Monday, October 31, 2005

Shades of 1987?


A strong Asian economy showing bubble-type characteristics, U.S. bond yields soaring, stocks bouncing around in 1% daily down-then-up-then-down-then up swings, and a new Federal Reserve Chairman to boot.

No, that is not October 2005 I’m describing—that is the summer of 1987.

For those of you too young to recall the sultry September weeks before what at the time appeared to be another Great Crash but was, in retrospect, a mere blip in a Great Bull Market, let me take you back to 1987 with a brief eyewitness account.

The market had jumped by a third in the first eight months of 1987 and peaked on August 25th. Without telling anybody it had peaked, the market began to wobble in a kind of one-step-forward, two-steps-back mode—the result of the Federal Reserve’s persistent interest rate hikes, which provided investors with higher alternate yields to what everybody “knew” were ridiculous equity valuations.

Yet despite the rate hikes, every institutional investor on the planet (including the one I worked at) felt pressure to remain fully invested: nobody wanted to be left behind.

Meanwhile, Japan was in the grips of a stock market bubble and the “smart money” was convinced the Nikkei was going to collapse, which would be the trigger for a U.S. crash—much like today’s concerns about a U.S. real estate bubble and the impact its winding-down would have on the rest of the economy.

And Alan Greenspan had just been appointed as Chairman of the Federal Reserve Board, replacing inflation-fighting Paul Volcker.

As a result, then, like now, stocks experienced wild swings; then, like now, rates were rising; then, like now, all eyes were on Asia; then, like now, nobody knew whether the new Fed Chairman was up to the task of filling his predecessor’s shoes.

The one big difference then versus now was the presence of a wonderfully misnamed financial product called “portfolio insurance.”

Without getting into the details of “portfolio insurance,” which I couldn’t because I never understood the details (although one of the smartest financial guys I’ve ever known had looked into at the time and pronounced “it works”), there was only one downside to the mechanics of the insurance program: when stocks fell, the program sold them.

Which, after weeks of up and down and down and up and down and down price action, is precisely what happened on that grisly 19th of August, 1987.

As far as I can tell, the best thing about the recent week’s up and down and down and up and down and up market is that we don’t have financial institutions loaded up on “portfolio insurance,” which in 1987 turned a normal bear market into a crash.

On the other hand, we do have something we didn’t have much of in 1987—hedge funds, and lots of ‘em.

And with a 1-and-20 fee structure (most hedge funds get a 1% management fee and 20% of any profits), the tolerance for loss on the trillion-dollars or so that they control is very low—because most hedge funds have what is called a “high water mark,” meaning they don’t get paid a bonus for losing money and then making it back.

Furthermore, the institutional investors throwing money at anything called a hedge fund have even lower tolerance for loss, because—unlike the wealthy investors that made up the capital base of the early hedge fund investors—institutions require stable returns, and they are quicker to cut their losses.

Much quicker, as we saw with the convertible arbitrage funds that have shut themselves down this year after absorbing losses which, in the world of equities, could be considered relatively minor.

Just recently, it was reported that a convertible arb fund called Arbitex Master Fund has lost 94% of its assets—from $517 million in January to $30 million at the end of August, with a -13.2% year-to-date investment return.

Imagine what a 13.2% whack in the equity market—which is really nothing too spectacular considering the Dow lost 22% on October 19th, 1987—might trigger among institutional hedge fund investment world.

Why, it could be “portfolio insurance” all over again!


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Friday, October 28, 2005

Gomen nasai


“Gomen nasai”—from the Japanese meaning “I’m really sorry we missed another quarter, and it was sort of my fault but not really my fault, because we are doing things for the future, and I still think GAAP breakeven is possible, and Project Propeller is really cool, and really it’s the shorts fault.”

See also:

“Hideki Matsui”
“Kung Pao Chicken”

“Tora! Tora! Tora!”


Jeff Matthews
I Did Make That Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Pattern Recognition


Earnings season is in full swing and here's what companies from various industries have said:


Lancaster Colony (salad dressing, candles, auto supplies):

The company will likely incur higher than previously anticipated costs for freight, natural gas, petroleum wax, synthetic rubber and plastic packaging due to the impact of the recent Gulf Coast hurricanes. The magnitude and duration of this trend remains unclear, although our Glassware and Candles segment will undoubtedly be the most sensitive to these changes. We are striving to implement selected price increases as well as further reduce costs, but these efforts may lag the adverse effect of higher energy-related costs.


Grey Wolf, Inc (land-based drilling rigs):


We have seen a significant increase in demand for the larger horsepower rigs and correspondingly, the day rates for these rigs have increased. The South Texas market remains strong with continuing increases in day rates and positive mobilization recoveries across all rig classes.


Furniture Brands (furniture, obviously):

The remainder of the decrease in gross margins is related to raw material cost increases…. As you are all aware by now, we, along with the rest of the industry, are facing dramatic cost increases in polyurethane foam…. In the past few weeks we have seen the price of foam increase 25%-30%.


Agco (farm equipment):

You know pricing is up year-over-year really in all our markets. We were in a situation where the whole industry--we're pricing to offset the higher material costs that we started seeing last year, particularly on the steel. I think that we have been successful in adding price. I think that we have seen some relatively good pricing improvements in all markets.


CSX (railroad):

Revenue growth for surface transportation was once again strong, up 9% or $182 million compared to the same period last year. Our pricing, fuel surcharge, and yield management continued to drive revenues, while volumes held steady at near record levels. The team's focus on productivity also contributed to financial improvement. As a result, our overall operating ratio improved more than four points from last year to an 83% operating ratio this year.


