will take on telecom service providers abated when AT&T (T) announced second-quarter results that met analysts' forecasts. The numbers buoyed confidence in how well other U.S. phone companies will weather the economic storm and indicated that recent telecom share declines may be overdone.

    Early on July 23, AT&T said second-quarter net income jumped 30%, to $3.7 billion, as operating revenue rose 4.7%, to $30.86 billion. It also reported adjusted operating margins of 37.3%, beating the expectation of some analysts, including John Hodulik of UBS (UBS), who forecast a margin of 36.7%.

    Tough, Competitive Market

    Sure, some of the strength came from cost cuts, and the economic slowdown is crimping demand for some services, including high-speed Internet access. But AT&T was able to offset weaknesses through ongoing demand in such areas as wireless calling. "While the macroeconomic environment remains challenging, our business is more resilient than most," AT&T Chief Financial Officer Rick Lindner said during a conference call discussing the results. AT&T shares rallied 4.1% on the news. Verizon (VZ), the second-largest U.S. phone company, gained 3.3%.

    Before AT&T's report, there had been plenty of reason of late to sell telco shares. "Recent data points to greater-than-expected pressure from the economy and wireless competition, causing us to lower our estimates," Goldman Sachs (GS) analyst Jason Armstrong wrote in a July 14 report. The investment bank lowered its AT&T price target to $42 and removed the stock from its Americas conviction buy list of favored stocks. Pessimism toward the telecom industry was validated July 22 when Vodafone (VOD), the world's largest mobile-phone service provider, trimmed its sales forecast (, 7/22/08), citing a difficult "macroeconomic and competitive environment."

    The turmoil has led to big declines in telecom shares. Before July 23, AT&T stock had dropped 20%, to 31.82, since early May. Over the same time Verizon shares had declined 12%, to 34.68.

    Wireless Is Holding Up

    But now, some analysts say telecom stocks may be undervalued. "They will be impacted" by economic malaise, says Todd Rosenbluth, an analyst at Standard & Poor's, which, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP). "We just think the stock market has more than reflected these challenges." S&P, which has a strong buy on Dallas-based AT&T, expects the company's shares to rise to $42 in 12 months. The company has a buy on shares of New York-based Verizon.

    Even as consumers cut back spending in some areas, they're holding on to telecommunications services, according to recent research by JupiterResearch. In a June survey of 3,730 consumers, Jupiter found that only 2% said they would unplug home broadband connections due to economic pressures.

    Demand for wireless is holding up particularly well. Sales of mobile-phone calling rose 16% in the second quarter, AT&T said. The company also said its level of churn, or the average monthly pace of customers' service cancellations, fell to 1.1%, its lowest level ever. On July 22, Verizon reported it added 1.5 million wireless subscribers in the second quarter, beating the forecasts of some analysts.

    Landlines Untethered

    Revenue from data services is also surging. AT&T's wireless data sales rose 52%, to $2.5 billion, in the quarter. And that could be just the beginning: About 18% of AT&T's customers use devices like the Apple (AAPL) iPhone, which provides Web access, and these users typically end up generating twice the average revenue per user. Meanwhile, in the few days since the new iPhone 3G went on sale July 11, AT&T has seen double the iPhone sales vs. when the first Apple model was introduced a year ago.

    AT&T also said it's on target to reach more than 1 million customers with its U-verse TV offering by yearend. In the second quarter, the company gained 170,000 U-verse subscribers, bringing the total to 549,000.

    Bright spots notwithstanding, telecom companies aren't out of the woods. AT&T added 46,000 broadband users in the second quarter, compared with 400,000 a year earlier. The pace of landline service cancellations quickened, rising to 8.1% in the quarter. And concern over the economy may cause consumers to switch off nonessential communications services, such as TV. In the Jupiter survey, 12% of consumers said they would consider cutting premium TV channels.

    For now, the big telecom providers will keep banking on the wireless and data services to get them over the rough patch.

  • RIM Shares Hammered
  • Marcial: Two Thumbs Up for RIM
  • Chinese Telecom: Who Wins, Who Loses?
  • Friday, July 25, 2008

    Marcial: Betting on a Buyout at MGM

    Marcial: Betting on a Buyout at MGM

    Las Vegas sizzles in the summer, but casino stocks haven't been so hot. In fact, they have been losers all year, and MGM Mirage (MGM), whose shares have crashed from $73 in February to a 52-week low of 21.65 on July 15, has been among the big casualties. But since then its stock has developed some oomph, vaulting to 32.76 on July 23.

    The rally in the stock is surprising because MGM—which owns the Mandalay Resort Group (acquired in 2005), plus 10 casino-hotels on the Vegas Strip and a joint-venture partnership in the Borgata casino-hotel in Atlantic City—is far from being a favorite on the Street. Of the 22 analysts who follow the company, 13 rate the stock a hold and three recommend selling it. Only six analysts rate it a buy.

    So what's going on at MGM?

    One pro sees a possible buyout. It's no secret that MGM has attracted the fancy of Dubai, which has acquired a 10% stake through its Dubai World group. The average price that Dubai paid for its 30 million shares, which it bought in the last 12 months, is about $85 each. The biggest stakeholder in MGM is activist investor Kirk Kerkorian, who has accumulated some 54% of MGM, or about 150 million shares. The other big stakeholders include Marsico Capital Management, which owns about 5.8%; Private Capital Management, with 3.8%; and Capital Research Global Investments, with 2.9%.

    Dubai, Private Equity Might Team Up

    "With the stock trading at such a discount, notwithstanding the rally in the past few days to 30 a share, there is a strong likelihood that a buyout offer for MGM at about 50 a share will surface," says Stuart Shikiar, president of Shikiar Capital Management, which owns shares. Kerkorian, he notes, is now 91 and may be looking for a profitable exit from the stock. Given that Dubai paid a lot more for its stake, it may be thinking of doing a deal with MGM and Kerkorian for a buyout, says Shikiar. He figures that excluding the shares now held by Kerkorian and Dubai, the number of shares in public hands totals 125 million. At $50 a share, the amount needed to take MGM private, estimates Shikiar, is $6.2 billion.

    With MGM's cash flow of $2.3 billion, a deal to take the company private at $6.2 billion is definitely attractive and doable, he says. MGM posted revenues of $7.7 billion and net income of $1.4 billion, or $4.70 a share, in 2007. Of late, the company has been busy buying back stock. In the fourth quarter of 2007, it repurchased some 7 million shares at $90 each, followed by another purchase of 15 million shares in the first quarter of 2008 at $80 a piece. It repurchased another 7 million shares subsequently at an average cost of $72. And in May it bought back 20 million additional shares, at $61 each.

    Who would go after MGM? Shikiar believes Dubai World, probably in partnership with some Asian investors and U.S. private equity groups, may decide to pursue MGM in a nonhostile manner. Dubai has struck a standstill agreement with MGM to limit its stake to 20%. So any deal will have to be mutually agreed on between Dubai and MGM's board. Foreign investors are limited to a 15% ownership in U.S. casinos, notes Shikiar, which means that Dubai and other foreign investors will have to team with U.S. private equity groups or investors to swing a deal.

    Kerkorian could be part of a group that might propose to buy MGM, says Shikiar. Apart from its 10% stake, Dubai also bought a 50% joint-venture interest in MGM's Project CityCenter development in Las Vegas. It plans to build and develop hotels and casinos, scheduled to open in late 2009, on 87 acres of land that it owns adjacent to the Bellagio Hotel.

