economy
Oracle shows off art of war by hiring Mark Hurd
Sep 8th
Larry Ellison has launched another phase of his long-standing battle with Silicon Valley. A Sun Tzu admirer, the Oracle boss roundly mocked the board of rival Hewlett-Packard when it forced out Chief Executive Mark Hurd last month. By hiring Hurd, Ellison backed up his words. He not only gains a well-regarded operations guru, he follows the Chinese general’s sixth-century BC dictum “Know your enemy.”
Hurd should slot in nicely as a lieutenant. He’ll serve as co-president alongside Oracle veteran Safra Catz, who will continue to manage legal affairs, finance and acquisitions. Sales, marketing and client support will be Hurd’s mandate. Ellison will still chart the ship’s course — and presumably assume any other tasks that suit him.
This division of power would seem to invite executive infighting — but should nevertheless work for Oracle. It has worked for years now, with Hurd filling the role of the departing Charles Phillips. Ellison is bored by day-to-day operations and prefers to focus on the broad technology landscape. Moreover, the persistent critique of Hurd is that he lacks strategic vision. His new position should allow his strengths to shine.
Hurd is perhaps best known for cost-cutting following acquisitions. Before he was forced out of HP for allegedly fiddling his expenses related to a sexual harassment claim, he grew operating margins from 4 percent in 2005 to about 9 percent. Investors like the prospects — and sent Oracle shares up about 5.5 percent.
Oracle is also a serial acquirer. The company has made 60 acquisitions over the past five years, according to Thomson Reuters. That’s about 20 more than HP made over the same period. Moreover, Oracle is still digesting the purchase of Sun. Hurd’s experience at running NCR and HP — two companies that produce both software and hardware — should enable him to make contributions on Sun right away.
Hurd’s past may be his most valuable attribute. Oracle and HP are now in heated competition from business software to servers. Inside knowledge of how its rival runs and the status of its client relationships could prove invaluable. And Hurd will presumably be plenty motivated to stick it to his former employer. Ellison is proving himself a shrewd disciple of the art of war.
China needs political reforms for future growth
Sep 7th
Thirty years ago, a small fishing village called Shenzhen led China’s economic miracle. Now, it has a more challenging mission. President Hu Jintao said Shenzhen should test political reforms. Although changes may be disruptive in the short run, more checks and balances and rule of law are key for sustainable growth.
China’s authoritarian system has shown its merit during the global financial crisis. When Western banks stopped lending, China’s state-owned banks kept pumping credit into the system. The centrally planned economy was also good at funnelling cheap capital and resources to industries. That has helped China to continue its transition from a poor rural economy into a global manufacturing powerhouse.
Yet the shortcomings of the system have also become more evident. A centralised government overwhelms the power of the market. New policies aimed at rebalancing this face resistance from various interest groups. One of China’s biggest challenges is to get its people to spend. But as long as the state controls the bulk of the wealth and power, ordinary people can’t afford to consume more.
More balanced growth requires political reforms. Beijing needs to let the market play a bigger role in setting input prices, if it is serious about promoting energy efficiency and technological advances. Citizens need to have more voting power in order to create checks and balances in the system. Rule of law is needed for economic and political stability.
Those changes may be painful in the short term. Market-based input prices will make Chinese goods more expensive. Local government and powerful interest groups will resist changes. Democracy can’t be learned in a day.
Yet China can’t afford not to change. To reduce wasteful investment, China needs to reduce the concentration of resources at the state level and give people more wealth. As ordinary Chinese get richer, they will demand more political rights.
Thirty years of economic success has made the Communist Party popular and powerful. China’s future hinges on whether some of that power and wealth is shared more evenly with its people.
When should investors sell their Apple stock?
Sep 7th
When should investors sell Apple shares? The group’s push overseas and into the business market still holds promise, as does the steady stream of fresh gadgets such as Apple TV, unveiled by chief executive Steve Jobs last week. Apple’s trajectory should continue for some time, so its stock — which has gained more than 40 percent each year for the past five — looks attractive at 15 times estimated 2011 earnings.
