Wednesday, December 31, 2008

Bringing Broadband to the Urban Poor

Bringing Broadband to the Urban Poor

Anthony Celestine was a latecomer to the Internet Age. The 40-year-old Harlem resident has owned a small Jani-King commercial cleaning franchise since 2004, but until recently, the New Yorker hadn't owned a computer or even surfed the Web or had an e-mail address. "I didn't know what none of that stuff was," he says.

Now he uses the Internet all the time to scout out new customers, communicate with Jani-King headquarters in Dallas, and trade e-mails with fellow franchisees on how to do certain kinds of jobs better. "I talk to my franchise brothers about what works and what doesn't," says Celestine, "I'm learning about new procedures faster than before. It's like riding a bike and then switching to a car. It's just a whole better world with the PC."

Celestine entered that world earlier this year when he moved from Brooklyn to an apartment in Harlem and got a PC and a high-speed Web hookup as part of his rental agreement. Celestine's apartment is owned by Harlem Congregations for Community Improvement (HCCI), a 22-year-old, $240 million nonprofit community development organization based in Harlem's Bradhurst neighborhood. HCCI was able to provide the computer and Internet connection thanks to the efforts of other nonprofit groups and an organization that funds affordable housing projects.

The Broadband Have-Nots

Millions of Americans—many of them also residents of the inner city—remain on the other side of the chasm that separates those who have high-speed Internet access from those who don't. President-elect Barack Obama has taken to delivering a weekly address not only over the radio but also through videos on Google's (GOOG) YouTube. Yet almost half of U.S. adults don't have the necessary broadband connections that make it easy to view those messages, according to recent data from the Pew Internet & American Life Project. A survey by the Information Technology & Innovation Foundation ranked the U.S. 15th on household broadband penetration, having slipped from fourth place in 2001, according to the Organization for Economic Cooperation & Development. (Denmark ranked No. 1.)

In a Dec. 6 speech, Obama called the current state of U.S. broadband access "unacceptable" and said plans to "renew our Information Superhighway" would be a priority of his Administration. To deliver, Obama will need to address the wide swaths of the U.S. that remain unconnected. In some places—most of them rural areas with low population density—people who are willing to pay for service can't get it because telecom providers can't justify the necessary investment.

In the case of the urban poor, service may be readily available, but many families can't afford the $30 to $50 it costs each month to get broadband. Many also lack computers at home. Among households with an annual income of $50,000 or less—about half the country—only 35% have broadband service, according to Free Press, a technology advocacy group. Households with annual incomes above $50,000 are more than twice as likely to have broadband service.

A Nonprofit Policy Leader

Telecommunications companies have made some efforts to make broadband affordable. AT&T (T), the largest U.S. phone company, offers DSL access for $10 a month to new customers in 22 states, a condition for government approval of the 2006 merger between SBC and BellSouth that created AT&T. In another concession to Uncle Sam in exchange for merger approval, AT&T agreed to donate 50,000 DSL lines to low-income households. Verizon Communications (VZ) has a subsidiary called Verizon Enhanced Communities that works with developers and apartment building owners to make high-speed connections available in low-income and other housing complexes.

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  • Danish Supercar

    Danish Supercar

    The numbers and specifications of the newly announced Danish-built Zenvo ST1 sports car put it in elite company. With 1104 bhp and a weight of 1376 kilograms, the Zenvo has a power to weight ratio only bettered by a handful of cars on the planet—the Caparo T1, SSC Ultimate Aero TT, Koenigsegg CCXR, Caterham Levante and the LeBlanc Mirabeu—plus a few supersport motorcycles. The 7 litre V8 engine uses a novel forced induction set-up featuring both supercharging and turbocharging to give it a staggering maximum torque figure of 1430 nm at 4500 rpm (Bugatti Veyron = 1250 nm), making it one of the fastest accelerating cars in existence—0 to 100 in 3 seconds fast. Only 15 will be built with what we expect will be a price tag in seven figures, commensurate with its electronically-limited 375 kmh top speed.

    The chassis is comprised of a lightweight steel racing frame with carbon fiber body panels and hydraulic ride height control—equally as good for getting out of driveways as it is for top speed on the autobahn. Our guess is that Zenvo in electronically limting top speed to 375 kmh, doesn't want to create a target for others just yet because its aerodynamic credentials and power suggest it'll be a contender for the fastest car title.

    Inside, it's hardly the sort of Spartan interior normally associated with elite sports cars—it comes with heads-up display and g-force meter for starters, then there's the dual zone automatic climate control, an electronic analog instrumentation display including a Driver Information Center, keyless access and both racing seats electrically adjustable as is the telescoping racing steering wheel for easy access and identical settings every time. With a car of this height, an auto-dimming rear view mirror is yet another touch that indicates they've thought it all through.

    Denmark has seen a number of outrageous kit cars produced prior to now, but has never had an elite manufacturer of sports cars of this ilk—it's the brainchild of designers Jesper Jensen and Troells Vollertsen and we look forward to keeping you abreast of their ambitious plans.

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  • Starbucks' Union Blues

    Starbucks Union Blues

    Starbucks (SBUX), once the undisputed leader in premium-price caffeine fixes, has long cultivated a corporate image for social responsibility, environmental awareness, and sensitivity to workers' rights. Now that carefully crafted reputation is under assault, thanks to a messy legal dispute with a group called the Starbucks Workers Union (SWU) (part of the Industrial Workers of the World, or IWW), which started recruiting employees in 2004 and now claims 300 members.

    The National Labor Relations Board found on Dec. 23 that Starbucks had illegally fired three New York City baristas as it tried to squelch the union organizing effort. The 88-page ruling also says the company broke the law by giving negative job evaluations to other union supporters and prohibiting employees from discussing union issues at work. The judge ordered that the three baristas be reinstated and receive back wages. The judge also called on Starbucks to end discriminatory treatment of other pro-union workers at four Manhattan locations named in the case. The decision marks the end of an 18-month trial in New York City that pitted the ubiquitous multinational corporation against a group of twentysomething baristas who are part of the International Workers of the World.

    The timing isn't ideal for Starbucks, which faces lower demand from the recession, an overall loss of panache for the brand, and a sliding stock price. "[The ruling] is a real thumb in the eye—a real gotcha moment with potential for heartache," says Eric Dezenhall, chief executive officer of Dezenhall Resources, a crisis management public relations firm in Washington D.C. "I don't think it's a crisis, but it hovers between [being] a nuisance and a problem."

    eyeing 401(k) contributions

    Starbucks intends to appeal the decision. The company maintained during the trial that the baristas were fired for perfectly legal reasons, such as disrupting business in its stores or threatening a manager. "This is an issue with particular employees," says Tara Darrow, a Starbucks spokeswoman. "We felt we handled it consistently and fairly. In this particular situation the NLRB disagreed. We're disappointed with that."

    The ruling comes at a time when Starbucks is trying to get its groove back in a very grim economy. The company's shares more than halved in value in 2008, now trading just above $9, while Dunkin Donuts and McDonald's (MCD) continued to grab market share among coffee drinkers. As the recession deepens, Starbucks recently said it may end or trim contributions to workers' 401(k) accounts in 2009.

    While the New York case marks the first that has gone to trial, Starbucks has been the target of numerous National Labor Relations Board complaints over unlawful violations of workers' rights. Starbucks settled another case in New York concerning illegal firings for union activity without admitting guilt in March 2006, paying $2,000 to former employees and offering their jobs back. In early October 2008, Starbucks settled the case of barista Erik Forman, who was fired for talking with co-workers about managers' apparent efforts to fire him for union organizing at a Minneapolis location. Starbucks ultimately invited Forman back to work. A similar case is getting under way in Grand Rapids, Mich.; the trial is expected to begin Jan. 7.

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  • Medical Bills You Shouldn't Pay

    Medical Bills You Shouldnt Pay

    Editor's note: For a CBS Evening News report on balance billing that was made in collaboration with BusinessWeek, go

    As health-care costs continue to soar, millions of confused consumers are paying medical bills they don't actually owe. Typically this occurs when an insurance plan covers less than what a doctor, hospital, or lab service wants to be paid. The health-care provider demands the balance from the patient. Uncertain and fearing the calls of a debt collector, the patient pays up.

    Most consumers don't realize it, but this common practice, known as balance billing, often is illegal. When doctors or hospitals think an insurer has reimbursed too little, state and federal laws generally bar the medical providers from pressuring patients to pay the difference. Instead, doctors and hospitals should be wrangling directly with insurers. Economists and patient advocates estimate that consumers pay $1 billion or more a year for which they're not responsible.