    MGM did not return calls for comment. Dubai World and Kerkorian could not be reached for comment.

    MGM Mirage: Undervalued?

    Shikiar isn't the only one who thinks MGM is undervalued. "The current stock price grossly undervalues MGM's assets and future projects," says Lawrence Klatzkin, an analyst at investment firm Jefferies (JEF). He has a buy rating on the stock, with a 12-month target of $102. "MGM is one of our top three picks, as it continues to develop into a diversified leisure company with limited cash needs," says Klatzkin.

    But Klatzkin doesn't think Kerkorian is looking for an early exit, although he concedes that at some point he may want to do a deal. "Kirk is a very young 91 and very active, and looks like he enjoys doing what he is doing," he says. If there is a deal, it won't be soon, the analyst predicts. But a buyout could happen in the future should Kerkorian decide to retire, says Klatzkin.

    Deal or no deal, the Jefferies analyst believes Dubai is "more positive on the company now than ever before." MGM, he adds, is a great investment, with its 1,300 acres of Las Vegas Strip property and other land, which Klatzkin values at $87.5 billion.

    Indeed, banking on a buyout at MGM may be risky for investors. But looking at the potential players, the prospects of a deal look like a pretty good bet considering that on fundamentals alone, MGM Mirage is a solid, underpriced asset.

  • Marcial: BioSante May Be Buyout Bait
  • Nobody Loves a Three-Year-Old SUV

    Nobody Loves a Three-Year-Old SUV

    Auto executives just can't catch a break. Add to slumping sales and lofty gasoline prices a ticking time bomb in their auto leasing operations. During the past several years automakers from General Motors (GM) to Nissan Motor (NSANY) to BMW leased millions of cars and trucks. As those leases end, the companies have to take back the vehicles—many of them the gas-guzzling SUVs, pickups, and luxury models people don't want anymore. You know what that means: more pain as the automakers offload those vehicles at a loss.

    Art Spinella, president of CNW Marketing Research, estimates that this year alone the industry will lose $4.7 billion on sales of previously leased SUVs. "This caught everyone by surprise," he says. And it's a problem that will keep on giving because many automakers only recently started to write fewer leases. So there are plenty of newly leased gas-guzzlers out there, some with terms as long as 39 months. Spinella sees $10 billion more in lost value as thousands more SUVs come off lease in 2009 and 2010.

    When automakers calculated lease terms three years ago, they assumed the cars and SUVs would be worth much more once the lease ended than they are. But resale values on large SUVs have fallen 13% from March through May, with some pickups dropping more than 20%, according to Manheim, the nation's largest used-vehicle wholesaler. Knowing the value has plunged, consumers aren't extending leases on many SUVS and aren't keen to buy the vehicles outright.

    That harsh reality is already showing up in carmakers' financial results. In the first quarter, BMW took nearly a $400 million charge for losses on off-lease cars, mostly SUVs in the U.S. GM and Ford (F) have warned that losses from their leasing portfolios will cost them. Ford has said that its usually profitable lending division will lose money this year; GM has hinted that it faces the same issue. Over the next 18 months, GM will incur $600 million in lease-related costs and Ford $1 billion, predicts JPMorgan Chase (JPM)analyst Himanshu Patel. Lehman Brothers (LEH) analyst Brian Johnson thinks their lending arms will write down $1.1 billion and $1.5 billion, respectively. (GM's corporate profits are less exposed than Ford's because its GMAC lending arm, which is 51% owned by Cerberus Capital Management, shares some of the car lease risk.)


    Carmakers aren't the only ones getting spooked. Wells Fargo Bank (WFC) said that, starting at the end of July, it will no longer buy auto leases from carmakers. And investors are sharing the pain, too. Last month, Standard & Poor's (MHP) put nine asset-backed securities packed with auto leases on credit watch for a possible downgrade. Investors holding that paper have already taken a hit.

    Carmakers are doing damage control. BMW has started offering loans at 3.9% to help sell 2005 models coming off lease. A number of other automakers are offering leaseholders deals to buy their SUVs at a discount, says Jesse Toprak, executive director of industry analysts for, which tracks car pricing on the Web. It won't be easy getting drivers to bite in an age of $4 gasoline. But the alternative, sending the vehicles to an auction lot, is even dicier. Carmakers pay $500 or more to get a car ready for auction and have it sold, while auctioned vehicles typically fetch much less than they do at the used-car lot.

    Automakers are still writing leases, but they're offering discounts and rebates to consumers who want to buy SUVs while getting more aggressive with leases for smaller passenger cars. Why? Because prices for compacts and family sedans finally are going up.

  • Alfa Romeo to Return to the U.S.
  • Honda Goes Whole Hog for Hybrids
  • What's Your Port in This Storm?

    What's Your Port in This Storm?


    Harold R. Evensky, President, Evensky & Katz Wealth Management, Coral Gables, Fla.


    $1 million in 10 certificates of deposit (CDs) or money-market funds from Charles Schwab (SCHW) or Fidelity Investments. For the most risk-averse investors, 100% in U.S. Treasury Bills, which currently yield 2.3%.


    Some advisers use 10 or more banks to avoid hitting the $100,000 limit on insurance from the Federal Deposit Insurance Corp. Evensky would put all the cash in one-year CDs from Fidelity or Schwab that yield about 3.8%. If investors need cash in less than a year, he likes Schwab Value Advantage Money Fund (SWZXX) (yield: 2.24%) or Fidelity Cash Reserves (FDRXX) (yield: 2.42%).


    Stephen Cohn, co-president, Sage Financial Group, West Conshohocken, Pa.


    $150,000 Vanguard Short-Term Tax-Exempt Admiral; $150,000 Vanguard Limited-Term Tax-Exempt Admiral; $150,000 Schwab Municipal Money Fund; $95,000 in Vanguard Prime Money Market; three $95,000 CDs from banks such as Schwab, Wells Fargo (WFC), or JPMorgan Chase (JPM); $85,000 in an ING Direct (ING) savings account; $85,000 in a checking account.


    Cohn would spread $450,000 among the Vanguard and Schwab bond funds. Each holds mostly high-rated securities and has low expenses (respective yields: 3.4%, 3.53%, and a tax-equivalent yield of 1.82%). Vanguard Prime yields 2.21%. The remaining money goes into FDIC-insured instruments. Keep CDs to $95,000, since FDIC insurance includes principal and interest. An ING Direct savings account yields 3%.


    Louis P. Stanasolovich, president, Legend Financial Advisors, Pittsburgh


    $200,000 each in Pimco Developing Local Markets (PLMIX); Prudent Bear Global Income (PSAFX); Pimco Total Return (PTTRX); Hussman Strategic Total Return (HSTRX); structured notes, which are custom-designed bonds.


    A mix of bond funds, currency plays, and inflation hedges aims for a portfolio yield upwards of 7%. The Hussman fund offers inflation hedges, while Prudent Bear Global Income and Pimco Local Developing Markets provide exposure to foreign debt. The most esoteric element: custom-designed bonds paired with an options contract (BW—June 30); Pimco Real Return is an alternative choice.

  • Stashing Cash at Higher Rates
  • Thursday, July 24, 2008

    Tough Times for eBay Entrepreneurs

    Tough Times for eBay Entrepreneurs

    Ann Wood was thrilled last January when her eBay (EBAY) store, Willow-Wear, had its best month ever, grossing around $33,000. In February, however, Wood experienced a sharp drop-off in sales. Since 2004, Wood has run the home-based business, listing and selling high-end jewelry, clothing, shoes, bags, and antiques for more than 40 clients around the country. She works four to six hours a day, and had sales of about $250,000 in 2007, she says.