Anybody else see a pattern to all this?



Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Thursday, October 27, 2005

Wanted: Skilled Labor in Nevada


Back on August 5th of this year, when certain readers of this blog goaded yours truly into making an actual investment call—as opposed to merely tossing out “sarcastic and rambling” content, as BusinessWeek put it—I stated then and there that the housing cycle as we knew it had peaked.

At the risk of doing a Bob Dole by referring to myelf in the third person, here’s the quote from that day’s piece called “Playing the Spot Market...For Houses”:


I guess—like the old-time money managers in 1999-2000 who either closed up shop or got with the New Economy—I'd better either jump on the real estate bandwagon or stop barking at the tires.Nope. I'll put a stake in the ground right here, and say what so many others have been saying for so long that they've shut up already: the housing cycle is over. The high-water mark has been reached, today, August 5, 2005, when the 2 year yield hit 4.10%.

Now, the point of today’s piece is not to talk about how smart that call looks. It could still be wrong, and, in hindsight, very dumb.

After all, Tuesday’s Wall Street Journal reported that the hurricanes that have caused such havoc and destruction along the Gulf Coast have also caused something else…real estate mania:

“It’s like we got on the map with the storms,” said one Pensacola realtor: “We’re getting investors from Massachusetts, Colorado, Oklahoma—places we never saw buyers from before.”

Recently, one such buyer from Oklahoma bought a property for $200,000 and sold it weeks later for $395,000…


Now, I am sure somebody from Massachusetts or Colorado or Oklahoma is much smarter than a chuckle-headed Pensacola native willing to sell his battered house to a speculator from Wellesley and take a rental down the street.

But before leveraging up to the eyeballs, those somebodys had better check their Bloomberg screens, or, at the very least, the interest rate tables in their Daily Oklahoman and Boston Globe.

If they do, they will see that the yield on the two year note, which bottomed at a mere 1% before the Fed started jacking up rates last year, reached 4.37% yesterday—higher even than the 4.10% yield which, I concluded on August 5th, was high enough to put the kibosh on the housing bubble.

Why, you may ask, is the two year yield so high relative to the benign “core inflation” number of 2% that all the TV economists toss around?

Well, perhaps the bond market is no longer restricting its reading material to Federal Reserve meeting minutes and Steve Roach End-of-the-World forecasts, but is observing what is actually happening out in the real world, by, say, listening to some of the third-quarter earnings calls that are freely available to all comers.

If so, the New Bond Vigilantes would have heard management from the King of Beers last night discuss “significant” increases in packaging costs and “huge” increases in utility and energy costs.

For the moment, those higher-than-core-CPI costs will not show up in the price of a can of Bud, because the company is engaged in a market-share battle with a newly revived Miller while both lose drinkers to hard liquor. So Bud eats the cost increase.

Not so for home builders and cruise line operators, however.

Pulte Home’s average selling price was up 9% over last year, while Royal Caribbean Cruises raised prices enough to more than offset a 6.4% increase in cost per passenger. And while it is quite literally coining money thanks to decade-high prices for gold, Newmont Mining is struggling to deal with “shortages of skilled labor in Nevada and higher prices for energy.”

And thus the “core inflation” rate—i.e. “ex food, energy, beer cans, utilities, housing, gold, insurance, health care and skilled labor in Nevada”—can be manipulated to look pretty much as it always has: 2%.

But the bond market is no longer fooled: it wants 4.37% for a two-year commitment to government paper.

Housing buyers beware.


Jeff Matthews
I Am Not Making This Up


Note: this piece was written prior to the announcement of an SEC investigation into accounting practices at General Motors, which has caused an early-morning “flight to safety” in the treasury markets, bringing the two-year yield down to 4.35% as I write this. Still a far cry from the 4.10% of August 5th, and the 1% bottom in 2004.




© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Wednesday, October 26, 2005

Sometimes Less Is More


Companies love to talk about “enhancing shareholder value.”


They usually do so when announcing share buybacks that frequently have very little to do with “enhancing shareholder value” and more to do with preventing earnings dilution caused by the generous option grants which the insiders who control the corporate money spigot give themselves, in the interests of “aligning management with shareholders.”

For all the self-congratulatory claptrap, when companies buy back stock it offsets the added shares from all those options grants and helps inflate the “Earnings per Share” calculation so as not to rouse the shareholders’ ire.

According to DuPont’s management, which announced a large share repurchase yesterday morning, the difference between their repurchase and others is that only about half of all announced share repurchases actually get done. (DuPont did not wait around to buy back stock in the open market: instead, the company bought $3 billion worth of stock from a Wall Street firm, which presumably shorted the stock to DuPont.)

One company that probably wishes it had not followed through on its buyback announcements must be Lexmark, the beleaguered printer company which earlier this month announced the biggest earnings miss I can remember at a mainstream technology-related company.

A 50% miss.

Management blamed all sorts of things—but it mainly came down to business falling off a cliff.

I don’t know about you, but in the old days—five to ten years ago—printers were an important part of my computer purchases. They churned out envelopes, labels, letters, and stacks of faxes that came in every morning filled with the research musings of Wall Street’s Finest, all the while consuming gallons of the expensive ink that made Lexmark’s razor/razor blade model so profitable.