    Yolanda Fil, a 59-year-old McDonald's (MCD) cashier in Maple Shade, N.J., got tangled up with balance billing after gall bladder surgery in 2005. She and her husband, Leon, a retired state transportation worker, have coverage through Horizon Blue Cross Blue Shield of New Jersey. Horizon made payments on Fil's behalf to the hospital, surgeon, and anesthesiologist. Then, in 2006, Vanguard Anesthesia Associates billed Fil for an unpaid balance of $518. Soon, a collection agency hired by Vanguard started calling Fil once a week, she says. Although she thought her co-payment and insurance should have covered the surgery, Fil eventually paid the $518, plus a $20 transaction fee. "I didn't have any choice," she says. "They threatened me with bad credit."


    Luckily for Fil, her insurer decided to get tough with Vanguard. In December 2006, Horizon Blue Cross sued the medical practice for balance billing Fil and more than 8,000 other policyholders who received invoices for a total of $4.3 million for service from 2004 to 2006. A New Jersey judge last year ordered Vanguard to stop billing the patients and provide refunds to those who had paid. Fil is awaiting her $538 refund. Vanguard didn't respond to requests for comment.

    National statistics aren't available, but there's little doubt that many consumers unwittingly fall victim to balance billing. The California Association of Health Plans, a trade group in Sacramento, estimates that 1.76 million policyholders in that state received such bills in the past two years, totaling $528 million. The group found that 56% paid the bills. "Patients think they owe this money, and it causes tremendous stress and anxiety for people," says Cindy Ehnes, director of the California Managed Health Care Dept. "It is inappropriate to put the patient in the middle of this."

    Balance billing most frequently occurs when medical providers participating in a managed-care network believe the plan's insurer is imposing too deep a discount on medical bills or is taking too long to pay. California, New Jersey, and 45 other states ban in-network providers from billing insured patients beyond co-payments or co-insurance required by the plan. Similarly, federal law prohibits providers from billing Medicare patients for unpaid balances.

    These laws require medical providers to seek payment only from the insurer for services covered by the plan. Many states also shield insured patients from balance billing by out-of-network hospitals and doctors in emergencies, since patients usually don't control who treats them in those situations. (Bans on balance billing generally don't apply when a patient gets an elective procedure, such as cosmetic surgery, or seeks out-of-network, non-emergency service without a referral.)

    Some physicians, hospitals, and labs take advantage of consumer befuddlement, argues Jane Cooper, CEO of Patient Care, a Milwaukee firm that employers hire to help insured workers fight billing mistakes. "Medical providers count on the fact people will pay these bills because they don't have time to figure it out," Cooper says.

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  • Tuesday, December 30, 2008

    Israel's Gaza War: The Economic Fallout

    Israels Gaza War: The Economic Fallout

    Located in the kibbutz of Kfar Aza, just a kilometer from the border with the Gaza Strip, chemical company Kafrit Industries (KAFR) operates one of the dozens of factories ordered to shut down until further notice by the Israeli government, just after its air force carried out massive air strikes on the Hamas-controlled territory. Even before the latest escalation of violence began on Dec. 27, the producer of additives used in the plastics industry had to deal with intermittent Palestinian rocket fire. But lately Kafrit Industries—like most Israeli companies—has been more concerned about the impact of the global recession.

    Now, the worst Israeli-Palestinian military flare-up in years has taken center stage. "Up to now we've been able to meet all of our commitments, but the security situation has now made operating our business even more challenging," says Avi Zalcman, chief executive of Kafrit. Luckily for the company, it has plants in Germany and China that can at least partially offset the loss of production in Israel. But others like RMH Lachish Industries (LHIS), a producer of agricultural machinery based in nearby Sderot, are less fortunate. "One hundred percent of our production is for export, and we've already had to cancel orders," says Gershon Goldberg, CEO of Lachish.

    The impact on the Israeli economy is only starting to be felt. So far, plant closures have been limited to nonessential facilities within 4.5 kilometers (2.8 miles) of the Gaza border. Farther afield—though still within range of Palestinian rocket fire—companies like Intel (INTC), which employs 2,000 workers at a semiconductor facility in Kiryat Gat, are continuing to operate at full capacity.

    Eyes on the Deficit

    The shutdown of plants near Gaza is a relatively minor part of the broader impact on the Israeli economy of renewed warfare. Israel's Manufacturers Assn. pegs the current loss of production at $1 million a day. And though it's still too early to assess the final cost of the military operation, unofficial estimates have put the price tag at $25 million to $50 million a day. "The cost will run up sharply if reserves are called up for a ground operation and if the conflict goes on for more than a few weeks," predicts Leo Leiderman, chief economist at Israel's Bank Hapoalim (POLI.TA).

    Jittery traders worried about geopolitics drove the price of oil up by as much as 12% on Dec. 29, to $42.20 per barrel before it settled back below $39. But the reaction of Israel's financial markets has so far been fairly muted. The shekel has barely budged against the U.S. dollar in recent days (though it has weakened vs. the euro), even despite a 75-basis-point interest rate cut, to 1.75%, by the central Bank of Israel late on Dec. 29 that's intended to spur the economy.

    Stocks, too, aren't faring badly. After initially dropping on Sunday in response to the Israeli air strikes on Gaza, the Tel Aviv stock market recovered part of its lost ground on Dec. 29. Analysts say the real test for local financial markets will be the impact of the military operation on the budget deficit.

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  • M&A Looks Grim for 2009

    M&A Looks Grim for 2009

    If the last few days of 2008 are a sign of things to come, the prospects for mergers and acquisitions in the new year are certainly bleak. The latest evidence is the trouble facing Dow Chemical's (DOW) proposed $15.3 billion acquisition of rival Rohm & Haas (ROH). The deal was put in doubt Dec. 29 after the Kuwait government cancelled a joint venture with Dow that would have indirectly provided key financing for the buyout.

    The Rohm & Haas deal could be saved or renegotiated, but if it's cancelled it would hardly be a rarity in such a troubled climate for mergers and acquisitions. According to preliminary data from Dealogic, 1,309 M&A deals, totaling $911 billion, were scrapped in 2008. Deal volume in the U.S. is off 29% from 2007, but M&A activity has all but halted more recently.

    Deal Market Falters as Capital Dries Up

    U.S. deal volume plunged 86% in November 2008 compared to the previous November, according to R.W. Baird. "It's a staggering number" that reflects the fall's sharp tightening of credit markets and fears of a global economic slowdown, says Baird investment banker Howard Lanser. "December isn't looking any better."

    The past year "was a horror show," says William Lawlor, a partner and M&A specialist at the Dechert law firm.

    The primary problem was the drying up of credit markets. Since the fall, even well-respected companies have found it hard to borrow to finance acquisitions. Never mind the riskier private equity shops: Their access to capital dried up earlier in 2008, with Dealogic estimating financial sponsor M&A buyouts fell 71% in the past year.

    A second problem is fear: Executives and boards, along with stock investors and lenders, have trouble predicting where the economic and financial environment will take their companies. "If you don't have that confidence as a catalyst, deals just don't get done," Lawlor says.

    "Mergers of Necessity"

    Still, companies remain hungry to make acquisitions for a variety of reasons. Many deals under consideration are "mergers of necessity," says Robert Filek, a partner in PricewaterhouseCoopers' Transaction Services Group. Companies are "forced into [deals] by economic realities." Companies may need to sell assets to raise capital, he says. Or weaker rivals may need to be swallowed up by stronger competitors, which can then cut costs in the merged company. The troubled financial sector was a hotbed of these sorts of deals, with Bank of America's (BAC) $44.3 billion buyout of Merrill Lynch (MER) one of many examples.

    In 2009 companies may be able to take advantage of opportunities created by market turbulence. The stock market is pricing companies at "great deals," Lawlor says. "There's just too much opportunity out there."

    Marino Marin, managing director at New York-based investment bank Gruppo, Levey & Co., predicts dealmakers in 2009 could look for M&A possibilities in industries like mining, health care, media, and technology. Baird's Lanser predicts deals in technology, health care, and education and training outfits. He says private equity investors, with about $350 billion "in capital sitting on the sidelines," may also start hunting for opportunities.

    Sluggish Credit, Uncertain Outlook

    But even those optimistic about the M&A environment admit conditions must change before buyers start making, rather than cancelling, big deals. Credit markets have recovered somewhat since October. But that is only after "an almost complete failure of the banking system in the United States," Lanser says. "Banks are still hoarding money" needed to finance deals, he says. "You've got a bottleneck in credit."

    And then there is the general uncertainty that hangs like a dark cloud over the entire economy. Filek offers two extreme examples: In the energy industry, the big swings in fuel prices scramble all calculations of oil and gas firms' future financial results. That makes energy executives reluctant to pursue deals. Meanwhile, consolidation in the automotive sector is being prevented by big questions about the future of the U.S. auto industry. "Automotive M&A can't get rolling until there is some visibility into what a restructured U.S. auto industry looks like," he says.