    "I've still got steady sales and I'm making money for my clients," Wood says, "but I've been seeing more caution from buyers on the items priced for $1,000 and over. People are being smart. They're acting like my husband and I are trying to act, which is to be more careful about purchases and not buying everything we want."

    Yet Wood's inventory is growing as her clients scour their closets, hoping to make some extra money selling unused items, and telling their friends Wood can do the same for them. The other bright spot for the former appellate attorney, who became a home-based entrepreneur after her three children were born, is international sales. "A great portion of my stuff is shipped overseas. With the dollar so weak, I've got great deals for people in places like Germany and Italy. I even sold something to Tahiti recently," Wood says.

    "Pay to Play"

    But overall, it's a tough time for entrepreneurs who sell products through online retailers like eBay, Craigslist (BusinessWeek, 4/16/08), Etsy (, 6/12/07), and myriad other sites. It's also tough to get solid financial data on these individuals, many of them hobbyists conducting virtual yard sales in their spare time, rather than serious business owners. "What we know is that probably half of all online retail happens through companies that are smaller than the top 100 e-commerce retailers," says Sucharita Mulpuru, a principal analyst in the retail division at Forrester Research (FORR).

    "I suspect that probably about 60,000 small and medium-size businesses have some sort of Web presence, and another 650,000 sole proprietors are selling through an online marketplace where anybody can upload their product catalogs," Mulpuru says. "I can't imagine that they're doing particularly well in this economy." Small online operations must either sell unique items, such as antiques and collectibles that appeal to niche buyers, or do enough sales volume to keep prices low.

    "The challenge is that if they're sole proprietorships, they will not be particularly well-branded. In order to attract traffic, they have to pay for some interactive marketing program, which adds to their expenses and cuts into their margins," Mulpuru says. "They have to pay in order to play, but many of them don't have the resources to do that."

    That's not to say lots of people aren't trying. A study of eBay market activity released in May shows that in 2007 the top 10 markets in the country—Los Angeles, New York, Chicago, Philadelphia, Dallas, Orange County, Calif., Washington, Houston, Nassau-Suffolk, N.Y., and Fort Lauderdale—generated more than $7 billion, accounting for 55% of all U.S. sales on eBay. In Los Angeles alone, 196,089 residents sold 24,051,645 items for a total of $1.3 billion in sales, with cell phones, cell phone accessories, and clothing the top categories.

  • Should You Tell Clients You Work from Home?
  • Mom-and-Pop Multinationals
  • Entrepreneurs Reinvent the Funeral Industry
  • Should You Tell Clients You Work from Home?

    Should You Tell Clients You Work from Home?

    When Ilene Drexler was laid off as a corporate consultant in April 2004, she decided to launch a professional organizing business, The Organizing Wiz, out of her one-bedroom apartment on Manhattan's Upper East Side. But gaining the trust of potential customers was a challenge at first, in part because she wasn't running her solo operation out of an office building. To compensate, Drexler offered free organizing sessions to friends and family at their homes and offices. It worked. "Their testimonials bridged that credibility [gap]," says Drexler, 47, whose "low six figures" revenue increased 36% from 2006 to 2007.

    Drexler's is one of roughly 16.5 million home-based businesses in the U.S. today, a segment of entrepreneurs who add more than $530 billion to the national economy each year, according to the Small Business Administration. For such operations, one perennial challenge is establishing credibility without the luxury of an office suite or a corporate mailbox. How do these business folk persuade customers that the company can be competitive when the head honcho's desk is five steps away from the head honcho's living room? Moreover, do these entrepreneurs have the responsibility to tell customers they're home-based from the beginning?

    A lot depends on the industry. While Internet businesses can operate out of homes and encounter few customers who know or care that they do so, most companies in fields that rely on regular face-to-face meetings opt for commercial space because of the stigma attached to home offices, say small business consultants and home-based entrepreneurs. Claire Thompson, who launched Sterling Advertising, an ad agency in Pittsburgh, in 2007, remembers one potential client who requested an office meeting, only to find out that the company operated out of Thompson's home. When Thompson suggested meeting at a coffee shop, that was the end of their conversation. "A lot of people want a big showy office and long hallways," Thompson says. "If they're looking for that kind of company, I can't offer them that."

    Don't Create Illusions

    The key, say home-based entrepreneurs, is to be honest. Though owners need not proclaim that they are based at home, they do have an obligation to paint an accurate picture of their company for clients. "You don't have to shoot yourself in the foot by saying, 'By the way, I'm home-based," says Thomas White, the Hilton chairman of business ethics at Loyola Marymount University in Los Angeles. "But don't overpromise in terms of your size or expertise—and make sure people are getting what they pay for." While obtaining an 800 number is a courtesy to customers, giving them the illusion that you're in an office suite is not. White argues that so-called alibi agencies and virtual offices (BusinessWeek, 3/27/08) misrepresent a company's true character.

    "Ask yourself, if somebody found out the truth, would it create a credibility issue?" says Gene Fairbrother, a small business consultant for the National Association for the Self-Employed. Put yourself in the customer's shoes, he says, since the line between appearing classy and being deceptive boils down to common sense.

    To establish credibility, home-based entrepreneurs agree it's necessary to set up a separate business phone line, establish a secluded office space in the home, and invest in a better Web site than the competition's (, 6/9/08). Says Jim Osgood, a 54-year-old broker who operates the commercial real estate site from his home in Sammamish, Wash.: "You don't need to make yourself appear big, but [you do need to appear] professional."

    Pricing Advantage

    Another reason to tout a home location is to show you have lower operating costs. "Most people appreciate the fact that we are running out of our home, because we can offer them a better price," says Sue Grover, of R.H. Grover Tree Service in Carlton, Minn. Grover and her husband, Russell, say that, though their budget is less than their competitor's, customers like the fact that their business is domiciled in the community it serves.

    Above all, entrepreneurs should realize that having an office on Main Street isn't the only way to convey legitimacy. "Fifteen years ago, if you said you were running a business out of your home, everyone thought, 'Oh, you're not real,'" says Fairbrother. "But all of that has changed." The traditional model of an office with a secretary and a conference room is no longer a prerequisite for businesses. What hasn't changed is the recipe for a healthy business: delivering a product or service consistently, whether from the board room or the living room.

    "Don't try to hide it," says Ken Galo, who has run L&K Cleaning Services in Milwaukee since 1999. In considering those who don't want to deal with you simply because the company is home-based, he admonishes: "You wouldn't want them anyway."

    For 10 home-based business credibility dos and don'ts, flip through this slide show.

  • Collecting Money in a Bad Economy
  • What I Did at VC Camp
  • Tough Times for eBay Entrepreneurs
  • Costco Gets Bitten by Inflation

    Costco Gets Bitten by Inflation

    Higher commodity prices finally caught up with Costco (COST), as the Issaquah (Wash.)-based retailer announced that fourth-quarter earnings (for the period ending Aug. 31) would come in well below analyst expectations. But what sent the stock reeling—finishing down nearly 12% to 63.43 on July 23—was Costco's underlying message. With its costs rising, Costco could choose to please either investors by maintaining profit margins or its customers by keeping prices low. It chose its customers.