But then all that information began to move around in digital form, and the printers piled up around my office like Tequila bottles in the parking lot after a Dave Matthews Band concert.

And HP got its act together.


And finally came the mind-boggling earnings miss from shareholder-friendly Lexmark.

On yesterday’s conference call discussing the actual earnings report, the Lexmark folks discussed their active share repurchase program: year-to-date the company has bought back 12.6 million shares at a total cost of $870 million—average price, $68.83.

Yesterday’s close: $39.69.

Negative “enhancement” to the value of Lexmark shareholders: $367 million.

In the case of Lexmark and its share repurchases, less would have been more. DuPont shareholders should hope its management has greater insight into its business than the folks at Lexmark.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Saturday, October 22, 2005

This Just in: Free Markets Work


Good thing the Hawaiian Public Utilities Commission doesn’t run the U.S. government.

In August, that body decided to cap gasoline prices in Hawaii—where gasoline prices are the highest in the country, as one might expect given the fact that everything else in Hawaii costs more than on the mainland—to teach those nasty, price-gouging oil companies a lesson in the wake of hurricane-related price spike.

Such a gas cap sounds like a good idea, I suppose, unless you were around in the 1970’s, when the U.S. government decided to cap prices on crude oil in the United States and helped create a long-term oil crisis that didn’t get resolved until Jimmy Carter signed the law deregulating crude oil prices.

Carter did the right thing: by freeing oil prices to market-clearing levels, he exposed U.S. consumers to the fact that oil prices had gone up—which, naturally, caused consumers to implement all sorts of energy-savings techniques. He also, however, unleashed a short-term inflationary spiral resulting in the ultra-high interest rate policy of Fed Chairman Paul Volcker designed to crush that inflation.

Energy demand fell and so did oil prices, which in time set the stage for a disinflationary economic environment that triggered one of the greatest bull markets of all time.

Unfortunately for Jimmy Carter, he was not around to see the great bull market, because American consumers had voted him out of office owing to the inflationary spiral and the interest rate spike triggered by his decontrol of oil prices.

Like Richard Nixon’s wage and price controls back in the 1970’s, the 2005 Hawaiian PUC’s response to the hurricane-inflicted oil supply disruptions was sorely misguided, as proven by the recent price trend at my local Gulf Station.

After hitting highs around $3.25 a gallon for unleaded regular a month or so ago, the price at the Gulf Station has been falling steadily. More recently it's dropped like a rock: just yesterday it was down a dime, from $2.67 a gallon to $2.57, overnight.

Seems rising gasoline and deisel and jet fuel prices caused total oil product demand in the U.S. to fall more than 3% year-over-year in the last month, reversing a steady upward climb over the last decade that helped put us in the position whereby world oil supply was barely keeping up with demand.

Combine that demand reduction with the surge in supplies shipped over from Rotterdam and elsewhere to make up for the lost hurricane-related supply; and you get lower prices at the Gulf Station in New England.

Now, $2.57 a gallon is still up 20% from last year—and U.S. consumers are still not out of the woods.

But they’re a lot better off than the dark post-hurricane days when the folks in Hawaii decided to do something about the free market price of gasoline.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Thursday, October 20, 2005

17.7 Weeks


This one needs no commentary, other than to note that the country being described below is commonly regarded by legislators in America as a role model in considering how to restructure our own highly flawed health care system:


Waits for Canadian Health Care Shorten a Bit

By ELENA CHERNEY Staff Reporter of THE WALL STREET JOURNAL
October 19, 2005; Page A11

TORONTO -- After a dozen years of lengthening durations, Canadians awaiting medical care got access to treatment a little faster in 2005 than in the prior year, according to a survey of medical specialists by a conservative think tank.

The study by the Fraser Institute, which supports introducing more private-sector health care in Canada, comes as provinces grapple with potential fallout from a Supreme Court of Canada ruling last summer. In a decision on a Quebec case that could open the door to more private health care across Canada, the court found that long waits under the current public system violate Quebecers' rights by preventing them from paying for private care. Each of the 10 provinces runs its own health-care system, funded partly by federal payments.

Canadians waited an average of 17.7 weeks for treatment after their first visit to a general practitioner during the first three months of 2005, compared with 17.9 weeks in the same period last year, the study by the Vancouver, British Columbia-based Fraser Institute found. One reason for the incremental improvement was that Saskatchewan improved its performance by 7.8 weeks to 25.5 weeks. The study looked at 12 kinds of treatment, including cardiovascular surgery, cancer care and plastic surgery.

What this means is that if you or I were diagnosed with a cardiovascular problem or cancer which required treatment today, we would be admitted to the hospital along around February 5th.

Quite a role model indeed.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Wednesday, October 19, 2005

Burn the Boxes


Paul, I wanted to first just delve a little more into the impact of these natural gas price increases. I know you don't you use a tremendous amount. But it sounds like even in your system, you're seeing the way it can impact the cost curve steepening it quite dramatically. Is there any way you can give us a sense of what it is doing to cash costs at facilities, which are being powered by natural gas?

So asked an analyst on yesterday’s Packaging Corporation of America conference call. PKG, as the stock goes by, makes cardboard and corrugated boxes—the containers that contain the stuff that get shipped all around the country.

Such containerboard manufacturers are the nearest thing to an economic temperature gauge we have, and PKG is a company worth paying attention to when earnings season comes around.

Best of all, the CEO is much easier to understand than Alan Greenspan.