    The best hope for a revival in M&A comes from a gradual stabilization of both the economic environment and the credit markets. "With the new year comes new hope," Lanser says. Until then, Marin says, bankers will need to be "very creative" to get deals done.

    Efforts to save the Rohm & Haas buyout may be an early 2009 test of the ability to get deals completed despite the toughest M&A conditions in a generation.

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  • Monday, December 29, 2008

    The 65 mpg Ford the U.S. Can't Have

    The 65 mpg Ford the U.S. Cant Have

    If ever there was a car made for the times, this would seem to be it: a sporty subcompact that seats five, offers a navigation system, and gets a whopping 65 miles to the gallon. Oh yes, and the car is made by Ford Motor (F), known widely for lumbering gas hogs.

    Ford's 2009 Fiesta ECOnetic goes on sale in November. But here's the catch: Despite the car's potential to transform Ford's image and help it compete with Toyota Motor (TM) and Honda Motor (HMC) in its home market, the company will sell the little fuel sipper only in Europe. "We know it's an awesome vehicle," says Ford America President Mark Fields. "But there are business reasons why we can't sell it in the U.S." The main one: The Fiesta ECOnetic runs on diesel.

    Automakers such as Volkswagen (VLKAY) and Mercedes-Benz (DAI) have predicted for years that a technology called "clean diesel" would overcome many Americans' antipathy to a fuel still often thought of as the smelly stuff that powers tractor trailers. Diesel vehicles now hitting the market with pollution-fighting technology are as clean or cleaner than gasoline and at least 30% more fuel-efficient.

    Yet while half of all cars sold in Europe last year ran on diesel, the U.S. market remains relatively unfriendly to the fuel. Taxes aimed at commercial trucks mean diesel costs anywhere from 40 cents to $1 more per gallon than gasoline. Add to this the success of the Toyota Prius, and you can see why only 3% of cars in the U.S. use diesel. "Americans see hybrids as the darling," says Global Insight auto analyst Philip Gott, "and diesel as old-tech."

    None of this is stopping European and Japanese automakers, which are betting they can jump-start the U.S. market with new diesel models. Mercedes-Benz by next year will have three cars it markets as "BlueTec." Even Nissan (NSANY) and Honda, which long opposed building diesel cars in Europe, plan to introduce them in the U.S. in 2010. But Ford, whose Fiesta ECOnetic compares favorably with European diesels, can't make a business case for bringing the car to the U.S.


    First of all, the engines are built in Britain, so labor costs are high. Plus the pound remains stronger than the greenback. At prevailing exchange rates, the Fiesta ECOnetic would sell for about $25,700 in the U.S. By contrast, the Prius typically goes for about $24,000. A $1,300 tax deduction available to buyers of new diesel cars could bring the price of the Fiesta to around $24,400. But Ford doesn't believe it could charge enough to make money on an imported ECOnetic.

    Ford plans to make a gas-powered version of the Fiesta in Mexico for the U.S. So why not manufacture diesel engines there, too? Building a plant would cost at least $350 million at a time when Ford has been burning through more than $1 billion a month in cash reserves. Besides, the automaker would have to produce at least 350,000 engines a year to make such a venture profitable. "We just don't think North and South America would buy that many diesel cars," says Fields.

    The question, of course, is whether the U.S. ever will embrace diesel fuel and allow automakers to achieve sufficient scale to make money on such vehicles. California certified VW and Mercedes diesel cars earlier this year, after a four-year ban. James N. Hall, of auto researcher 293 Analysts, says that bellwether state and the Northeast remain "hostile to diesel." But the risk to Ford is that the fuel takes off, and the carmaker finds itself playing catch-up—despite having a serious diesel contender in its arsenal.

    Business Exchange related topics:
    Global Auto Industry
    U.S. Automakers
    Green Cars
    Electric Cars
    Hybrid Cars
    Diesel Cars

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  • Will Work for Praise: The Web's Free-Labor Economy

    Will Work for Praise: The Webs Free-Labor Economy

    It's dawn at a Los Angeles apartment overlooking the Hollywood Hills. Laura Sweet, a graphic designer in her early 40s, sits at a computer and begins to surf the Net. She searches intently, unearthing such bizarre treasures for sale as necklaces for trees and tattoo-covered pigs. As usual, she posts them on a shopping site called Asked why in the world she spends so many hours each week working for free, she answers: "It's a labor of love."

    Later this morning, a half-hour's drive to the west, a serial entrepreneur named Gordon Gould strolls into the Santa Monica offices of ThisNext. Gould has managed to entice an army of volunteers, including Sweet, to pour passion and intelligence into his site for free. Traffic on ThisNext is soaring, with unique visits nearly tripling in a year, to 3.5 million monthly. What's in it for the volunteer workers? "They can build their brands," Gould says. "In their niches, they can become mini-Oprahs."

    Here's how it works. Entrepreneurs like Gould build meeting places that provide visitors with tools to express themselves, mingle with friends and strangers, and establish their personal "brands." The result, when it works, is an outpouring of creativity. It has produced not only ThisNext, but also YouTube and even American Idol.

    Abundant Nonfinancial Rewards

    You might think that with the economy crashing, the free-labor business model would be crashing, too. Will people continue to invest in their personal brands during hard times? Gould is betting they will. Between investor visits during a late November trip to New York, he sips a soy latte and speculates. During the downturn, he says, firings are sapping loyalty to companies and steering people toward goals of self-sufficiency. In Gould's acerbic phrasing: "The only person I can rely on not to screw me—hopefully—is myself."

    Beyond brand-hungry strivers, masses of free laborers continue to toil without ever seeing a payday, or even angling for one. Many find compensation in currencies that predate the market economy. These include winning praise from peers, earning an exalted place within a community, scoring thrills from winning, and finding satisfaction in helping others.

    But how to monetize all that energy? From universities to the computer labs of Internet giants, researchers are working to decode motivations, and to perfect the art of enlisting volunteers. Prahbakar Raghavan, chief of Yahoo Research (YHOO), estimates that 4% to 6% of Yahoo's users are drawn to contribute their energies for free, whether it's writing movie reviews or handling questions at Yahoo Answers. If his team could devise incentives to draw upon the knowledge and creativity of a further 5%, it could provide a vital boost. Incentives might range from contests to scoreboards to thank-you notes. "Different types of personalities respond to different point systems," he says. Raghavan has hired microeconomists and sociologists from Harvard and Columbia universities to match different types of personalities with different rewards.

    Virtual Focus Groups

    To date, he says, most of the research on recruitment and incentives comes from far simpler domains such as frequent-flier programs and cell-phone subscription campaigns, where goals and incentives are usually aligned. But the volunteer economy has many more variables. What are the signs that a participant will be enthusiastic and well-informed? How do leadership qualities manifest? Do recruits bring in networks of potentially productive friends? Researchers comb through petabytes of network behavior searching for telltale patterns. One of the current studies rates the probability that a person who's gifted in one domain is likely to perform well in another.

    Communispace, a market research company near Boston, conducts similar studies as it enlists volunteer marketing consultants.

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  • Friday, December 26, 2008

    The Worst Predictions About 2008

    The Worst Predictions About 2008

    Here are some of the worst predictions that were made about 2008. Savor them—a crop like this doesn't come along every year.

    1. "A very powerful and durable rally is in the works. But it may need another couple of days to lift off. Hold the fort and keep the faith!" —Richard Band, editor, Profitable Investing Letter, Mar. 27, 2008

    At the time of the prediction, the Dow Jones industrial average was at 12,300. By late December it was at 8,500.

    2. AIG (AIG) "could have huge gains in the second quarter." —Bijan Moazami, analyst, Friedman, Billings, Ramsey, May 9, 2008

    AIG wound up losing $5 billion in that quarter and $25 billion in the next. It was taken over in September by the U.S. government, which will spend or lend $150 billion to keep it afloat.

    3. "I think this is a case where Freddie Mac (FRE) and Fannie Mae (FNM) are fundamentally sound. They're not in danger of going under…I think they are in good shape going forward." —Barney Frank (D-Mass.), House Financial Services Committee chairman, July 14, 2008

    Two months later, the government forced the mortgage giants into conservatorships and pledged to invest up to $100 billion in each.

    4. "The market is in the process of correcting itself." —President George W. Bush, in a Mar. 14, 2008 speech

    For the rest of the year, the market kept correcting…and correcting…and correcting.

    5. "No! No! No! Bear Stearns is not in trouble." —Jim Cramer, CNBC commentator, Mar. 11, 2008

    Five days later, JPMorgan Chase (JPM) took over Bear Stearns with government help, nearly wiping out shareholders.