But no company can grow sales at that pace forever. While it may sound premature or even churlish to do so, Breakingviews offers up some strategic cues that could act as warning signs for investors that Apple’s growth is slowing:
Discounting:
While Apple computers and handsets account for less than 5 percent of global unit sales, the company racks up extraordinary profits on them. Its reputation for producing quality gadgets means Apple can charge a premium over competing products. Its operating margin is almost 30 percent. Even small gains to its market share result in supercharged profit growth.
Apple has used the so-called “halo effect”, rather than price cuts, to gain market share. Its devices work well together. And users who try one often adopt Apple’s other products. This can be seen now in the enterprise market, where Apple has traditionally been weak. The iPad appears to be a big hit among corporate executives and professionals. This should increase adoption of iPhones and Macs. Moreover, Apple appears to have avoided the discounts typically offered to big customers. If salespeople want iPads, there’s nowhere else to turn but retail.
Apple could boost market share quickly by offering discounts or cheaper devices. While this would bump up profits in the short term, it would be a flashing yellow light because the high end of the tech market is disproportionately profitable.
While Apple could profit from selling lots of low-end gadgets, it’s a tough place to make a buck because of greater competition and lower capacity to differentiate products. Nokia’s operating margin on phones is around 11 percent. Those in the commodity PC market aren’t better — Dell’s are around 5 percent. There’s a big risk, too, that selling cheaper goods could tarnish the brand. A loss in the company’s ability to charge an “Apple premium” or a small fall in market share at the high end would hit profits hard.
Raising tolls:
One way Apple has maintained premium pricing for its gadgets is by improving them each year. In the case of the iPhone, a large chunk of this improvement has come from the increased number of applications that can run on the handset.
Partners who develop these bear much of the cost. Apple vets the applications and distributes them in exchange for 30 percent of sales. Apple hasn’t historically run its online stores to maximise profits. Instead, the goal has been to make the devices more valuable and entrenched. The result is a virtuous circle. Consumers like the gadgets because they have become increasingly useful, and software developers follow the customers. Apple could, theoretically, extract bigger tolls – take 50 percent of revenue from sales, for example. Those increased revenues would fall right to the bottom line.
Yet developers could eventually turn elsewhere, and users might follow. Google, for example, plans to take only a 5 percent chunk of sales on games that it sells online, plus a small processing fee. Second, ratcheting up the toll might invite regulatory attention, because it smacks of anticompetitive behavior. While raising its revenue share could generate some short-run growth, it would be a bad sign for the company’s future.
Big acquisitions: Apple has $46 billion of cash and investments on its balance sheet. Mr Jobs may find this fast-growing stash comforting. But it isn’t earning much interest. Apple has wisely avoided big acquisitions. When many companies see their growth slowing, however, they often try to buy it through “transformative acquisitions” in the way Intel is purchasing McAfee or HP buying 3PAR. Apple’s cash could buy a majority of companies in the S&P 500. Surely it could find a big firm that would generate a better return than what it earns in the bank, right?
Don’t count on it. Integrating two big companies more often than not results in unproductive executive infighting and bloated expenses instead of valuable new product innovations. Most damningly, sellers usually extract the gains. Just look at Cisco. The firm is an efficient M&A machine, yet its shareholders have received little benefit over the past decade from CEO John Chambers’ shopping. If Apple ever headed down this route, it would be a sign that the firm has transformed itself into a lesser company.
U.S. jobs figures provide subdued reassurance
Sep 4th
Friday’s U.S. jobs figures provide subdued reassurance. The private sector employment gains of 67,000 in August, together with positive revisions totaling 123,000 for previous months, should dispel fears of an economic double-dip for now. With just one more jobs report before November’s elections, the latest data also offer a glimmer of hope for Democrats.
Continued and fairly steady private sector job growth, together with a surprising decline of 323,000 in long-term unemployment should be reassuring for the unemployed and those fearful of losing their jobs. That’s despite that fact that the end of temporary census employment led to a headline loss of jobs in August. It is also likely to help Democrats in November’s midterm elections, blunting the force of Republican attacks on their handling of the economy.
That said the recovery is less than vigorous, whatever the Democrats might claim. Following the last comparably deep recession in 1983, monthly job creation was on average 288,000. So far in 2010, job creation has averaged less than a third of that — and in recent months has gone negative. That isn’t enough to make even a modest dent in unemployment. The civilian non-institutional population aged over 16 has increased by 2 million since last August. Some 65 percent of Americans participate in the workforce, so the 723,000 jobs created since last December are insufficient to absorb new workers.