    Most analysts agree that the giant retailer has a culture of putting its customers well above investors. That's how it has managed to continue opening new stores, growing membership, and driving sales. As the cost of goods rose over the last year, Costco has passed on only a small portion to customers and will continue to do so as long as possible.

    Analysts expected Costco to earn $1 per share in the current quarter. While Costco refused to provide an earnings number, Chief Financial Officer Richard Galanti said on a conference call that it would be at least 5 below expectations.

    "Some [of the shortfall] relates to us consciously holding some key price points on selected items to…help our customers," Galanti said. "We must and will maintain their confidence of what we stand for."

    Shouldering the Burden of Rising Costs

    So far, it seems to be working. Sales are up, as are renewal rates. But Costco left no doubt that rising commodity prices have finally infiltrated consumer goods. While Galanti refused to give numbers, he said that gas sales, which helped drive earnings during the fourth quarter of 2007, have become much less profitable. The cost of freight has gone up as well.

    And while Costco's vendors had been raising prices by 2% to 4% during the earlier part of the year, they're now going up at a 5%-to-10% clip. Costco has tried to avoid sticker shock, but something will have to give. "Right now, they're eating the difference," says Edward Jones retail analyst Stephanie Hoff. "Ultimately, they'll have to pass that on to the customers."

    The question is when. The big price clubs like Costco, Sam's Club (WMT), and BJ's Wholesale (BJ) watch each other closely to see what the others are charging, even sending shoppers into competitors' stores. They're playing a high-stakes game of chicken, and Galanti said he wants to be the last one to raise prices, on the belief that it will help Costco gain market share.

    Sell the Stock? Not So Fast

    But that also means it will take longer to pass costs through to customers. "The risk of not raising prices is your profits get squeezed and you have to make up for it with greater sales," said UBS (UBS) analyst Neil Currie.

    Does that mean Costco's stock is a screaming sell? Not necessarily. In good times, Costco benefits because people are happy and want to spend. But during tough times, the same shoppers turn to Costco to save money. And if inflation is here to stay, it won't just be the usual bargain hunters heading for the stores. Middle- and upper-middle-class shoppers will be looking for value as well, says Piper Jaffray (PJC) analyst Mitchell Kaiser.

    However, the stock isn't a buy, either. Before the July 23 earnings warning, Costco shares had been up 3.2% for the year. While other retailers had been trading at the low end of their multiples, Costco was trading at 23 times 2008 estimated earnings, and even after the July 23 haircut its price-earnings ratio is still above 20. "That's a pretty frothy multiple in this environment," Kaiser said.

  • Is Wal-Mart Stock Peaking?
  • Too Much Money: Inflation Goes Global
  • Wednesday, July 23, 2008

    Anheuser-Busch's Troubled Brew

    Anheuser-Busch's Troubled Brew

    Within the clubby confines of the beer industry, it's an odd coupling, not unlike, say, Angelina Jolie and Billy Bob Thornton or Lyle Lovett and Julia Roberts. InBev (INTB) and Anheuser-Busch (BUD) —which on July 13 succumbed to InBev's hostile bid and agreed to be acquired for $52 billion—couldn't be more different.

    At Belgium-based InBev, Chief Executive Carlos Brito and his team have steamrolled their way through a series of acquisitions that prompted one analyst to call them "machete-wielding investment bankers." To pay for those deals, Brito cuts costs to the bone: The native of Brazil orders his executives to fly coach on most flights, is stinting with standard industry perks like company cars and free beer, and encourages employees to photocopy on both sides of each sheet of paper.

    By contrast, InBev's new bride, Anheuser-Busch, comes to the marriage with expensive tastes. The company has spent lavishly on New Media ventures. There was ESPN in the 1970s and more recently the ill-fated Longtime CEO August Busch III routinely made the 10-mile commute to work by helicopter and once mused whether to buy a castle in Europe for a commercial shoot. His successor and son, August Busch IV, continues the tradition: Employees enjoy free admission to the company's theme parks and get two free cases of beer each month. "I think even the Clydesdales [stabled at Anheuser-Busch headquarters] get better treatment than your average InBev employee," jokes one industry consultant. Executives at Anheuser-Busch and InBev declined comment for this story.

    Steely Leadership

    Brito clearly has a lot riding on his ability to mesh these disparate cultures and realize his vision of creating the "best beer company in a better world," as he put it in a conference call announcing the deal. This 48-year-old executive is known more as a steely operator than motivator, having made his name by developing systems that measured the productivity of everything from the company's breweries to its sales force. In a speech to Stanford MBA students last February, Brito recalled how he once chafed when given a promotion that included oversight of human resources and technology: "For me, sales was everything," he recalled, while a "touch-feely" concept like leadership "was for poets."

    To make his latest deal work, Brito will need all of those tough qualities and more. Of the $52 billion he's paying for Anheuser-Busch, $45 billion is borrowed. That means the combined debt burden for the renamed Anheuser-Busch InBev will work out to a hefty 12.4 times the company's combined cash flow, giving Brito little margin for error.

  • Critics of the Bud Buyout Are Frothing
  • Big Pharma: What Safe Haven?

    Big Pharma: What Safe Haven?

    Pharmaceutical stocks have been rallying of late, buoyed by news of richly priced mergers, including Roche's $44 billion bid for Genentech (DNA) on July 21 and the $7 billion offer by generic drugmaker Teva Pharmaceutical Industries (TEVA), a few days earlier, for rival Barr Pharmaceuticals (BRL). But it's not just consolidation that's drawing investors to drug stocks. Even in the face of unprecedented challenges, ranging from patent expirations on billion-dollar products to an increasingly tough regulatory environment, investors keep piling in. On July 15, the market value of health-care stocks in the Standard & Poor's 500-stock index exceeded that of financial-services firms for the first time since 1992. The American Exchange Pharmaceutical Index is up 4.1% since July 1, while the S&P 500 has dropped 1.7%.

    But amid this pharmaceutical frenzy, investors got a sobering reminder of just how risky it is to be investing in drugmakers. On July 21, Schering-Plough's (SGP) shares—which had rallied 35% in the prior three months—plunged 12% on news that its embattled cholesterol drug Vytorin performed poorly in a clinical trial. The news also pushed down shares of Merck (MRK), which co-markets Vytorin.

    The share declines underscored the risks of flocking to pharmaceutical companies as safe havens in bear markets. Investors often favor drugmakers as an alternative to battered sectors because people generally don't stop taking their prescription drugs when their pocketbooks get squeezed. Most large pharmaceutical companies have healthy cash flows, and they pay generous dividends, even in the worst of economic slumps. What's more, investors can make out fabulously when they place bets on companies that are strong takeover targets: Roche offered a 9% premium over Genentech's previous closing price, while Teva offered to pay 43% more than where Barr's stock had been trading.

    Unfounded Reputation for Stability?

    The drug industry's safe-haven status is coming into question, as even the most basic assumptions about its stability are proving untrue. In the second quarter, the number of prescriptions fell for the first time since the mid-1990s. Polls show that because of rising health-care costs, patients are more apt to skip doses or cut their pills than they were three years ago. And nearly one-quarter of patients report not filling a prescription because of expenses, says the Henry J. Kaiser Family Foundation.

    Add in the long-term threats to the industry, and it starts to look as if cash or perhaps U.S. Treasuries might be a safer investment than drugs. Some of the biggest industry names are facing daunting patent expirations. Pfizer (PFE) will lose its $13 billion-a-year cholesterol blockbuster, Lipitor, to generic competition in 2011. Bristol-Myers Squibb's (BMY) powerhouse blood thinner Plavix, with $5 billion in sales, goes off patent that same year. Merck already lost patent protection for its $3 billion osteoporosis drug, Fosamax, earlier this year.