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  • Wednesday, December 24, 2008

    Toyota Likely to Pick Scion As Next President

    Toyota Likely to Pick Scion As Next President

    From the moment Akio Toyoda joined Toyota's (TM) board of directors in 2000, rumors circulated that the scion of the Japanese carmaker's founding clan was being groomed for the top job. Now the 52-year-old executive vice-president is likely to succeed President Katsuaki Watanabe after winning the board's support, a source close to the Japanese automaker told BusinessWeek.

    If Toyoda is appointed, he would be the first executive from the founding family to lead since 1995. He would also face the difficult task of restoring the automaker to profitability and getting it through one of the toughest periods in its 71-year history.

    News about Toyoda, the grandson of founder Kiichiro Toyoda, was first reported in Japan's Asahi Shimbun newspaper on Dec. 23. A Toyota spokesman said no personnel decisions had been made.

    Confirmation May Be Months Away

    Toyota normally announces executive promotions by April and confirms them at the annual shareholder meeting in June, so Toyoda's formal appointment could still be months away. Typically, Toyota presidents serve two or three terms of two years each. Watanabe, who has been president since 2005, had considered stepping down several months ago for personal reasons but stayed on to help draw up an emergency plan as the U.S. financial crisis rattled markets globally, said the source, who requested anonymity.

    It's unclear whether Toyota's profit warning on Dec. 22 played a role in hastening the board's decision to replace Watanabe. Hurt by a mix of unfavorable currency swings, slumping worldwide auto sales, and high materials costs, Toyota forecast an operating loss for this fiscal year through March 2009 of $1.7 billion—its first-ever annual loss. The profit revision was Toyota's second in six weeks and reinforced how the global auto industry has been slammed by the U.S. banking crisis. Net profit, which includes income from joint ventures in China, is forecast to shrink 97%, to $555 million.

    Analysts expressed mixed feelings over news of Toyota's C-suite change. UBS (UBS) analyst Tatsuo Yoshida said that Toyoda could be a unifying force for the company, but questioned why the company had to act now. "I don't think it is a good time to change top management," Yoshida says. Others worried that a new president could slow the decision-making at a time when the company needs to be able to react quickly to unexpected events. "It would have the effect of intensifying the sense of crisis within the company," says Mamoru Kato of Tokai Tokyo Research Center.

    Toyota's defenders say critics would be right if the company depended on a single authoritative figure, but the automaker's management reaches decisions by discussion and consensus. "When top management makes decisions, it does so as an organization, as a team," says a person with close ties to Toyota's management. "Akio's promotion isn't enough to assess what will happen to Toyota. The organizational changes in April and June should reveal a lot more."

    Building a Web Site

    Toyoda would appear to be well qualified to become the top executive. He has gone to great lengths to earn his promotions on merit, not because of his family connections, say observers.

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  • Anxious Job Hunters Head for the Emirates

    Anxious Job Hunters Head for the Emirates

    When Akram Alami organized a job hunt trek to Dubai in November for London Business School students, he expected a limited response, as just 13 students signed up last year. Instead, the second-year MBA student found himself overwhelmed with applications, with 71 students clamoring to get a spot on the trip, which cost close to $3,000. Interest was so high that Alami, president of the school's Middle East Club, had to turn 33 students down due to limited space.

    As the job market in the U.S. and Europe weakens, business-school students are increasingly setting their sights on the Middle East. Although the Gulf region is itself feeling the impact of the worldwide financial downturn, the job market remains fairly buoyant in financial hubs like Dubai and Abu Dhabi, career services officers from top business schools said. Recruiters from sectors like financial services, private equity, and consulting are still hiring, if perhaps being more cautious and selective than before.

    In response, business schools in Britain and U.S., including London Business School and the University of Pennsylvania's Wharton School are organizing job treks to the United Arab Emirates, connecting students with alums working there and organizing symposiums and forums in the region.

    A Grim Job Market Elsewhere

    It's all part of a push to help students find jobs in what is becoming an increasingly grim job market, said Grant Phillips, acting head of Oxford Business Alumni, who is organizing a Gulf job trek for Oxford University's Said Business School students in the early part of 2009, as well as ones to China, Singapore, India, and Africa.

    "We have to help our students find jobs wherever that job might be." Phillips said. "Sectors like banking may still be challenging to get into, but there are potentially more opportunities in places like the Gulf."

    City University of London's Cass Business School, which runs an executive MBA program in Dubai, will be running its first ever Dubai Symposium this spring to help the school's London-based students connect with local recruiters, as well as the school's Dubai-based students.

    Stern Tests the Waters in the Gulf

    While many British business schools are taking the lead in this area—a number have campuses and executive MBA programs in Dubai—a growing number of U.S. schools are helping students facilitate relationships in the Middle East as well.

    For example, New York University's Stern School of Business's United Arab Emirates Initiative, a new student group, will be hosting a job trek to Dubai and Abu Dhabi over spring break next year for the first time. There are 23 Stern students who signed up for the trip, five or six from the Middle East, with the remainder of the students from the U.S. and Europe, said Joshua Weiner, one of the trip's organizers.

    Wharton will be hosting a Global Alumni Forum in Dubai this March, which will connect senior executives, Wharton faculty, alumni and current students. Meanwhile, MBA students from the school's Arab Club and Private Equity Club have plans for job treks to the region this spring. Within the past year, the school's Arab Club has sponsored job trips to Dubai and Egypt, according to the group's Web site. The Private Equity Club also ran a trip to Dubai last school year.

    Breaking In Isn't Easy

    "The Middle East is clearly a very strong growth area," said Ivan Kerbel, senior associate director of Wharton's MBA Career Management Office.

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  • Rethinking Computers in the Classroom
  • University of Washington Admissions Q&A
  • Reasons for Keeping Your Money Invested Overseas

    Reasons for Keeping Your Money Invested Overseas

    Just as investors warmed to global investing, global stocks tanked. While the Standard & Poor's 500-stock index has fallen 40% through Dec. 12, the damage outside the U.S. has been worse—and in emerging markets, it has been devastating.

    That convinced many investors that a basic argument for diversifying overseas, called decoupling, was no longer valid. Decoupling is the idea that foreign countries have large enough domestic economies that they are insulated from a financial shock or recession in the U.S. With that concept seemingly debunked, investors steered clear of foreign markets. Making matters worse for investors who had sent money overseas, currencies turned against them. In the boom years, a weakening dollar hiked returns when overseas investments held in Euros or rupees were sold and converted back to dollars. Until the Federal Reserve's latest rate cut and corresponding fall of the dollar, a strong dollar had done the opposite.

    But there are good reasons to stay invested overseas. The U.S. represents less than half of global market capitalization, and many overseas countries (especially Brazil, India, and China) continue to grow at a faster rate than the U.S. Over the long term, adding foreign stocks decreases volatility and increases returns. So for those who want to add to foreign holdings, or want to get in for the first time, depressed equity prices (and today's relatively strong dollar) offer a chance to buy globally on the cheap. Finally, while markets tend to track each other more tightly when investors are afraid of their own shadows, as the global economy turns up, markets will reflect their individual strengths. Just because stocks in the U.S. and China, say, move in the same direction doesn't mean they're doing so at the same rate, with the same returns.

    "While it's not the case that the U.S. is going to go through a painful recession and the rest of the world will go its merry way, other countries will hold up better," says Russ Koesterich, head of investment strategy at Barclays Global Investors in San Francisco. One hurdle for the U.S., he says: Consumers have too much debt. "Other countries, such as those in Asia, don't have those same imbalances. When this cyclical headwind starts to ease up, these longer-term imbalances won't hold them back as much." Koesterich says many U.S. investors should add exposure to foreign stocks: "Most have too high of a weight in the U.S. relative to global markets."

    The percentage of your portfolio that should be overseas depends on your age and risk tolerance. Many advisers recommend 25% to 40%, with more going to developed markets in Europe and Asia and less going to emerging ones, such as China, India, Brazil, and Russia.

    Jack Caffrey, equity strategist at J.P. Morgan Private Bank (JPM) in New York, is allocating 30% of equities to foreign stocks now, vs. a more typical 40%. Caffrey is a big believer in overseas investing for the long term. But in the short term, he argues, the aggressive approach the U.S. has taken to tackling its problems will lead it out of recession sooner than other countries, particularly those in Europe, where the response has been more sluggish. "We're more comfortable that a recovery will be relatively early in the U.S. vs. international markets," Caffrey says. "But at some point markets will become more certain, and you will start seeing assets moving to their own rhythms."

    After all, those hurt the most by falling foreign markets are the ones who rushed in at the peak. Invest for the long term now, and, with luck, you'll ride the markets back up. "If you're really taking the long-term view, there is greater long-term growth outside the U.S. than in it," says Uri Landesman, head of global growth at ING Investment Management. "It probably won't be reflected in global equity prices for another year. But you'd better not give up on overseas, especially emerging markets, just because of what's gone on this year."