According to PKG, the economy’s temperature is pretty healthy. Not only were September volumes were up year over year for the first time since spring, but, as the CEO said on the conference call:

And I have to tell you that the first 8 days of October have been very, very good -- our bookings are 8% better than last year, and our billings are 6% better. But 8 days a season does not make. And so it is still going to come down to December. We put our best pencil on December, and we came up where we came up. And maybe there's a little upside to that, but it's far too early to say that.

But back to that analyst’s question about “the impact of these natural gas price increases.” The answer was a long one, but worth following:

Yes, some strange things happened when the cost of a material doubles. And the best way -- the best example that I can give you is at our Filer City Mill. And again, as you said, we don't use much gas. Our first line of defense against high gas costs is not to use gas if possible. And we got our consumption down to 5% only in the third quarter, which is pretty low.

But at Filer City, we make roughly 1,100 tons a day there. And in the third quarter, we virtually made it essentially with burning coal. And rough number, our energy cost at Filer City -- and we consider Filer City a first-quartile mill cost-wise -- a little under $30 a ton would be the energy cost; that is on running coal.

Now what is going to happen to us at Filer City and at our other mills is winter weather. You've got to heat the buildings. And a rough, rough number, it takes 20 tons of water to make a ton of paper, and all that water has to be heated. So you got energy to heat colder water. And as a result, your steam load will probably increase, again at Filer City maybe 50,000 pounds an hour. So you got a choice -- you could sustain production at say 1,100 tons, but you've got to use gas probably on the last 75 tons, natural gas, because our coal boilers max out if we try to make more steam. Or you can make 75 tons less and use coal.


When you look at the numbers, it is astounding. On that last 75 tons, our energy cost goes from less than $30 a ton to almost 200 -- almost a seven-fold increase. And why is that? Because gas costs seven times more than coal roughly.

So I guarantee you that with $200 energy costs, we have -- our cash cost is higher than the selling price. On the first 1,150 tons, we are in good shape. So that's a long-winded answer, but I think it illustrates my point in what gas costs can easily do if you are paying current market price, $13, $14 per million BTUs is, it has the ability to take a first quartile mill to a fourth quartile mill in one fell swoop because of that large increase.

Now there are ways to mitigate that; if you have the ability to switch to other fuels. But on the margin, where you have a choice of fuels, those last tons as they are burned on gas, it's hard for me to believe that they would not be above cash cost in virtually any mill around.

In short, the incremental cost of linerboard at that particular plant went from $30 a ton to $200 a ton.

Following this disclosure, one of Wall Street’s Finest actually asked the most insightful question on the call:

Why don't you burn your competitors' boxes?

To which the CEO responded in his folksy, decipherable, comprehensible, plain-spoken, non-Alan Greenspanish fashion:

You know, I'll tell you something; that end is not as dumb as it sounds. Because right now, the BTU value, the cost per million BTUs if you burned old corrugated containers, it is about $7.50 a million BTUs; gas is at $13. So strange world when you can burn old corrugated containers as fuel value.

Strange world indeed.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Tuesday, October 18, 2005

Blaming the Hurricane


ProQuest Company (NYSE: PQE), a leading publisher of information and education solutions, today released a preliminary financial outlook for its third quarter of 2005. This outlook includes the business impact of Hurricanes Katrina and Rita, and the resulting impact of delays in reading and math intervention funding in Texas.


The company expects third quarter revenue of $158 to $160 million and earnings of $0.58 to $0.60 per share.

For the third quarter, approximately $4.0 million of revenue was lost because of damage to Voyager customer schools in Louisiana, Mississippi and Texas, some of which are closed indefinitely. In addition, reading and math intervention funding of more than $100 million was approved by the Texas state government, but disbursement of these approved funds has been delayed. The delay is a result of the State of Texas having to evaluate its schools' needs after the damage of Hurricane Rita, and at the same time enrolling many new students that have relocated to Texas. The earnings impact of the shortfall in revenue of Voyager products is approximately $0.20 per share for the third quarter.

"The hurricanes had two unforeseen impacts on our Voyager business," said Alan Aldworth, chairman and CEO of ProQuest Company. "Limited sales to customers in hurricane-ravaged areas of Louisiana and Texas reduced Voyager's third quarter sales by approximately $4.0 million which we do not believe will be made up in 2005. Additionally, Texas funding delays had an adverse impact on Voyager's revenue of approximately $10 million. Since the reading intervention funds have already been approved by Texas legislators, we expect that the funds -- while currently delayed -- will be disbursed for the current 2005-2006 academic year. I believe that the majority of this revenue will be recovered in early 2006, with a small amount realized in 2005," said Aldworth.

Talk about blaming the hurricanes!

Reporting season is in full swing, and aside from the direct impact on many chemical and oil-related companies, the impact of the two hurricanes has been fairly muted—the effect being most fully felt in the rising cost of goods as opposed to any large-scale reduction in end demand.

But ProQuest—these are the guys who transformed a dying microfiche business into a nicely profitable online document service (when you search the archives of the New York Times, for example, you are searching ProQuest’s own files)—has been hit in the head by a two-by-four.

The impact, as the press release explains, is on their Voyager Expanded Learning education business, which ProQuest bought early this year as a way to exploit greater Federal spending on K-12 learning.

Voyager is a reading program using internet-based teacher training and online feedback to raise student reading levels, and ProQuest’s stock got quite a boost from the deal.

When I looked at the company, however, I was not able to find educators highly familiar with the product—and there are many competing offerings.