    Drug companies are trying desperately to come up with substitutes for these big products, but even there, Big Pharma is struggling. Part of the problem is that the Food & Drug Administration has become increasingly picky and cautious. The federal regulator has been rejecting more drugs because of safety concerns or a lack of compelling evidence that they represent a true advance over what's already available. In April, Merck suffered two FDA rejections in three days, including one for a cholesterol drug that analysts had predicted would be a blockbuster.

  • Bulking Up: Japan’s Drugmakers
  • Apple's Forecast Sets Off a Stock Slide

    Apple's Forecast Sets Off a Stock Slide

    News that Apple expects thinner profit margins sent shares of the consumer electronics maker plummeting on July 22.

    The prospect of diminished profitability through the rest of fiscal 2008 and into the following year overshadowed what was otherwise a blowout quarter. Having forecast earnings of $1 a share on sales of about $7.2 billion, Apple (AAPL) delivered earnings of $1.19 a share and revenue of $7.46 billion.

    But investors fixated on the margin forecast. CFO Peter Oppenheimer said gross margins, a key gauge of profitability, will drop below 32% in the current quarter, which ends in September, from 34.8% in the second quarter, which ended on June 30. Gross margins will probably average 30% in fiscal 2009, Oppenheimer told analysts and investors during a conference call discussing the results.

    The prospect of thinner margins is particularly jarring at a time when Apple is selling more Macs than ever. The company sold 2.5 million units of its flagship computer this quarter, a record. Oppenheimer was circumspect in his explanation for the margin forecast. He chalked it up to a "a future product transition that I can't talk about today."

    New Chips, Bigger Screen?

    Apple is typically tight-lipped about coming products until they're ready to be discussed in detail. But analysts inferred that Oppenheimer means cheaper products are on the way. The most likely candidate: Mac notebooks. Rumors of a major revamp of the notebook line, which accounted for 30% of sales in the quarter, have been rife for months. And sales of notebooks are typically strong during the company's fourth quarter, which covers the back-to-school shopping season.

    TBR analyst Ezra Gottheil, in a research note issued after the conference call, speculated that the most likely candidate for a product change is an Apple notebook sporting the latest Intel (INTC) chips. "We believe Apple will refresh its notebooks with the latest Intel Centrino 2 processors, which will improve performance and increase battery life," Gottheil wrote in the note. Apple may also introduce a larger-screen MacBook, he said.

    Why cut prices on the Mac? According to Charles Wolf, an analyst at Needham in New York, the most likely reason is that Apple wants to press its already impressive market-share gains in the PC market. Research firm Gartner (IT) pegs Apple's share of the U.S. PC market in the second quarter at 8.5%, behind Hewlett-Packard (HPQ) and Dell (DELL) but ahead of Acer and Toshiba (6502.T). "Apple rarely cuts prices," Wolf says. "What it usually does is enhance products within a price band. This suggests to me that they're going to drop prices on the MacBook or the iMac and that it will carry a lower gross margin."

    A Juicier Apple TV

    Add the potential price cut on MacBooks, with an already announced back-to-school promotion that involves giving a free iPod to customers who buy a Mac, and you have a recipe for falling margins.

    Apple may also be plotting a revamp of its Apple TV, a device that lets users play video downloaded from the Web, says Gartner analyst Mike McGuire. A major upgrade to Apple TV—say, the inclusion of a much larger hard drive or the ability to record TV shows the way a TiVo (TIVO) does—might eat into margins. So might a substantial expansion of Apple's iTunes Store and online rental capacity, which would force Apple to buy more servers and more Internet-serving capacity. Recent moves involving online movie-rental service Netflix (NFLX) and its partnership on a set-top box with electronics concern Roku, McGuire says, might be spurring Apple into action on this front.

    Shaw Wu, an analyst at American Technology Research in San Francisco, suggested that prices of materials Apple uses in its products—aluminum and plastics—may be on the rise. Oppenheimer and COO Tim Cook said pricing on components like flash memory and LCD screens are "favorable," while prices on DRAM computer memory are likely to increase in line with higher seasonal demand in the second half of the year. "Everyone knows Apple is typically very conservative in its guidance, but given the way the markets are now, people are taking it at face value and assuming the worst," Wu says. "Right now there are just so many unknowns."

    The Steve Question

    Another unknown for some observers centers on the health of CEO Steve Jobs, who in 2004 was successfully treated for pancreatic cancer. During the conference call an analyst asked whether Jobs had taken ill again. Oppenheimer was dismissive. "Steve loves Apple and serves at the pleasure of Apple's directors," he said. But "Steve's health is a private matter."

    Piper Jaffray (PJC) analyst Gene Munster found the response "un-comforting," but reckons the company would say more if there was reason for doubt. "If there was anything he knew about [Jobs'] engagement being in question, I think they would have said something," Munster says.

    But analysts were mainly focused on margins—and felt a chill from Apple's remarks. Word of slimmer expected profits hammered the stock in extended trading. On July 22, it dropped $16.40, or almost 10%, to $149.89. The rout got under way the day before, in extended trading, after the results were released.

  • RIM Shares Hammered
  • Marcial: A China Play Beyond the Olympics
  • The iPhone’s Impact on Rivals
  • Tuesday, July 22, 2008

    The Future of Fannie and Freddie

    The Future of Fannie and Freddie

    Fannie Mae (FNM) and Freddie Mac (FRE) have never seemed more indispensable than in the current credit crisis. They are the last nongovernmental players standing in the business of buying mortgages. On July 15, Treasury Secretary Henry M. Paulson Jr. asked Congress for unlimited authority to lend to them to reassure markets of their creditworthiness. He compared the requested credit line to a bazooka he hopes will never have to be used.

    Oddly, though, the very fact that policymakers are bending over backwards to protect Fannie Mae and Freddie Mac makes it all the more important to talk about whether they should, in the long run, live or die. When this crisis is over, should these quasi-public, shareholder-owned companies be nationalized? Privatized? Closed down entirely? Or left essentially intact, except perhaps with smaller portfolios and tighter regulation? The emerging debate will sweep up a wide range of issues, from Fannie and Freddie's implication in the housing bubble to national competitiveness.

    It may seem premature to plan for a restructuring in the middle of an emergency, but short-term fixes could have harmful consequences if they wind up being permanent. Peter D. Schiff, the head of brokerage Euro Pacific Capital, says Paulson's "bazooka," by propping up Fannie and Freddie, would allow them to buy "more mortgages on overvalued homes," with U.S. taxpayers and foreign dollar holders ultimately picking up the tab.

    Questions about the proper role of Fannie Mae and Freddie Mac have come to a head because the companies lost the confidence of investors at the moment they were most needed—when other mortgage buyers had gone on extended holiday. The Treasury Dept. and Federal Reserve made emergency statements of support on Sunday, July 13, for fear that without their explicit backing the firms might not be able to keep raising money. Worries that a potential government takeover or restructuring would wipe out shareholders have driven the two companies' stock prices down nearly 90% over the past year. The market consensus now is that the two companies don't have the resources to survive a severe market downturn without government backing.

    The fate of Fannie and Freddie is hugely important because the two have grown to dominate the U.S. mortgage market. Fannie dates back to the Depression year of 1938; Freddie to 1970. Although they don't originate loans, they own or insure about 40% of the $11 trillion in residential mortgages in the U.S., according to Inside Mortgage Finance, a trade publication.