    Return to the Investment Outlook Table of Contents

  • Economic state may affect spending
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  • Global Stocks: Should You Pull Out?
  • Stocks: The Individual Investor’s Dilemma
  • Emerging Markets: Foreign Currency Debt Troubles
  • Tuesday, December 23, 2008

    Auto Bailout: UAW Chief Draws a Line

    Auto Bailout: UAW Chief Draws a Line

    If General Motors (GM) and Chrysler executives want federal loans beyond the initial $17.4 billion provided by President Bush and the Treasury Dept. on Dec. 19, they will need to wring concessions from the United Auto Workers. And that means dealing with Ron Gettelfinger.

    As became clear in mid-December, Gettelfinger, the 64-year-old union president, is no pushover. With the fate of an industry hanging in the balance, he refused to back down when Senator Bob Corker (R-Tenn.) demanded that the UAW commit to cutting wages to secure a bailout of Detroit's Big Three. Gettelfinger's stance—critics call it intransigence—pushed a government rescue to the brink until the Bush Administration stepped in.

    But even after the Administration released funds for GM and Chrysler, Gettelfinger bristled at the labor concessions that Treasury is insisting on. In response to the Administration's demands for wage and benefits cuts, he said: "We are disappointed that he [Bush] has added unfair conditions singling out workers." Gettlefinger even said he would go to the Obama Administration—which promises to be more labor-friendly—to work out a deal.

    Push from Bush

    That sets the stage for negotiations beginning in earnest in January with management at GM and Chrysler as the union and the carmakers try to craft a restructuring plan. Gettelfinger and his staff will first face off against a team headed by GM President Fritz Henderson.

    The Bush Administration has already laid out some concessions that it wants from the union. The plan closely mirrors what Senator Corker wanted Gettelfinger to agree to in advance of getting any government money. In documents spelling out the loan terms, Treasury asked to close down the JOBS bank—an anachronism that keeps UAW workers on the payroll even when they aren't working—and make UAW wages, benefits, and plant floor work rules competitive with those of foreign-owned factories in the U.S. by the end of 2009. (The union agreed to suspend the JOBS bank in early December.) The union also must take company stock instead of cash for half of the money that car companies pledged to finance a health-care trust.

    The talks themselves are historic: The most powerful industrial union in America will be asked to reopen its contract to ensure the survival of the automakers. And Gettelfinger himself will be walking a tightrope.

    On the one hand, he knows that the stakes are too high for the government to walk away from an industry that directly and indirectly employs an estimated 3 million people. On the other, he knows concessions are inevitable and that to sell them to his 640,000 members he needs to be seen as a defender of the working stiff.

    Saving Jobs

    "The goal is to make these companies competitive so that as many jobs as possible are preserved," says Harley Shaiken, a labor economist at the University of California at Berkeley. "The union has a devastating context in which to achieve it."

    Gettelfinger's challenge is to find a way to help save GM, Ford (F), and Chrysler without destroying the union he has spent much of his life protecting. "We're very concerned, first of all, about the companies staying in business," Gettelfinger said in an interview. "Secondly, we want to maintain a decent standard of living. We're also concerned about our retirees."

  • Automakers Rev Up for a Bailout, Too
  • Automakers Rev Up for a Bailout, Too
  • Congress to Detroit: What’s Your Plan?
  • Chrysler’s CEO on a Bailout
  • Monday, December 22, 2008

    Marcial: L-3, a Stellar Pick in Security Tech

    Marcial: L-3, a Stellar Pick in Security Tech

    Vigilant preventive action worldwide against terrorism is in high gear. And that is boosting global demand for an array of surveillance and reconnaissance systems, as well as devices that detect explosives and firearms at airports, seaports, train stations, and government buildings. Analysts expect sales of such protective equipment will only accelerate in the years ahead.

    Investors looking into homeland security technology plays may find L-3 Communications (LLL) on their radar. The company is a leading provider of secure high-data communications systems, defense electronics, and other related products, primarily for military and government uses. Some 75% of L-3's total orders come from the U.S. Dept. of Defense, with its "specialized" products accounting for 39% of operating profits and 34% of sales. These include little-publicized undersea warfare equipment and sophisticated security and detection systems,

    Although the business of providing security systems is regarded as recession-resistant, L-3's stock has been beaten down along with other issues that investors dumped because of the recession and financial crisis.

    From a 52-week high of 115.33 a share on Apr. 24, the stock had been battered to 50 by Nov. 21. By Dec. 19 it had bumped up to 70.

    But that sharp decline from 115 "has all the more made L-3 an attractive buy," says Marian Kessler, co-portfolio manager of Becker Value Equity Fund (BVEFX), who figures the stock will snap back to 95 in a year (Becker owns shares).

    picture of health

    In these bleak economic times, most investors flock to companies that are financially healthy, and L-3 fits that bill. Since 2006, L-3 has posted an annual growth rate in operating profits of around 51%, and in sales of about 35%. Its return on invested capital (operating profits after taxes, as a percentage of long-term debt, plus equity) was 8.8% in 2007, up from 7.2% in 2006. And free cash flow (cash flow from operating activities minus capital expenditures) as a percentage of sales was 8% in 2007, vs. 7.4% in 2006.

    At its current price of 72 a share, the stock is trading at 9.7 times Kessler's estimated earnings of $7.40 a share in 2009—below the stock's p-e range of 19-13 in 2007. This indicates, says Kessler, how undervalued the stock is.

    With the incoming Obama Administration, the demand for homeland security systems and equipment in the U.S. is likely to continue, if not increase, argues Kessler. "These are not the big-ticket defense items like missiles or jet fighters that may get careful scrutiny in a review of the defense budget by the Obama administration," opines Kessler. If anything, Obama, as President, may substantially increase government spending on all anti-terrorism programs, she adds.

    transition play

    Indeed, L-3 may just be the right stock for investors now, even before Obama gets sworn in on Jan. 20. "It is our safe-haven defense play," says analyst Cai von Rumohr of investment firm Cowen & Co. (COWN), who rates the stock outperform.

    The company's "broad products and service mix, low pension risk (the pension fund is fully funded), and coherent plan for 10% or more [annual] earnings-per-share growth," he says, make L-3 an attractive buy during the Administration changeover. The analyst's 2009 earnings estimate for L-3 of $7.70 a share is higher than Kessler's, although his 2008 estimate of $6.80 is lower than Kessler's forecast of $7.30.

    Standard & Poor's analyst Richard Tortoriello, who rates L-3 a buy, has a price target of 100 a share, based in part on the company's mix of defense electronics and specialized military products, and government services. And the company's "good organic sales growth, strong cash-flow generation, and attractive valuation," he says, should benefit investors. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP.)

    L-3 is gaining traction in large part because, whether or not another terrorist attack occurs, investors expect government spending on the kinds of products and services the company provides will expand. And the general belief that no country can be overly vigilant against terrorism underscores the importance of L-3's products and technology.

    Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

  • Oracle Dives Headlong into Hardware
  • Corning's Silicon Valley Connection

    Cornings Silicon Valley Connection

    Many CEOs brag about nurturing a culture of innovation, but few have managed to do it over the long haul. The bosses at Corning (GLW) have. Over the company's 157-year history they have reinvented Corning time and again, tapping its ample budget for research and development to turn simple sand into a succession of big products, from heat-resistant glass for railroad lanterns and CorningWare ceramics to optical fiber and LCD screens. Now, even as other manufacturers are pulling back on R&D, Corning is pushing ahead to find the next hit.

    Nearly 2,400 miles from its headquarters in Corning, N.Y., the company has set up a mini tech center in Silicon Valley. Working from the foothills behind Stanford University, 10 full-time researchers hope to hook up with folks at Google (GOOG), Hewlett-Packard (HPQ), and Intel (INTC), among other high-tech giants based nearby, and pitch them on Corning's latest inventions. These would-be customers could also pass along product ideas so Corning could develop them.

    The staff is zeroing in on three areas: improving high-speed communications between computers using optical fiber, adding solar power to handheld devices, and developing better displays for smartphones and laptops. "We are trying to see what people are complaining about, and then we will come up with solutions that will help," says Waguih Ishak, the center's director.


    Opening a long-distance lab isn't all that new: Plenty of U.S. companies have built R&D facilities in Europe and Asia to tap local talent and tweak products for local markets. Corning's mission is different and perhaps riskier, however. Its new outpost exists primarily to suck up ideas and then relay potential winners across the continent to develop them into products.

    Xerox (XRX) tried a similar experiment decades ago at its famed Palo Alto Research Center. Scientists there came up with such breakthroughs as the computer mouse. But back at Xerox's head office, upper management's focus was its basic photocopying business, recalls John Seely Brown, a former director of the center. "We would invent all sorts of things that didn't fit into the core business," he says, "so then they would sit on the shelf or eventually be spun out or licensed to other companies."