What I am looking for is feedback here regarding Voyager itself:

1. Is it widely used?
2. Is it effective?
3. Are the problems in Texas strictly due to budget pressures caused by the hurricanes…or is something else going on there?

Informed opinion is, as always, welcome.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Monday, October 17, 2005

The Word from China


XIANGHE, China -- U.S. Treasury Secretary John Snow struck a surprisingly conciliatory tone after talks with China's top economic leaders, saying he has faith that the Chinese will reform their financial system.


Mr. Snow said he came away from the weekend meetings convinced that China is clearly "preparing the way" for a more modern financial system and a more flexible exchange rate for its currency, something Washington has pressed for.

"It's real. It's happening," Mr. Snow said. He added that he was "heartened" by the many changes Beijing was putting in place.—Wall Street Journal



Like he has a choice!

U.S. commercial interests and the Chinese economy are so intertwined it’s hard to figure what kind of leverage Mr. Snow has pressing China for anything more than extra duck sauce on his Kung Pao Chicken at the state dinner.

A friend who runs a small consumer products business just returned from two weeks in that country, touring the plants where almost 100% of his company’s products are made and also visiting the buyers for the U.S. retailers which sell almost 100% of those products.

He thinks the Yuan will be allowed to appreciate over time, eventually, but what worries him more is making sure he’s getting the right products made and shipped in time for the Christmas selling season…and lining up next year’s production.

And any notion that the Chinese somehow might knuckle-under to threats from Secretary Snow and change the way they conduct their economic ‘long march’ to prosperity is not part of that equation.

As for the changes he has witnessed over a decade of trips to China, the most profound is the immense wealth creation accruing to the men who bought the state-owned businesses that now churn out his product, how the plants have grown in size and modernized their production techniques, and the trickle-down impact of all this on the workers themselves:

“Five years ago I’d walk through the plant with the owner, and the women cowered at their machines. Now they seem happy. I can’t explain it.”

I can: it’s called money.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


Friday, October 14, 2005

Closing the Barn Door


S.E.C. Accuses Hedge Fund of Deceiving Its Investors


So reads the headline in today’s New York Times, and so the Feds, arriving at the farm in Ketchum, Idaho, prepare to securely close the barn door after the horse has scampered out over the north forty, splashed across the Wood River and made its way to the freedom of the mountains beyond.


"There was no effective oversight of the investment manager and no effective control or checks on his [John Whittier, manager of Wood River Capital Management] actions," said Peter Bresnan, associate director in the enforcement division at the Securities and Exchange Commission.

As opposed to the effective oversight and effective control at, say, Refco—which had real auditors, unlike the fake ones employed by Wood River (identified by Whittier as “American Express Tax and Business Services” although that firm does not perform audits)—and real investment bankers and real SEC-filed documents detailing everything except what the CEO wanted the auditors and investment bankers and the SEC to find out.

Add Wood River to the list of hedge funds with the bucolic names (Bayou among them) and the hellish business model that no amount of supervision from above could prevent, given bad intent by the likes of John Whittier and Phillip Bennett, and the rest.

How forcing all hedge funds to register with the SEC—the very same entity that missed the massive alleged fraud at Refco and is now searching vainly for what caused the barn door at Wood River to be left wide open in the first place—is beyond me.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Thursday, October 13, 2005

They Never Get It


“The question is whether anybody will want to watch videos on a small screen like that.”

Flicking back and forth between the two baseball games last night I chanced upon a news clip of Steve Jobs, pacing a large stage and holding aloft the new video iPod for the adoring Apple fanatics, while a 55 year-old newscaster solemnly reported on some facts and figures regarding yesterday's stock market reaction to Apple's earnings report.


Then the solemn 55 year-old newscaster pronounced, quite rhetorically, his question of whether anybody will want to watch videos on a small screen like that.

It cracked me up, having just come from the caf√© of our local Borders, where, in the course of doing some work on my wireless, I had observed a pair of students hunched over a “small screen like that”—in this case, a cell phone—playing some kind of game for an hour while their books (this particular Borders is a mile from the nearest university) sat opened and unused on the table.

And that, oh solemn 55 year-old newscaster, is why anybody will want to watch videos on a small screen like that.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Wednesday, October 12, 2005

The Amway Salesman in the Driveway


Microsoft, Yahoo Plan Instant-Message Pact

Quite the dramatic headline in today’s Wall Street Journal. You’d think Microsoft and Yahoo had discovered oil and gas on the Internet.


Internet users have long complained that they can't get their instant-messaging services to talk to one other. That is about to change.

Isn’t this exciting?

In a competitive realignment of the heated Internet industry, Microsoft Corp. and Yahoo Inc. are expected to announce today that consumers using their free communications services -- including instant messaging and computer-to-computer voice calling -- will be able to communicate directly with each other for the first time, say people familiar with the matter.

Now if indeed anybody actually used Microsoft and Yahoo’s Instant Message service, this might be big news.

The expected alliance represents a breakthrough in the fractured market for instant messaging…. In the past, consumers using Yahoo's Messenger instant messaging could communicate only with other Yahoo users and not with those using instant-messaging software from Microsoft or others; the same restrictions applied to those who used Microsoft's MSN Messenger instant-messaging software.

The fact is, however, I know exactly one person who uses “Microsoft’s MSN Messenger instant-messenger software,” as the WSJ calls it. Just one—compared with the 56 individuals who are, at this moment, working online according to my AOL Buddy List, not to mention the other 64 who are offline at the moment.