    From an economic perspective, the chief complaint is that Fannie and Freddie exacerbate swings in the housing market instead of dampening them. In the boom that began around 2000, Fannie and Freddie formed a critical link in the transfer of savings from countries like China and Japan to home buyers in America. They packaged their debt conveniently to resemble U.S. Treasuries, and although the debt didn't carry the explicit backing of the government, many foreign buyers assumed—correctly, it turns out—that the government wouldn't let Fannie and Freddie default. China alone owned $387 billion of securities of Fannie Mae, Freddie Mac, and other government-sponsored enterprises as of mid-2007, or 27% of the total owned by all foreign countries.

    Homes But No Jobs

    In short, Fannie and Freddie were not just passive bystanders in global capital flows. Says Brad W. Setser, a fellow at the Council on Foreign Relations: "The agencies became a mechanism that allowed the U.S. to transform a pool of mortgages, which wouldn't be a classic central bank asset, into a set of assets that foreign central banks found attractive." It's possible, says Setser, that if not for the two companies, more foreign money might have gone into corporate bonds. That would have meant more investment by U.S. companies in capital equipment—and less in housing, which does little to boost U.S. competitiveness. As it is, too many Americans have beautiful homes but no jobs.

    When the bust came, Fannie Mae and Freddie Mac kept packaging mortgages for sale even after others had gotten out of the business. But they were also losing money. And because they were thinly capitalized, it didn't take big losses to make investors worry about two stocks long viewed as bulletproof.

  • Builders: Give Home Buyers a Tax Credit
  • Are P-E's Past Their Prime?

    Are P-E's Past Their Prime?

    The price-earnings ratio is a popular tool for investors. But these days, as both prices and earnings fluctuate rapidly, the p-e tool is getting extra attention because it tries to answer a key question: With the broad Standard & Poor's 500-stock index down almost 20% from its October peak, are stocks cheap enough to make them a great bargain for long-term investors?

    Fueling the debate over p-e's, the same stock can look cheap or expensive, depending on how the p-e ratio is determined. The p-e ratio is calculated by dividing a stock's price (or the value of an index) by its annual earnings. A high p-e can be a sign that a stock is either overvalued or poised for stellar growth. A low p-e can be a sign of a stock that is a good long-term value—or a sign of a company in trouble.

    While a stock's price is easy to determine, earnings are harder to measure. Some investors prefer forward earnings, often determined by analyst estimates for earnings of the next 12 months. The problem is that analysts are often wrong, as they have been about financial stocks over the past year. "No one has a perfect crystal ball," says Brian Reynolds, chief market strategist at WJB Capital Group.

    Is "E" Trustworthy?

    For investors looking for more certainty, trailing earnings are preferred. This measure of earnings, often based on the past 12 months, has the disadvantage of looking backward while the stock market is often looking forward, trying to predict future trends. Trailing p-e's "won't tell you much about turning points," Reynolds says.

    In either case, investors need to determine how much they trust the "e" in the p-e ratios.

    Until a year ago, the market had learned to expect large earnings from financial stocks. Little did investors know how fragile those earnings were. With firms relying so much on subprime loans and other questionable debt, "those earnings have gone away forever," says John Merrill, chief investment officer at Tanglewood Capital Management in Houston. "You want to use [p-e ratios] as a starting point, but you want to use a little common sense on how sustainable those earnings are," he says.

    The trailing p-e ratio for the S&P 500, which includes the first of the second-quarter earnings reports, is 16.4, according to Thomson Reuters (TRI). The forward p-e is 12.2. The average p-e since 1935 is 15.8, but stock valuations have been much higher in recent decades, with the average p-e above 20 in the past 25 years. That puts trailing p-e's in a gray area, not obviously cheap nor expensive. The forward p-e of 12.2, however, is cheap by most historical comparisons.

    But that forward p-e includes some ambitious assumptions about where earnings are headed in the next year. After an expected 17.1% fall for earnings in the second quarter, Thomson Reuters says, analysts are predicting an earnings rebound of 12.7% in the third quarter, followed by a 61.5% jump in the fourth quarter, and increases above 30% in the first half of 2009.

    Ashwani Kaul, director of research at Thomson Reuters, points out that these estimates assume a big rebound for financial earnings. "Maybe the banks have turned the corner," he says. Hopes were raised by better-than-expected second-quarter earnings from Citigroup (C), Wells Fargo (WFC), and JPMorgan Chase (JPM). However, "we're not as confident in the 'e' as we were just a year ago, because the analysts have been so wrong on their projections," Kaul says. That makes the stock market jittery despite the low forward p-e ratio.

    A Good Screen?

    With so many questions about the reliability of p-e ratios, there is naturally a lot of debate about how useful p-e's are to investors in picking stocks.

    "I've never found p-e ratios to be a particularly good screen for me," says John Wilson, chief technical strategist at Morgan Keegan. After all, the stocks that do the best in the stock market are those that beat their earnings estimates, he says. Some of the best-performing stocks can have higher p-e ratios, reflecting their better growth prospects.

    Brian Gendreau, investment strategist at ING Investment Management, says p-e ratios are "a very strong and powerful indicator." He adds, though, that p-e's are not a good way of predicting the near future. "Sometimes, the market is cheap because growth prospects are not very good," Gendreau says. "If valuations are inexpensive, they can stay that way for quite a while."

    For example, energy stocks tend to have low p-e's—with the average under 10—because, despite rapid growth from this sector, most investors assume huge profits won't be sustainable when energy prices cool off.

    "Just because something is cheap doesn't mean it's a bargain," Reynolds says.

    Guiding the Long View

    Still, p-e's can be a good guide for investors with a long time horizon. In the past, periods where stocks have low p-e's have been great times to invest, as long as you're not eager for quick returns.

    While valuations are cheap, the broader stock market's recent momentum is "dreadful," Gendreau says. But, he says, p-e's demonstrate that stocks should eventually recover—perhaps in a year to 18 months.

    "If you've got a two- or three-year time horizon, this is an excellent time to buy," Merrill says.

    The concern of many on Wall Street is what happens to prices, earnings, and p-e's over the next year. More financial troubles and an economic slowdown could prove that today's p-e ratios are appropriate or even overly optimistic. But for individual investors with the stomachs to handle a wild ride, p-e's say this might be a good time to buy.

  • What’s Hurting Tech Stocks
  • Is Wal-Mart Stock Peaking?
  • Marcial: A China Play Beyond the Olympics

    Marcial: A China Play Beyond the Olympics

    Chinese stocks have lost much of their allure as they have tumbled from their 2007 peak levels. Even so, the hunt is on for stocks that likely will reap a bonanza from the 2008 Summer Olympics in Beijing, which commences on Aug. 8. That isn't surprising, but the better strategy is to snap up shares of Chinese companies that will remain champs even after the summer extravaganza is long forgotten.

    One such outfit is ATA (ATAI), a leading Beijing provider of computer-based testing services, including career-oriented educational programs. It went public in the U.S. on Jan. 8, 2008, at 9.50 per ADS (American Depositary Share) on the Nasdaq. It has since perked up to 12 for one basic reason: Earnings and revenues are going gangbusters.

    For its fiscal year ended Mar. 31, 2008, ATA's revenues soared 103.6%, to $24.6 million, and operating income totaled $3.7 million, or 17 per ADS, vs. a loss in the previous year.