    Corning, with a wider array of markets, appears more open, says Brown, who sits on Corning's board. "There is a unique, passionate interest in the whole innovation process and finding ways to cross-pollinate," he says.

    Corning's upper management has given its outreach venture up to five years to show its proposals can generate sales. The company should be able to afford it. David Morse, a senior vice-president at Corning, says the Silicon Valley outpost will cost just under $5 million a year to operate, a rounding error at a company with $5.9 billion in revenue in 2007 and 25,000 employees worldwide. Still, Corning is pinching pennies, as its share price has sunk by two-thirds in 2008. Ishak has halted hiring and cut back on travel by using videoconferencing.

    It helps that Ishak is running the place. Born and raised in Egypt, Ishak, 59, has spent 30 years in Silicon Valley, much of it in HP's labs, and boasts 2,200 business contacts in his Outlook database. "When you sit at a table in a restaurant in the Bay Area, behind you is Apple (AAPL), next door is Google, and then Cisco (CSCO) and HP nearby," he says. Just listen, he adds, and you'll learn.

    For a video interview of Corning's Waguih Ishak, go to

    The Consumer Electronics Inventory Glut

    The Consumer Electronics Inventory Glut

    Automakers aren't the only ones halting production as inventories pile up. The consumer electronics industry is also coming to grips with rising stockpiles of unsold goods that are likely to result in price pressure and falling profit.

    Recent evidence of growing inventories came Dec. 15, when SanDisk (SNDK), a maker of memory cards and storage drives, said it will temporarily stop production at two Japanese plants for two weeks through Jan. 12. After that, the factories will resume work at 70% capacity. SanDisk hopes the cutbacks will help it whittle away at the piles of unsold devices in warehouses and on retailers' shelves.

    Seasonal Sales Worse than Forecast

    The inventory glut that's afflicted chipmakers such as Hynix and Micron (MU) for months has now spread to makers of finished goods including computers, cell phones, and flat-panel TVs. In what's typically the strongest quarter of the year for many tech vendors, recession-weary consumers have cut spending on everything but the essentials. "There's probably too much inventory given sales levels," says Stephen Baker, an analyst at researcher NPD Group.

    Not only are rising inventories a sign of dwindling demand, but they're often a harbinger of profit-slashing moves such as price cuts aimed at moving items off shelves and writedowns of goods that aren't expected to be purchased. The glut is sure to worsen fourth-quarter results for manufacturers and retailers that have already been bracing for a slow holiday sales season. The malaise may linger into 2009, analysts say. "January looks really bad," says Randy Giusto, an analyst at researcher IDC. Some tech manufacturers may need to follow SanDisk in tapping the brakes on production, analysts say.

    PC makers are likely among the casualties. The percentage of computers shipped this quarter that won't be sold could rise into the double digits, Giusto says. Desktops and traditional notebooks are piling up as many consumers opt for cheaper, smaller netbooks, low-power PCs that sell for as little as $300. "It's possible that traditional notebooks have seen a little bit of a buildup because of demand for netbooks," says Shawn DuBravac, economist for the Consumer Electronics Assn.. IDC this month cut its forecast for computer unit sales growth to 5% from 13.2%.

    Desktop and traditional notebook sales at such vendors as Dell (DELL) and Hewlett-Packard (HPQ) may be especially hard-hit. In the December quarter, sales of Apple (AAPL) iMac desktops may decline 9% from a year earlier, says Kaufman Bros. analyst Shaw Wu.

    Supply Pileup at Retailers

    Oversupply of cell phones from such manufacturers as Samsung and LG could hamper first-quarter sales for the whole industry, says Geoff Blaber, an analyst at researcher CCS Insight.

  • Rough Times Ahead for the Electronics Industry
  • Losing Faith in Gambling's Allure

    Losing Faith in Gamblings Allure

    Get-rich-quick schemes might seem appealing in tough times. But while gambling was once considered virtually recession-proof, state lotteries and casinos across the country are reporting sales declines as U.S. consumers battle the moribund economy. Some lotteries are managing to buck the trend by launching new products, but the overall trend shows many consumers shunning the lure of easy money.

    "Just like Coke or Pepsi, we're competing for discretionary dollars in the marketplace," says David Gale, executive director of the North American Association of State & Provincial Lotteries in Geneva, Ohio. "People have fewer dollars left over after paying their bills, and they're spending carefully."

    Sales for the 12-state game Mega Millions are down 8%, from $2.77 billion to $2.54 billion, for the 12 months ended November 2008 from the same period the previous year. Sales for Powerball, which runs in 29 states plus Washington D.C. and the U.S. Virgin Islands, are also lower for the first half of fiscal year 2009 compared to the same period in fiscal year 2008.

    Individual state lotteries are also reporting a slump, as revenues from New York to Virginia to Kansas have fallen. Lottery revenues from New York to Virginia to Kansas have fallen. Overall sales in Missouri are flat—after two decades of nearly unbroken gains—and it's the same in Washington State. For New York, sales of conventional lottery games, such as the multistate Mega Millions game, dropped 1.6% over six months, from $1.53 billion in April to $1.5 billion in September, although racetrack video products helped lift overall sales 2.8%. Lottery sales in Texas for the first four months of the 2009 fiscal year dipped 4.3%, to $45 million, reports Bobby Heith, a spokesman for the Texas Lottery Commission in Austin. "It's been a rough start to the fiscal year," Heith says. "We do have hopes of coming back."

    Few Big Jackpots

    In California, sales are down 10% since the beginning of fiscal year 2009, which began on July 1. "We believe the decline is caused by a slowing economy [and] the lack of recent large jackpots," says Alex Traverso, a spokesman for the California lottery. Traverso says he hopes sales will revive with larger jackpots and with the January launch of a new televised game show called Make Me a Millionaire. "We can't just show a bouncing ball and expect [consumers] to get excited," says Traverso. "We're now looking more at the game-show element."

    At a 7-Eleven store in the Highland Park neighborhood near downtown Los Angeles, sales started dropping five months ago. The store is now taking in about 10% less than its usual average of $500 per day. "We have fewer customers in general," says Charles Nicassio, who owns and manages the franchise store. "People are just cutting back on everything and being more frugal." He says that some games prove resilient, however—like a bingo scratch card. "It's straightforward, and people understand it," he says. Still, not every lottery retailer is seeing a slowdown. "Sales haven't dropped at all in the lottery," says Stephanie Emerson, manager of a Flash Foods convenience store in Thomaston, Ga. "We get a lot of traffic on Fridays, especially when the Mega Millions [jackpot] gets real high."

    Because other factors besides the economy determine lottery sales—namely, the size of jackpots and the appeal of new products—there are some bright spots. Georgia's lottery sales are up 3% from the same point in 2007, after enjoying record sales and profits each year for the last five, says Margaret Requa DeFrancisco, president and chief executive of Georgia Lottery. She credits aggressive marketing of the games, along with telling potential buyers that a portion of state lottery proceeds are used to fund scholarships for Georgia students and pre-kindergarten education. "There's a lot of marketing and energy behind it," says DeFrancisco. In one recent promotion at an Atlanta Falcons football game, the lottery offered scratch tickets for a chance to win a Harley-Davidson (HOG) Fat Boy motorcycle and a Ford (F) F-150 pickup truck.

  • Focus Stock: Tough Times Favor Family Dollar Stores
  • The iPhone Apps Sweepstakes
  • Sony Blames Profit Warning on Yen, Weak Demand
  • The iPhone Apps Sweepstakes
  • Saturday, December 20, 2008

    Steep Drop, Slow Ascent

    Steep Drop, Slow Ascent

    Investing for the long haul is even more important in today's volatile markets, but as John Maynard Keynes once quipped: "In the long run, we're all dead." Right now most people just want to know what's in store for the coming year. To get some ideas, BusinessWeek surveyed 45 economists around the nation about their expectations for everything from growth and profits to inflation and unemployment.

    It's not a pretty picture. On average, the forecasters expect the economy to contract 0.2% in 2009, the same as in 2008. The worst of the declines in real gross domestic product will come early, with some stabilization in growth by midyear, followed by a tepid start toward recovery. That scenario will lift the jobless rate to a peak of 8.1% by yearend.

    The recession, plus plunging oil prices, will push inflation sharply lower. By yearend these prognosticators believe consumer price inflation will have fallen to 1.2%, having already slid to an expected 2.1% by the end of 2008. Not surprisingly, profits will get hammered. Even before the Federal Reserve's latest radical move, the forecasters looked for the Fed to cut its target federal funds rate to nearly zero and hold it there, perhaps all year. The Fed accommodated that expectation much earlier than expected by slashing its target rate on Dec. 16 to a range of zero to 0.25% and committing to hold it there for as long as it deems necessary.