But you wouldn’t know that almost nobody actually uses Microsoft or Yahoo’s IM from today’s WSJ story:

The expected linkup of Microsoft's and Yahoo's communications services would immediately challenge the leading instant-messaging market share of Time Warner
Inc.'s America Online unit.

AOL has a 56% market share world-wide, according to research firm Radicati Group Inc. It has long resisted letting users of other instant-messaging services connect with its own. A combined Yahoo and Microsoft could command 44% of the global instant-messaging market…

That is, as they say, corrupt data, as my daughters and their six million IM-dependant friends could have told the Journal reporter.

For example, I actually do have Microsoft Messenger on my home computer.

But I never asked for it. Rather, Microsoft Messenger insinuates itself on anybody who uses Microsoft’s email product. Every time my computer boots up, Microsoft Messenger is there, lurking, like an Amway salesman in the driveway.

And I ignore it, like I ignore that Amway salesman, hoping it will go away.

The trouble is I actually know one person who uses Microsoft Messenger, and therefore I keep it there, just in case he pings me, which happens once a week or so.

Meanwhile, at this very moment, my IM icon is flashing with the messages of a half-dozen individuals who, like myself, find instant messaging to be far superior to working the phones.

So Microsoft and Yahoo can combine their two instant-message services, and on paper it might show they command a 44% market share “of the global instant-messaging market” on paper.

But in the real world, this alliance looks to me like another one of those high-tech alliances we read about from time-to-time—like Sun Microsystem’s “alliance” with Microsoft, or Google, or whatever successful company Sun is trying to attach itself to these days.

Which is to say, nothing important.

Why, I haven’t even gotten an instant message about it this morning.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Monday, October 10, 2005

Everything from Coffee to Tissues…


Office Vacancies Hit 3 ½-Year Low; Rents Rise

Vacancies in the nation's office market fell to their lowest level in 3½ years in the third quarter while rents rose, a new survey said….

Effective rents -- the amount of money a landlord takes in after factoring in concessions to tenants -- rose for the third-straight quarter, heading up 0.8% to $20.41 a square foot from $20.24 in the second quarter. That is doubly good for office owners because asking rents went up just 0.6% in the quarter. That means landlords are dropping the concessions, like free months of rent, that they have used to lure tenants for the last four years.


So reports today’s Wall Street Journal, and to the facts it contains I can testify, based on the following excerpts from a letter, just received, from my office manager:


Some of you have had no increase in rent or service charges for three or four years… As I look ahead, I must candidly advise that we will begin implementing periodic rent and service charge increase to offset rapidly increasing expenses in each of the following areas:

1. Base Rent: Our rent to the landlord increases periodically….

2. Building Expenses and Real Estate Taxes: The building’s operating expenses (including electricity) and property taxes have risen rapidly and are likely to increase further…..

3. Healthcare Costs: Personnel costs are now much higher, largely due to increases in healthcare costs….

4. Consumables: Everything from coffee to tissues is more expensive today.

These trends should not surprise anyone…. My plan is to establish a pattern of reasonable periodic increases to stay ahead of rising costs.

I have no complaints: our office manager is both personally a very nice man, and also a very fair and responsive businessman. The letter is, as he himself is, straightforward and plainspoken.

Consequently, it is hard to argue with, so I will, of course, pay the “periodic rent and service charge” increases.

There is no arguing the fact that I have not had to pay such increases in the last few years, nor is there a debate about the rising real estate taxes, higher healthcare costs, and even the price of coffee.

My only argument is in that last paragraph—“These trends should not surprise anyone.”

Surely there is a long bond holder out there who hasn’t yet gotten the memo.


Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Sunday, October 09, 2005

Weekend Edition: Words, Words, Words.


“Raunchy, but funny.”

That was what my older daughter said last night in answer to my question: “How was the movie?” that she had just seen with some college friends.

What struck me was not that she had seen a “raunchy” movie—I’ve made the mistake of actually going with her to a few of the Ben Stiller/Will Ferrell-gang mega-hit movies over the last couple of years, thinking maybe I’d see something other than a Saturday Night Live sketch stretched into a movie with some gratuitous breasts-popping-up-randomly-during-the-slow-bits action and the inevitable zipper-getting-stuck routine that seems to be the foundation of all teenage humor, but to no avail. I find them occasionally funny and mostly harmless.

And, well, raunchy.

And that is precisely what struck me: that the word she had used—“raunchy”—told me everything I needed to know about the movie. Just two syllables described an entire hour and a half movie in way that I understand exactly what kind of movie she'd seen.

My online dictionary shows over fifty alternatives to the word raunchy, ranging from “awkward” to “vulgarian,” as follows:

Rude:
base, bawdy, blue, boorish, brutish, cheap, common, crass, crude, dirty, earthy, filthy, foul, foul-mouthed, gross, gruff, immodest, impolite, improper, impure, incult, indelicate, inelegant, loutish, low, lowbred, mean, nasty, obscene, off-color, offensive, raffish, raunchy, raw, ribald, rough, roughneck, rude, scatological, smutty, tacky, uncivil, uncouth, uncultivated, uncultured, unrefined, vulgar, vulgarian

Vulgar:
awkward, backward, barnyard, boorish, cheap, cloddish, clumsy, coarse, crass, dirty, earthy, filthy, foul, grody, gross, ignorant, ill-bred, indecent, indelicate, inelegant, insensible, lewd, loud, loud-mouthed, loutish, lowbred, obscene, raunchy, raw, rough, rude, savage, smutty, tacky, tactless, uncouth, unpolished, unskillful

— Roget's New Millennium™ Thesaurus, First Edition (v 1.1.1)Copyright © 2005 by Lexico Publishing Group, LLC. All rights reserved.