    "Because of China's booming economy, there has been a greater emphasis on education, and the result is a surge in demand for educational services—including testing programs," says Michael Moe, chairman of investment firm ThinkPanmure in San Francisco, who scouts for growth stocks worldwide. Moe is widely known as the first Wall Street analyst who recommended buying shares of Starbucks (SBUX) before it became a gigantic market winner.

    Moe is convinced that once Wall Street gets wind of ATA's solid fundamentals and strong earnings growth potential, the stock will zoom. Right now, the stock is little followed and still unknown to most institutional investors, notes Moe. He figures the stock will hit 20 or higher in 12 months based on its impressive earnings momentum.

    A Tech Edge Over Competitors

    Investors have yet to grasp the company's vast potential, he adds. For example, there has been an upsurge in the volume of test-takers at China's Ministry of Labor & Social Security, notes Moe. He expects ATA, which has 1,854 authorized test centers located throughout China, has a lot of room to grow. ATA projects that net revenues in 2009's first fiscal quarter will climb between 149% and 161%.

    Scott Schneeberger, an analyst at Oppenheimer (OPY), who rates the stock outperform, says there are more than 100 million test-takers in China each year. And he notes that about 95% of those tests are still paper-based, which presents a significant opportunity for ATA since those tests will likely have to be converted to computer-based tests, which are more cost-effective, scalable, and reliable. He says the company established high barriers to new competitive entrants because of its advanced technological advantage that it has developed over the nine years of its operations. Gross margins from ATA's testing and testing-preparation services, says Schneeberger, range between 60% and 90%.

    Another big bull on ATA is Mark Marostica of Piper Jaffray (PJC), who rates the stock a buy with a 12-month price target of $24 per ADS. He forecasts earnings of 48 per ADS for fiscal 2009 and 69 for 2010. The consensus forecast among analysts is even higher, according to Zacks Investment Research: 54 for 2008 and 79 for 2010.

    With the Chinese stock market currently in a sluggish mode, the strong performance of ATA makes it quite an attractive stock, says ThinkPanmure's Moe. "ATA represents a sensational growth investment idea," he adds.

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  • Sunday, July 20, 2008

    Food Companies: Recipes for Tough Times

    Food Companies: Recipes for Tough Times

    From soup to nuts, these are difficult times for food manufacturers. Spikes in energy prices have pushed up the costs of plastic packaging and transportation, while unprecedented surges in corn and wheat prices have also taken a toll on profits. On the other side are cash-strapped consumers who are reining in spending or switching to cheaper private-label foods in an effort to stretch their paychecks.

    Having already teased out costs through greater automation, shrinking inventory, and tighter logistics, manufacturers are now looking for new ways to improve, or just preserve, profit margins. Although they have no choice but to pass on higher costs to customers, they are now able to do it in smarter ways—by raising prices on only the least price-sensitive items instead of whole product lines or tailoring prices to various levels of demand in local markets, for example. Foodmakers are also tweaking product presentation and packaging in an effort to boost sales volumes.

    The weakened U.S. economy has actually created one benefit for the industry: a consumer shift to home-prepared meals and away from dining out. That's boosting demand for a wider range of specialty ingredients in stores as consumers try to add some restaurant-style pizzazz to home-cooked meals.

    A Return to Home Cooking

    Stephen Sibert, manager of the industry affairs group at the Grocery Manufacturers of America, a consortium of food manufacturers, cites a rise in consumer buying of ingredients as opposed to prepared foods. "There's a real opportunity for retailers and manufacturers to work together to bring that consumer back to the kitchen or back to the pantry, and get that consumer's confidence up again for preparing a multicourse dinner," Sibert says.

    Based on feedback from its more frequent consumer research studies, Campbell Soup (CPB) is creating recipes that include 5 to 10 high-quality ingredients for easy-to-make, nutritional, and low-cost meals, says Mike Salzberg, president of its Campbell Sales subsidiary. Campbell is also doing more to educate consumers about the nutritional value of its V-8 and V-8 V-Fusion fruit-and-vegetable juices. And by working with retailers to reorganize store shelves so shoppers can easily distinguish 100% juices from those with less nutritional value, Campbell is seeing sales rise where they were flat in prior years.

    "When…[consumers] understand more, they tend to purchase more, vs. getting frustrated and not buying at all," says Salzberg.

    In an environment where higher prices are unavoidable, another trend has been to back up price hikes by offering a higher-quality product that stands apart from its broader food category, such as cereals or packaged cheese—a product that warrants a premium price in consumers' eyes. That's becoming easier as consumers' preference for specialty and organic foods grows.

    High-Margin Organic Foods

    Bill Bishop, a principal at Willard Bishop Consulting, a Chicago firm that advises food manufacturers, sees a growing trend to add value to what are basically commodity products based on higher quality that can command higher prices. "If I'm the only guy who makes what you want and you need it to satisfy the needs of your customers, we're going to have a different price conversation than the other 10 [suppliers waiting] in line," he says. Kraft Foods' (KFT) 2% Milk Natural Cheese, made without added growth hormones, and its high-fiber and protein-rich products under the South Beach Living brand are examples of this approach.

    Another potential windfall from offering higher-quality, differentiated products: the chance to grab a piece of the lucrative Gen Y market, which has shown a bigger appetite for specialty, ethnic, and natural foods, according to Experian Research Services in New York.

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  • Honda Goes Whole Hog for Hybrids

    Honda Goes Whole Hog for Hybrids

    TOKYO - With a solid lineup of small cars and superflexible factories that can quickly shift from SUVs to subcompacts, Honda Motor (HMC) has prospered lately. In June the Japanese automaker saw its sales jump by 14% even as its biggest rivals slumped.

    But Honda's satisfaction with its results is tempered by the knowledge that they might have been far better if the carmaker had gotten its hybrid strategy right. While the company was the first major automaker to offer a hybrid in the U.S.—the Insight, introduced in 1999—Honda's efforts have long been overshadowed by Toyota Motor's (TM) success with the Prius. Honda misread what customers wanted, acknowledges research and development chief Masaaki Kato. As a result, the company has sold just 277,000 hybrids to date, compared with Toyota's 1.5 million. Honda stopped making the two-seat Insight in 2006 and last year ditched an unpopular Accord hybrid. Today, the company sells only one hybrid model: a version of the Civic compact. "I must admit that Toyota was better with its strategy of focusing on the Prius and trying to build an environment-friendly image," he says.

    Now, Honda is fighting back. By early next decade, it aims to sell 500,000 hybrids annually, up from just 55,000 in 2007. Next year it expects to offer a new compact in the U.S., Japan, and Europe that, like the Prius, will be sold only as a hybrid. Honda has high hopes for the car, and wants to sell 200,000 units a year eventually. In 2010, Honda will launch a hybrid sportster based on a sleek concept car called the CR-Z that it unveiled at the Tokyo Motor Show in October. That same year, Honda will likely release a new hybrid Civic, and it's planning to market a hybrid version of the Fit subcompact soon thereafter.

    As sales pick up and Honda gets better at making hybrids, the company expects to reduce costs sharply. R&D boss Kato says he can bring the price differential between a hybrid and an equivalent gasoline-only car below $2,000. While not as powerful as Toyota's hybrid technology, the Honda system is lighter and less complex, so its new models may offer better gas mileage. Honda hasn't disclosed pricing, but the compact hybrid due next year could retail for around $18,000-$3,000 less than a Prius, reckons Tatsuo Yoshida, an analyst at UBS (UBS) in Tokyo. He adds that while selling 500,000 hybrids a year will be a challenge, the new cars could also help Honda steal some of the green limelight back from Toyota. "Publicity-wise, the new hybrids are very good news for Honda," he says.