While there was a modest 0.8 percentage-point increase in the Institute of Supply Management’s manufacturing index in August, the larger 2.8 percentage point decline in its non-manufacturing index also indicates that economic recovery remains sluggish — although here too there is as yet no sign of a double-dip. Employment data confirm this; most of the rise in private sector employment was in healthcare services, while manufacturing employment declined, reversing last month’s increase. With construction employment down 271,000 in the last year, there is also little sign of a positive employment effect from the 2009 stimulus package, much of which was devoted to infrastructure.
In the short term, the jobs picture has improved slightly and fears of a double-dip should lessen. But there’s not yet much on which to pin longer-term optimism.
Bob Geldof’s African fund shows good timing
Sep 4th
Tiring of sex, drugs and rock’n’roll, 1980’s rock icons have found a new thrill — private equity. First, U2’s Bono became a partner in media investor Elevation Partners. Now, Bob Geldof is looking to raise $1 billion for an African private equity fund, to be called 8 Miles.
Geldof’s connection with the continent goes back many years. Since organising the Live Aid concert in the mid-1980s, he has campaigned for increased aid and debt forgiveness for African nations. His political contacts should help open commercial doors.
The musician’s fundraising effort also coincides with a flurry of renewed interest in Africa. The latest cheerleader is Jim O’Neill, Goldman Sachs’ chief economist and inventor of the BRIC acronym. He reckons Nigeria, Africa’s most populous country, could rival the economies of Canada, Italy or South Korea by 2050.
Of course, Africa has consistently defied the investment optimists. Conflict, corruption and poverty have made the continent a no-go area for Western businesses and investors for many decades. But there are plenty of encouraging signs. Real gross domestic product rose 4.9 percent per year from 2000 through 2008, more than twice its pace in the 1980s and 1990s, according to the McKinsey Global Institute.
China is part of the explanation. Its hunger for commodities has sparked a flurry of investment in African resource and infrastructure projects. But, other industries have also been on the receiving end of big international investments. HSBC is set to follow the lead of UK rival Barclays and buy a controlling stake in a South African bank. India’s Bharti Airtel has just spent close to $11 billion buying telecom group Zain Africa.
Geldof will need to make sure that 8 Miles’ investments are cleaner than clean. Given his profile, any hint of dodgy practices at a portfolio company could scupper its prospects. What’s more, new European Union rules on investment funds could make investing in some African markets difficult.
This isn’t the only fund looking to take advantage of Africa’s economic development. But it will be one of the biggest and best connected. Geldof looks better placed than most to be the person to make African private equity work.
Obama pulled two ways on stimulus 2.0
Sep 3rd
Departing White House economic adviser Christina Romer says last year’s $814 billion stimulus package fell short. That may suggest those arguing for more fiscal action are gaining ground with the administration. But short of a renewed economic slump, electoral politics are working against more stimulus.
Not that Romer thinks all the spending and tax credits — originally calculated at $787 billion — didn’t work more or less as expected. She believes the U.S. economy would be in far worse shape today without them. But in her valedictory on Wednesday, Romer said the economic team failed to anticipate the violence of the recession. So despite the stimulus, the output gap and unemployment rate are far worse today than they expected in early 2009. But even with those original, overly rosy assumptions, Romer’s analysis back then suggested the stimulus plan should be bigger, around $1.2 trillion.
Her view was countered by rival adviser Lawrence Summers — he didn’t want President Barack Obama to even see that pricier option — and White House chief of staff Rahm Emanuel, who both thought the plan should be smaller for economic and political reasons. They won that debate. But Romer still thinks additional government action — more spending and more tax cuts — is needed. And given that the White House seems to be mulling fresh stimulus options, the president may now be inclined to agree with her.
Romer’s speech will surely give hope to liberal critics such as newspaper columnist and economist Paul Krugman who have been hectoring Team Obama to do more. And if Democrats suffer historic losses in the November midterms, her remarks may be a cornerstone of the case to replace Summers and perhaps even Treasury Secretary Timothy Geithner. The heightened expectation of changes in the administration’s economic team is illustrated by the speed with which a now-dispelled rumor about New York City Mayor Michael Bloomberg replacing Geithner spread through Wall Street and Washington this week.