Now, “crude” and “foul-mouthed,” along with “smutty” and “coarse” might have been accurate, but would imply the movie had nothing else going for it.

And “filthy” would be too strong for a college student’s experiences, while “dirty,” “raw” and “rough” would have implied a harsh quality the movie clearly did not possess.

“Rude,” on the other hand, would suggest the movie gave offense, which it clearly didn’t—likewise “indecent” and “obscene.”

“Inelegant,” “insensible” and “loutish” are not even close, suggesting as they do that the movie-goer expected to find some sort of redeemable feature in the flick, which is clearly not the case.

No, I don’t see a single word out of those fifty-plus that could have described the movie’s entire sensibility the way “raunchy” does.

Which is, in and of itself, interesting, or notable, or just kind of cool.


Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Friday, October 07, 2005

News Flash: “The Best CIO in America” is Missing


It appears to be true: as reported elsewhere on this blog by a sharp-eyed reader, Shawn Schwegman, “the best CIO in America” (according to Patrick Byrne), is no longer listed as part of the “Management Team”on the Overstock.com investor relations web site. This comes exactly three weeks after the $30 million "inventory upload" because oops-we've-had-an-undisclosed-IT-problem press release.

Also, Patrick's “Sith Lord” rant has been removed to a separate "lawsuit" URL on the site, for some reason, along with the CNBC appearances in which Patrick quoted from affadavits that appear not to have actually been filed in court yet.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

This Too Will End Badly


Bain's Fault or Bad Luck That KB Toys Failed?


That was the headline above an excellent Wall Street Journal article earlier this week, asking whether it was fair-play for private-equity firms to extract cash in the form of special dividends, funded by debt, out of companies whose business models don’t stand a chance of making it when their capital structure is loaded with that very same debt used to pay off the private-equity guys.

The article explained:

Bain Capital, a private-equity firm, took control of KB Toys in 2000 by putting up just $18 million. It financed much of the rest of the $302 million purchase price by loading up the company with debt.

KB Toys, as anybody who accidentally went into one of their stores remembers, was a mall-based retailer that had the misfortune of selling pretty much the same toys you could buy at Wal-Mart, only cheaper.

Debt-wise, the toy business is tough to manage, being highly seasonal—hence cash flows are not steady throughout the year, and if you miss the Christmas season, you die. In other words, it’s not the kind of business you want to leverage up.

Which is exactly what Bain Capital did.

It all worked out well for Bain Capital, which in April 2002 collected a $121 million dividend -- a tenfold return on its investment in just 16 months, according to a court filing made by an unhappy holder of KB Toys debt.

KB Toys…couldn't recover with so much debt on its hands. Its financial troubles worsened, and the company filed for Chapter 11 bankruptcy protection in January 2004.

So why rehash a days-old WSJ story?

Actually, I’m not rehashing an old story: I am previewing a story that I expect will appear in the Journal one fine day, perhaps a year or two from now—but maybe sooner.

The story that will be told is about how Orchard Supply Hardware Stores, an 84 store, California-only hardware chain acquired by Sears in 1996 (giving Sears a full nine years to screw it up), was loaded with debt, KB Toys-like, in order to pay a big fat dividend, Bain Capital-like, to the parent company at the behest of the controlling shareholder of that parent company.

To whit, Eddie Lampert.

If you’ve never been in an Orchard Hardware store, think of Orchard as the Sears or K-Mart of the hardware business, but operating solely in California.

During its public existence the company never quite managed the transition to the Home Depot-era of home centers, and was languishing when Sears came along in 1996 and paid about a quarter-billion in cash for it.

Thus, for the last nine years, Sears has been managing Orchard Supply about as effectively as it has been managing itself...which is to say pretty badly.

For some time, word has been that Orchard was on the block, and today we read that Eddie Lampert’s Sears Holdings is extracting a $450 million dividend from Orchard Hardware—funded by $405 million of debt and a $58.7 million investment in Orchard by Ares Management LLC, an LBO group out of Los Angeles.

The Sears Holdings press release reads, in part:

David B. Kaplan, Senior Partner of Ares Management, said “We are delighted to partner with Sears and the management team of Orchard Supply in this transaction which provides the business with both capital and sponsorship. We all share the collective vision that Orchard Supply is an exciting retail concept with strong growth prospects…”

As far as I can tell, the “capital” that “this transaction provides the business” is in reality all of $13.7 million, as follows:

$405 million New Orchard Debt + $58.7 Ares “Investment” - $450 million Dividend to Sears Holdings = $13.7 million of new “capital” for the aging Orchard store base.

That is hardly enough “capital” to give the all stores a fresh coat of paint, let alone make them competitive with Home Depot and Lowes.

If there are any people left in the Sears PR operation after Eddie’s house-cleaning, they could save themselves some time by preparing the future press release on the sad d√©nouement of Orchard Supply transaction, by which Sears Holdings loaded a pile of debt onto an aging retailer with a deteriorating market position simply because it could.

And the Wall Street Journal might want to keep that Bain Capital/KB Toys article handy, as a reference for past deals-gone-bad.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


Wednesday, October 05, 2005

Couch Potato Alert!