    Honda is less interested in hybrid technology for heftier vehicles. Unlike Toyota, which makes hybrid versions of the Highlander SUV and some large Lexus models, Honda believes cleaner diesel is more appropriate for bigger cars. Next year, it's planning to add diesels to its Acura luxury line. Kato says Honda could introduce larger hybrids in the future, but its lighter hybrid system is less suited to big vehicles than Toyota's technology is. And he says he's skeptical of plug-in hybrids, which can be recharged using home electricity. Battery technology, Kato says, simply isn't ready.

    Honda's rapid hybrid expansion has its risks. First, there's no shortage of potential competition in greener cars. By late 2010, Toyota plans to introduce five new hybrid-only models in the U.S., including a revamped Prius, a minivan, and a new Lexus-some of them plug-ins. "Without focusing on measures to address global warming and energy issues, there can be no future for our auto business," Katsuaki Watanabe, Toyota's president, said at an environmental forum in Tokyo on June 11. European automakers have a slew of new, cleaner diesels in the works, and GM is developing the electric-powered Chevrolet Volt. Even Nissan Motor (NSANY) chief Carlos Ghosn, once skeptical about hybrids, is promising electric vehicles for the U.S. and Japan for 2010.


    Selling more hybrids could also eat into Honda's profits. Small cars typically offer lower margins than bigger vehicles, and adding hybrid technology is expensive. That means Honda will earn less on its new hybrids than it does on most of its current range of models, at least until it can pass on the full cost of the technology to customers. "They're finally getting the strategy right in terms of how they're going to position their hybrids in the market, but do the numbers add up?" asks Andrew Phillips, an analyst at KBC Securities in Tokyo. "They're going to have to be really careful on the cost and achieve their volume targets."

  • Japan’s New Green Car Push
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  • Brussels Throws Another Punch at Intel

    Brussels Throws Another Punch at Intel

    For the past 10 years, U.S. chipmaker Advanced Micro Devices (AMD) has been filing complaints with regulators in the U.S., Europe, and Asia alleging that Intel (INTC) engaged in anticompetitive practices that limit consumer choice. Every time, Intel has responded by painting the charges as nothing more than the gripes of a jealous foe.

    But in Europe, it's not just AMD that is complaining. The Brussels-based European Consumers' Organization (BEUC) also has expressed concern that Intel's practices may be limiting the variety of products offered to consumers—and consequently raising the prices buyers pay for personal computers.

    The BEUC has the ear of the European Commission, and on July 17 the EC's antitrust unit announced it is expanding an investigation of Intel that probes whether the chipmaker has infringed EC Treaty rules on abuse of a dominant position with the aim of excluding AMD from the market. To prevail, the EC must prove not only that Intel's business practices were illegal but also that they hurt consumers.

    Abuse of Power?

    The EC has been investigating Intel since 2005 and has twice conducted dawn raids on the company's European offices (, 7/27/07). In its new "statement of objections"—a formal step in EC antitrust proceedings akin to an indictment—the EC said it is investigating whether Intel provided rebates to Germany's MediaMarkt, an electronics retailing unit of the Metro (MEOG) chain, on the condition that it sell only Intel-based PCs.

    The EC is also examining whether Intel made payments to induce an unnamed computer manufacturer to delay the planned launch of a product line using an AMD microprocessor. And investigators are probing whether Intel provided substantial rebates to that same computer maker on the condition that it buy all of its laptop microprocessors from Intel.

    The EC said in a statement that each of these alleged actions is "considered to constitute an abuse of a dominant position in its own right." It went on to say that it "considers at this stage of its analysis that all the types of conduct reinforce each other and are part of a single overall anticompetitive strategy aimed at excluding AMD or limiting its access to the market." If the charges are found to be true, the EC could order the world's largest chipmaker to alter its behavior or face fines that could total up to 10% of its global revenue.

    Intel said in a statement that it is "disappointed" the EC has expanded its investigation, adding that the latest charges "suggest that the Commission supports AMD's position that Intel should be prevented from competing fairly and offering price discounts which have resulted in lower prices for consumers."

    To Whose Benefit?

    BEUC, the European consumer group, sees it differently. "We are shocked by the reaction of Intel, which is trying to make us believe that its aggressive practices to reduce prices are in consumers' interests," said Monique Goyens, BEUC's director general, in a statement released on July 18. "On the contrary, the main effect of these practices is to drive rivals out of the market in the long term, to the detriment of consumers."

  • The Mac in the Gray Flannel Suit
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  • Saturday, July 19, 2008

    Finding Strong Stocks in a Sickly Market

    Finding Strong Stocks in a Sickly Market

    Every day seems to bring news of another company with shaky finances.

    On July 15, it was General Motors (GM) trying to mend a broken balance sheet. The automaker is cutting costs and canceling its dividend as part of efforts to raise a much needed $15 billion.

    And this is a particularly difficult time to be cash-hungry. A year into the credit crisis, lenders are reluctant to lend to anyone, whether a company or a home buyer, with a shaky credit profile.

    In recent years, "it was pretty easy to get a loan," says Sam Stewart, chief executive and chief investment officer of Wasatch Advisors. That's changed. "If you're dependent on outside financing, you've got to review the playbook," he says.

    BusinessWeek asked investing experts for tips on how to avoid stocks with weak finances, and how to choose strong companies at a time when strength seems especially valuable.

    1. Look for lots of cash and low levels of debt.
    There are different ways to crunch the numbers, but expert investors agree on the importance of diving into the data. Look at how much debt is on the balance sheet, with short-term debt the riskiest. Look at how much cash the firm has. Compare cash and debt levels to rivals in the same industry. Another key measure many investors use is free cash flow, a determination of, when all is added up, whether more money is flowing into the firm than out in a given quarter.

    Companies with little debt and lots of cash have big advantages in an environment like this.

    "When they hit hard times, they have cash to tide them over," says Scott Armiger of Christiana Bank & Trust. He points to USG (USG), a building materials company hurt by the housing slowdown (, 6/18/08) but still modernizing its factories.

    A healthy balance sheet also allows firms to make acquisitions when market valuations are low. "Strenuous times [are] when they go shopping, because they see businesses on sale," Armiger says.

    Many weaker firms borrow heavily to finance acquisitions. "Debt can allow you to grow, but it can create a lot of problems in a downcycle," says Ken Hemauer, director of research at Baird Investment Management.

    Companies can be crippled by high debt burdens. Rob Lutts of Cabot Money Management points to the debt-laden auto and airline industries. "If they didn't have the debt, they could adjust their business operations and succeed," he says. Exxon Mobil (XOM), however, manages to operate in a capital-intensive business with almost no debt, Lutts says.

    2. Other financial measures.
    Cash and debt levels are at the top of most lists, but investors also include other criteria.

    Lutts looks for "very high" aftertax profit margins, often of 25% to 30%. "It brings more strength to a company on a daily basis," Lutts says, citing Google (GOOG) and the Chinese firm New Oriental Education (EDU) as examples.

    Mustafa Sagun, chief investment officer of Principal Global Investors' equities group, emphasizes not just good fundamentals, but improvements in those measures, such as increasing revenue, widening profit margins, and rising profits.

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