    The tumble in homebuilding is expected to bottom out by midyear, but house prices will fall an additional 9.8% by yearend 2009, the economists project, after a nearly 20% decline in 2008. On balance, they believe that enormous policy efforts by the Fed and Congress will prevent a serious recession from becoming worse. Here's a more detailed view of how they see the coming year:


    The recession already is a year old. If the forecasters are right, it will easily exceed the severe 1973-75 and 1981-82 downturns in length and about match them in depth. Those two slumps each lasted 16 months, with peak-to-trough declines in real GDP of 3.1% and 2.6%, respectively.

    Almost all economists, however, think the risks of an even worse outcome are high. "There are no precedents in modern-day experience for the breakdowns in financial markets dominating this recession," says Robert DiClemente at Citigroup. (C) In the classic pattern of past slumps, the Fed eased, financial conditions improved, and recovery took root. This time, faced with dysfunctional markets, conventional Fed policy is powerless to kick-start growth. "The downturn in the economy and problems in the financial markets are self-reinforcing, and the current dynamic will not self-correct any time soon," says Robert Mellman at JPMorgan Chase (JPM).

    Much damage has already been done, and the economy faces a bleak winter. "Consumer spending is the No. 1 factor taking the economy down right now," says Nariman Behravesh at research firm IHS Global Insight. Job losses, tight credit, and crumbling confidence are overwhelming the benefits of lower energy prices, and declines in real estate and stock market wealth are devastating nest eggs. "Individuals will need to begin accumulating wealth the old-fashioned way—by higher savings, which will limit growth in spending," says Michael Moran at Daiwa Securities America.

    With demand slumping badly, businesses are throwing in the towel. The Business Roundtable says CEO confidence tumbled at yearend, and sharp cutbacks in hiring and capital spending are sure to follow. "Costs cannot be cut fast enough," says Kevin Logan at the investment bank Dresdner Kleinwort, as businesses scramble to protect their bottom lines. Donald Straszheim, who heads his own consulting firm, thinks earnings estimates are still too optimistic. "Few sell-side stock analysts have any adult memory of past serious business cycles," he says. "They weren't even in the business yet."

  • The Great Inflation Debate
  • Credit Crisis: The Risk Hits Russia
  • The Fed's Risky Backdoor Bailouts

    The Feds Risky Backdoor Bailouts

    The U.S. Treasury Dept. has been blasted for handing out huge sums of money to banks without clear taxpayer safeguards or ground rules for the recipients. Yet the Federal Reserve is pouring trillions into banks with little transparency. The moves have helped to shore up the wobbly financial system in the short term. But some of the deals could end up hurting taxpayers, weakening the central bank, and weighing on the economy in the future.

    In one of its latest transactions, the Fed in November channeled $20 billion—more than the size of the proposed auto bailout—to a group of U.S. and European banks, including Socit (SCGLY), Deutsche Bank (DB), and Goldman Sachs (GS), according to people familiar with the deals. The only evidence that the vast sum had changed hands was an entry on the Fed's most recent balance sheet called "Maiden Lane III" and a series of cryptic regulatory documents.

    By making loans to financial institutions that can't get credit elsewhere, the Fed is the only part of the government that has the power to pump capital quickly into the financial system to stave off crisis. Historically such moves have been rare, and they've been made behind a curtain of secrecy on the thinking that public disclosure could spark a market panic. "We keep these transactions private because the Fed, as a lender of last resort, seeks to provide liquidity and not stigmatize those who seek it," says Calvin Mitchell, a spokesman for the New York branch of the Fed, which set up the Maiden Lane III transaction.

    The banks likely welcomed the fresh capital from Maiden Lane III. But in recent months the Fed has pushed the boundaries of its authority by taking larger and more opaque risks on its books. The central bank currently has $2.2 trillion in outstanding loans, up from $900 billion in September. It's also using new and untested weapons. Until this year the Fed mainly loaned to banks. Now it's buying securities, some tied to poisonous mortgages. If those bets don't pay off, the Fed will eat the loss.

    dangers lurk

    That could spell trouble for taxpayers—and the economy. If the Fed's new deals don't work out and the losses are too great, the central bank may have to print more money, flooding the financial system with dollars. Inflation could surge, making it harder for the Fed to focus on other objectives, such as economic growth. "We have to wonder if the Fed's balance sheet might be in danger," says Roy C. Smith, a finance professor at New York University's Stern School of Business. "It is legitimate to ask the Fed to defend [its actions]."

    There are growing calls for more accountability of the government's far-flung bailout efforts. The Congressional Oversight Panel, which monitors how Treasury spends its $700 billion bailout pool, is closely watching the Fed's moves as well. Elizabeth Warren, the independent chair of the panel and a Harvard Law School professor, says that's because the Treasury's actions dovetail with those of the Fed. Warren recently met with Fed staff to discuss how the central bank spends taxpayer money. As part of the ongoing inquiry she is also looking at Treasury money that indirectly funded the Maiden Lane III deal. "There were good reasons the Fed was made independent of oversight," says Warren. But "these are not ordinary times, and the amount of money and intervention by the Fed is extraordinary."

    The roots of Maiden Lane III can be traced to the Fed's rescue of troubled insurer American International Group (AIG) in September. With AIG on the brink of collapse, the Fed and Treasury stepped in to prevent a meltdown of the financial system.

  • Will Bank Rescues Mean Fewer Banks?
  • Britain’s Big Banks Bailout
  • Is the Fed’s $800 Billion Plan Cause for Concern?
  • Friday, December 19, 2008

    Attractive Stocks in an Ugly Old World

    Attractive Stocks in an Ugly Old World

    The Continent's leading stock indexes have plummeted more than 40% this year, and Old World companies—from steelmakers to insurers to purveyors of luxury goods—are trading at valuations not seen since the early 1980s.

    The question is whether to buy now or wait for prices to drop even further. Caution seems appropriate: The gloom in Corporate Europe is deepening as recession tightens its grip. "Over the last few weeks we have seen short-notice cancellation of orders," says Jean-Pierre Clamadieu, CEO of Paris-based chemicals group Rhodia, which issued a profit warning on Dec. 8.

    Even businesses that have plenty of orders are hamstrung by tight credit. "Firms could go under just because they lack liquidity," says Porsche CEO Wendelin Wiedeking. He says the automaker is paying some suppliers in advance because they can't get loans. It's no surprise, then, that many investors are hunkering down with shares in utilities, pharmaceuticals, food, and other businesses that offer reliable cash flow.

    Most analysts think it's unlikely that Old World bourses will rally before the second half of 2009. Still, investors with more appetite for risk—and a willingness to pore over balance sheets—can find some good values even in cyclical businesses such as manufacturing. Bleak earnings outlooks have already been factored into many share prices. And, says Philip Isherwood, chief European equities strategist for investment bank Dresdner Kleinwort in London, managers at some companies "are becoming more realistic," trimming their forecasts and moving aggressively to slash costs.

    Such companies are likely to outperform rivals even in a lousy economy, and they'll be well-positioned for the next upturn. One example: steelmaker Arcelor-Mittal (MT), which faces a collapse in demand from automakers and other big customers. It has announced tough cost-saving measures, including a plan to save $1 billion by cutting some 9,000 jobs. With its price-to-earnings ratio of just 2 based on 2009 predictions, it's now turning up on analysts' buy lists.

    Companies that dominate their sectors also can make good bets, as they may emerge from the downturn with a tighter grip on their markets. "In tough times, the people who are stronger and able to invest are better off than weaker competitors," says Nokia CEO Olli-Pekka Kallasvuo. Nokia (NOK), which holds 38% of the global cell-phone market, has twice revised its 2008 sales forecast downward, but it has a healthy balance sheet and generated more than $1.6 billion in cash flow during the third quarter. With its shares off by two-thirds in this year's market mayhem, it looks like a good buy, say managers.

    Currency gyrations could produce some winners, too. Shares of luxury-goods giant LVMH Mot Hennessy Louis Vuitton have fallen some 30% since September as key markets such as Russia and China faltered. Although LVMH's sales growth in 2009 will be only 3%, HSBC (HBC) predicts earnings will jump 6% because LVMH books about half its sales in dollars and yen, which have risen sharply against the euro.

    Though pickings are good, patience is a must. Morgan Stanley's (MS) European equities team is predicting a 33% drop in corporate profits next year, after a 14% slide in 2008. It's advising clients to boost cash positions and buy mainly defensive stocks, topped off with a few well-chosen cyclicals.