La-Z-Boy…today announced that one of its key suppliers of polyurethane foam has put its customers, including La-Z-Boy, on notice of allocation, due to the lack of availability of TDI (toluene diisocyanate), a key chemical component of polyurethane foam which is used throughout the upholstery and bedding industry.

—Company press release.

La-Z-Boy is not what it used to be.

The former champ of America’s den has been floundering for years, the result of a let’s-try-what-everyone-else-is-doing diversification outside the beer-drinking-and-football-game-watching demographic it once owned, and the rise of better run competitors such as Ethan Allen.

The company also said that this situation, coupled with the continued soft retail environment and damage to one of its plants by a tornado spawned from Hurricane Rita, will have a significant adverse impact on its results for the fiscal 2006 second quarter and potentially beyond.


The “soft retail environment” is understandable, what with the rise in the Fed Funds rate from 1% a year ago June to 3.75% today. But you wouldn’t think one little chemical compound could have such a huge impact on a company as this.

Kurt Darrow, President and CEO of La-Z-Boy said, "Several TDI suppliers have communicated that because of the effects of Hurricanes Katrina and Rita they have had to declare Force Majeure, a condition which allows companies to depart from the strict terms of a contract because of an event that cannot be reasonably controlled. As a result they will be limiting the amount of TDI they will be supplying which will limit the amount of polyurethane that can be produced.

We have been advised by one of our significant polyurethane suppliers to the La-Z-Boy® branded product of their industry-wide notice of an allocation of 50% of normal polyurethane supply. This situation will have a greater impact on us relative to the rest of the furniture industry given the higher percentage of upholstery in our overall product mix."

Just two short weeks ago the bond market was screaming higher on jubilation (the bond market is a very dark beast, delighting as it does in horrendous economic news such as corporate layoffs and high oil prices and such) that the back-to-back hurricanes would surely cause the Fed to ease up on the interest rate pedal.

But to no avail.

Greenspan went ahead and raised rates for the 11th time in a row, and the two year treasury, which had dropped from a 4.15% yield pre-Katrina to a 3.75% yield post-Katrina, now stands at 4.18%.

Darrow noted, "Polyurethane foam, because of the volume of storage space it requires, is shipped on a just in time inventory basis and therefore our inventories of this raw material are very minimal. Each of our divisions has a different mix of polyurethane suppliers and finished goods inventories and thus will be individually impacted.

"We anticipate that the price of polyurethane will increase and that our production schedules at various plants will also be modified according to availability of supply. We will therefore work judiciously to minimize the potential interruption to our customers in all effected divisions by closely communicating with them to assess and balance their product needs to the degree possible."

A friend of mine who runs a small consumer products company tells me how difficult it can be to run a “just-in-time” operation: a single supplier can screw up the entire operation—as it has in the case of La-Z-Boy.

It will be interesting to see who else is being hurt by lingering supply disruptions from two hurricanes which, according to the bond market, were going to diminish economic activity and, therefore, keep inflation at bay.

Just today somebody downgraded Lear, the large auto-seat supplier, on the same polyurethane concerns affecting couch potatoes around America.

Somebody should tell the bond market. This non-inflationary inflation could really start to snowball.


Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Tuesday, October 04, 2005

Microsoft to Music Moguls: Play Fair!


Microsoft Corp. has broken off licensing negotiations with the four global music companies, raising questions about the Redmond, Wash., software maker's plans to start a subscription-based music service, according to people familiar with the talks…

According to the people briefed on the discussions, the negotiations broke down Friday over what Microsoft considered unduly high royalty rates [emphasis added] sought by the labels….

—Wall Street Journal

Yes, that’s right. Microsoft is complaining about “unduly high royalty rates.”

This from a company that has been earning “unduly high” margins on hacker-prone operating software that nobody actually likes to use from Day One—and getting away with it.

Now, I know a lot of people disagree with my view that Microsoft has a monopoly, and that Microsoft abuses that monopoly whenever a competitor introduces a better product—which is almost always—by either incorporating the offending function into its operating system or by coming out with a half-baked clone and giving it away at cut-rate prices.

(Just today I was writing a document in Microsoft Word and made the mistake of trying to switch the page numbering from the upper right header to the lower right header. I ended up with page numbers at both the upper right and lower right of each page. I could see no way to change this—the “help” function in Word is like a computerized version of the so-called “instructions” found on the back of an IRS tax form, but even more useless. I had to find an earlier version of the draft lacking the duplicate page numbers and rewrite the stupid thing. So much for Alan Greenspan's famous computers-as-magical-productivity-tools theory.)

Still, I don’t begrudge Microsoft its monopoly. It was easy, and quite profitable, to short stocks of companies Microsoft was targeting back in the 1980’s and early 1990’s.

But those days are gone. Microsoft began losing its mojo along about the time the internet began changing the way people used their computers. Search, mapping, instant message—all these features have been pioneered by non-Microsoft companies. And the amazing thing is they remain the domain of non-Microsoft companies, because Microsoft can’t underprice free.

The lousy search function built into Microsoft Network, and the even worse instant-message function Microsoft keeps trying to foist on its users, are fooling nobody.

And now that Microsoft has clearly become an also-run in the department of downloadable music, the company is left to complain about the “unduly high” royalties being demanded by the music owners.

It’s like Darth Vader complaining about Luke Skywalker’s sword.

Jeff Matthews
I Am Not Making This Up


© 2005 Jeff Matthews The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.