But even a dramatic personnel shuffle won’t change the reality that the White House will almost surely face a far more hostile Congress in 2011. Angry liberals will want more spending, emboldened conservatives more tax cuts. Fashioning a politically viable compromise that makes economic sense and won’t alarm bond vigilantes will be a huge challenge. Romer should be relieved that it will be someone else’s.
Petrobras deal shows it’s more Gazprom than Exxon
Sep 3rd
Petrobras is shaping up more like Gazprom than Exxon Mobil. By overpaying for 5 billion barrels of reserves, the Brazilian state-controlled oil group is transferring up to $17 billion of value to the government, whose stake will also rise. The company is looking more like an instrument of the state than a guardian of shareholder interests.
A year after the capitalization plan was first announced, Petrobras shareholders are finally getting some clarity. That earned a relief rally in the company’s beaten-down shares on Thursday. But the news overall isn’t good.
At $8.51 per barrel, Brazil is charging its captive oil company well over the odds for the new reserves. An external certifier will have a shot at justifying that valuation, but a more reasonable figure may be as little as $5 a barrel. That means the government will gain at the expense of Petrobras shareholders. The deal will require the issuance to the government of $42.5 billion in new shares.
Private investors, meanwhile, will probably see their economic interest — currently more than two-thirds — decline because they won’t be willing to buy enough additional new shares to maintain their stake. A figure more like $25 billion of private cash is doing the rounds, which would bring their interest down below 60 percent.
Of course Petrobras was never a pure private sector play. The government, after all, owns a majority of its voting stock. Losing out in the oil-for-shares swap serves to remind shareholders of that.
It’s risky, however, for Brasilia to push Petrobras shareholders around too much. Even with fast rising cash flow, it will need around $58 billion by 2014 to meet its ambitious capital spending goals. Raising that cash should be a breeze for a company that expects to double output by 2020 — a growth outlook unmatched by any other big oil company. But investors will lose enthusiasm if they perceive that their interests come a distant second to the government’s.
Russian state-controlled Gazprom trades at just 5 times estimated 2010 earnings — at the low end of its peer group and less than half Exxon’s multiple. Petrobras is currently somewhere between the two. Private sector owners will be hoping the Brazilian government, which after all benefits if the company’s valuation rises, starts distancing itself more clearly from the Gazprom model.
Are Dell’s shareholders on Xanax?
Sep 3rd
Are Dell’s shareholders on Xanax? The company has finally bowed out of its mad bidding war for 3PAR. Yet its investors displayed neither much concern about overpayment nor relief about the deal being dropped. After a decade of scandals, missed opportunities and dismal performance, they may have stopped caring.
They had reason to worry. Dell appeared desperate to win storage company 3PAR. It raised its offer multiple times to match bids from Hewlett-Packard. HP’s $2.1 billion winning bid, which Dell came close to matching, was more than three times 3PAR’s undisturbed market capitalization and values the company at almost 10 times estimated sales. Based on a typical tech premium of around 40 percent, HP appears to have overpaid by more than $1 billion.
Dell’s investors should be happy to have avoided winning 3PAR at a price that would have been about 4 percent of Dell’s market capitalization. Moreover the company received a $72 million break fee for its troubles. Yet the stock only rose about 2 percent in mid-day trading. Investors’ tranquilized reaction was a reflection of their seeming lack of ability to feel much anger or sadness during the battle. Dell’s shares fell little after the initial bid or the frenzied subsequent offers.
Perhaps shareholders never thought Dell had much of a chance against the much larger HP. A better explanation may be that many investors have simply given up on the stock. Dell’s shares are down about 70 percent over the past decade. The company has acquired a reputation for producing inferior products and offering poor tech support. An accounting scandal cost the company $100 million. Apple’s increasing inroads into the computer market could cost Dell sales. And rivals such as HP, IBM, and Oracle are far ahead in offering one-stop shopping for clients.
While Dell’s weak recent record could easily continue, such investor apathy can be the sign of a stock bottoming. The shares trade at less than 10 times estimated earnings for this year, and the company’s cash flow yield is around 15 percent, according to Merrill Lynch. The company also has more than $7 billion of net cash on its balance sheet. Perhaps the shares have become so unloved that there’s finally a case for a bit of enthusiasm.