    With Jack Ewing in Frankfurt

    Return to the Investment Outlook Table of Contents

  • Stocks: Still Too Expensive?
  • Paulson: 'Orderly' Auto Bankruptcy May Be Necessary

    Paulson: Orderly Auto Bankruptcy May Be Necessary

    Treasury Secretary Henry Paulson said Dec. 18 that the government should exhaust all other options before allowing troubled U.S. automakers to fall into bankruptcy. But Paulson said bankruptcy might end up being the right solution if other measures fail.

    Speaking at a BusinessWeek-sponsored Captains of Industry forum at the 92nd Street Y on Manhattan's Upper East Side, Paulson showed mixed feelings about how to deal with General Motors (GM) and Chrysler, which are seeking emergency government assistance to stay in business.

    Paulson said he generally prefers free-market solutions, but said he agrees with President Bush that it would be imprudent to allow a disorderly failure of the automakers. Said Paulson: "This is a time when it makes sense to be prudent." The Treasury Secretary added, "If the right outcome is bankruptcy, then it's better to get there through an orderly process."

    Favors Oversight of Hedge Funds

    In other news, Paulson said he favors regulation of any institution whose failure could jeopardize the financial system, and that includes hedge funds, which traditionally have been lightly regulated. "The [Federal Reserve] should have oversight over hedge funds," he said.

    Paulson was interviewed by BusinessWeek Editor-in-Chief Stephen Adler as part of the 10-year-old Captains of Industry series, which features leading newsmakers.

    Among other points, Paulson said:

    • An economic downturn remains much more of a risk than inflation from the money that's now flooding the system. "That'll be a high-class problem when we can start worrying about growth and inflation again," Paulson said, adding: "The real cost would be to not do enough and then have the economy go into a free fall."

    • Banks that took U.S. funding should lend more, but he defended the Treasury's emphasis on getting them money right away without strings. "Our first priority was always, and we were clear from the day we went to Congress, to prevent the collapse of the financial system." He said, "There was literally a wave, just a string of financial institution failures or near-failures." Paulson added: "They need to lend more. We don't want them hoarding, we want them lending." However, he also said, "It is not in my judgment practical or prudent to have government…saying 'Make this loan, don't make this loan.'"

    • He defended the amount of disclosure by Treasury on the Troubled Asset Relief Program, or TARP. Paulson said, "We have been moving with lightning speed," and added, "We're building this organization as we're going."

    • "The No. 1 thing we need to do is stem the housing correction."

    • The government lacked the authority to prevent the failure of Lehman Brothers, the investment bank that went under in September. But he said that Lehman's failure was "in my judgment a symptom, not a cause" of the financial turmoil.

    • President Bush "is very current and he's on top of everything we've done." He said, "I know that's not conventional wisdom among some people but it's absolutely true."

    • China and the U.S. should be good partners. "We won't always have the same view, but engagement in my view is exceptionally important."

    Adler's final question to Paulson was what advice he would give his successor, Timothy Geithner, who is now president of the Federal Reserve Bank of New York. Paulson said Geithner doesn't need his advice, but added, "It's important when you're going through a time like this to define your job expansively."

  • Wall Street’s Perfect Storm
  • Thursday, December 18, 2008

    Mort Zuckerman on the Madoff Scandal

    Mort Zuckerman on the Madoff Scandal

    As if the housing crisis, liquidity freeze, deepening recession, and prospect of deflation weren't enough, now we have the Madoff Affair rocking Wall Street and investors everywhere. While no indictments have been handed down yet, prosecutors allege that Bernard Madoff, founder of Bernard L. Madoff Investment Securities, has orchestrated a long-running Ponzi scheme that duped investors—among them hedge funds, charities, and the rich and famous—out of billions. One big name allegedly taken to the cleaners was Mort Zuckerman, a principal of Boston Properties, proprietor of the New York Daily News and U.S. News & World Report, a political commentator, and a philanthropist who was on BusinessWeek's recent list of most generous givers. Zuckerman says he lost none of his personal wealth, but a chunk of the assets in a charity he controlled was invested with Ascot Partners, a hedge fund run by J. Ezra Merkin, managing partner of Gabriel Capital Group and chairman of GMAC Financial Services. Zuckerman said he got a letter from Ascot last week saying almost all its assets had been invested with Madoff and were presumed lost. At least one suit against Ascot has already been filed in federal court in Manhattan, according to news reports, and when I talked with Zuckerman on Dec. 16, he said he, too, would be going after Ascot. In an e-mail, Merkin's lawyer, Andrew Levander of the Dechert law firm, said: "The offering Memorandum for Ascot expressly named Madoff Securities as a prime broker for the fund in several places and accurately described Ascot's trading strategy. Moreover, Mr. Merkin regularly consulted with Mr. Madoff about the trades he was supposedly executing for Ascot, and Mr. Merkin's management team contemporaneously reviewed the trading tickets provided by Madoff Securities. To our horror, it now appears that those discussions and those trade tickets were a sham."


    What's the impact of the Madoff scandal on your charitable trust?


    Well, about $30 million, or about 10%, was invested in the Ascot fund, which had somewhere around $1.8 billion [under management]. To my astonishment, the fund manager put the entire amount into Mr. Madoff's hands. I had no idea of this. I never knew Mr. Madoff, never heard of him, and then last Friday I get the notice that the entire fund has been lost because of Mr. Madoff's activities. So, obviously, it's going to affect the ability of this [charity] to do more things. Thirty million is a lot of money that I intended to spend for the welfare of others.

    With that kind of money, you trusted somebody you knew, right? Was that someone Ezra Merkin?


    What has been his response about giving the money to Madoff?

    Oh, he has not given anybody a satisfactory response. I had a conversation with him, and I don't want to go into it.

    I understand. So…

    And nobody knew that he was doing it. I mean, there are dozens and dozens of people who…thought they were investing in a multiple and diverse group of funds. If you were going to invest all this money in another fund, it seems to me you should have told everybody that you were doing this so that they could decide whether or not that person was the person with whom they wanted to invest.

  • Mutual Funds: Know Where the Risks Lie
  • Mutual Funds: Know Where the Risks Lie
  • The Price of Forgoing Basic Research

    The Price of Forgoing Basic Research

    In the "good old days," the industrialized world was peppered with corporate research labs. At the same time, universities were generally well funded. Curiosity-driven research, a key component in innovation was the ethic of the academy. The university produced great minds that were encouraged to think deeply and creatively without the consideration of commercial relevance. Industry selected appropriate candidates from among this cohort and gave them a home where they could generate proprietary intellectual property on which that company's future could be based. Along the way, all did some outstanding basic science.

    But since about 1970, we have been on a path where industry's investment in basic research has been in decline. At the same time, there has been a significant shift toward applied, "industry-relevant" research within academia. I believe that these trends do not augur well for the future of industry, academia, or society as a whole.

    The Decline of the Corporate Lab

    Some might argue that the decline in the number of corporate research labs is no bad thing—that the market made a correction and halted investment in things that did not provide an adequate return. I can even hear someone bringing up Xerox PARC (where I worked) as an example. "Hey, they developed the laser printer, local area networks, and personal workstations and were still not a player in personal computing!" Well, if you want to argue that a failure in a particular technology transfer is sufficient to condemn the whole notion of corporate research, then we will just have to disagree. The invention of Nylon, Lycra, Spandex, Teflon, and Kevlar provide a clear illustration of how investment in research can sustain the long-term viability of a corporation (in that case, Dupont (DD).)

    Others might argue that corporate research has simply moved to other parts of the organization—to places where it can be more integrated with the rest of the company and therefore accelerate the adoption of research. They might even support such a conclusion by referring to the data reported in sources such as the OECD Science, Technology & Industry Scoreboard 200 which indicates that, in general, reasonable investments in research and development are being made by industry, academia, and government.

    But the term R&D is so broad as to border on useless for the purpose of analysis, since it covers the whole gamut of activities from basic research to product development. It ignores the significant difference between the work of a Nobel Prize laureate and a junior programmer. As early as 1980, the economist Edwin Mansfield showed that throwing everything into one R&D bucket obscured the fact that corporate investment in basic research, and even advanced development, was in decline. In this now-classic paper, Mansfield surveyed the R&D spending of 119 firms, representing about 50% of R&D expenditures in the U.S. He found approximately a 25% reduction in their investment in basic research between 1967 and 1977.

    That may seem like a long time ago—but think how long it can take for research or development to play out (for more on this topic, see my previous column, "The Long Nose of Innovation"). All of a sudden, the issue becomes contemporary. As a result, we should be skeptical of reports which lull us into believing that our R&D bucket is adequately full.

    There will still be those who argue that industry can no longer afford to undertake basic research and that any investment is best made in applied research and development.

  • Marcial: Procter & Gamble, Durable in a Downturn
  • Clouds over the Solar Power Industry
  • Marcial: Procter & Gamble, Durable in a Downturn