Stanton Champion

Months back, I wrote about the Bear Stearns collapse and why the government bailout was so important.  Now the meltdown continues, and this time it involves more people.

Here’s a quick rundown of the players and what’s involved.

Lehman Brothers - A very old and respected bank, Lehman has long been the “next bank to go” after Bear Stearns. As a bank, they were far more conservative than Bear, but they were still able to amass enormous losses from mortgage exposure.  They had previously been trying to find a buyer, but after a deal with the Korea Development Bank failed, Lehman’s stock has plunged in value.  This is the second time Lehman has been “on the brink” - the previous time was 1984 when the bank was bought by American Express after a massive internal power struggle left them in a precarious position (AMEX divested it in 1994). This time, possible deals with Bank of America and Barclays have failed.  Lehman will likely file for bankruptcy in the next 24 hours and be liquidated over the coming months.

Merrill Lynch - Another well respected bank that, like Lehman, has amassed enormous losses despite being relatively conservative.  They were frequently brought up in the same breath with Lehman as a bank on the verge of failing.  Tonight, to the surprise of most people, Bank of America announced they were buying Merrill instead of Lehman.  The reported price is around $44 - $50 billion.

Fannie and Freddy - Technically last week’s news, these are the government sponsored mortgage lending programs designed to maximize home ownership. Last weekend, the government announced a sweeping program to take over these two programs and put them under full government control.

AIG - The next to go.  AIG is a global insurance company with tremendous exposure to the mortgage industry.  They have long held a AAA debt rating, allowing them to borrow very cheaply, invest in higher returning assets, and make tremendous profits.  At this point, AIG basically needs cash, but it’s not clear if they’ll be able to find it.  What’s worse is that their debt rating may be downgraded, unleashing even more misery on their balance sheet.

All in all, it’s an interesting weekend.  Here are some links for articles:

Nation’s Financial Industry Gripped by Fear

AIG looking at “options” for businesses, capital

Frantic day on Wall Street as banks teeter

A.I.G. Seeks $40 Billion in Fed Aid to Survive

Lehman bankrupt, Merrill bought, AIG collapsing: Where does it all end?

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Hello FedEx Office. FedEx is reportedly eliminating the Kinko’s brand and leaving their own on all stores starting sometime soon. FedEx acquired Kinko’s in 2004, so the name is theirs to toss, but any time a company eliminates a strong brand they face trouble. In FedEx’s words:

“Kinko’s was primarily a copy- and print-service provider when it was acquired in 2004,” said Brian D. Philips, president and chief executive of FedEx Office. “The name FedEx Office more accurately represents our broader role. … We are a back office for small businesses and a branch office for medium to large businesses and mobile professionals.”

Since when was FedEx about the back office? That was always UPS’s territory while FedEx built their brand around reliable overnight delivery. The stores may have become a back office for small and medium businesses, but have they done so as FedEx or as Kinko’s?

The UPS Store

And speaking of UPS, they actually did this successfully a few years ago when they acquired Mail Boxes, Etc. and renamed it to the UPS Store. The renaming worked very well for them, mostly for reasons that do not apply to FedEx. Mail Boxes Etc. was never as strong of a brand as Kinko’s, while UPS had already started to establish itself with some backoffice credibility. On the other side, the Mail Boxes Etc. shtick had always been about shipping first, other stuff second, making it easy to move the brand for UPS. Today this differentiation still works - when you visit a UPS store you see more shipping material than copiers while a Kinko’s is all about document preparation

FedEx’s Path Ahead

FedEx has a very difficult path in front of it. I have a feeling this won’t work out so well for them and that in a year we’ll wonder why they spent $891 million doing this in the first place. Besides, when was the last time you heard someone say “I’m going to go make a copy at FedEx.” When one strong brand disappears, it’s usually the competitors that win. Expect some turmoil in the office supply and copier space soon.

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Microsoft has walked from the Yahoo! deal. Michael Arrington has a good rundown on what to expect this week for Yahoo!, but here’s a summary: they’re screwed.

This deal was always the equivalent of Microsoft throwing an armed hand grenade into a crowded room. Everyone knew the grenade was about the go off, but nobody had a clue when it would happen. Would the deal get done at too low a price, forcing Yahoo’s shareholders to sue everyone in sight? Would MS go hostile, costing them and Yahoo lots of time and money? I said in a previous post that there was a huge possibility that key talent would run for the doors leaving Microsoft with nothing for their trouble. Nobody liked this merger, but once the events were set in motion the outcome was inevitably bad for everyone.

Since nothing good would have come for Microsoft from this merger (SAI just started a series titled Why Yahoo-Microsoft Will Be a Disaster), walking from the deal is probably a win for them. On the other hand, this is the the worst outcome for Yahoo!. Shareholders have been angry at their bad performance for years, and many believed this was the only way to get any kind of value out of the company. On Monday, expect the Yahoo! stock price to plummet while Microsoft’s will rise. Oh, and expect a bounty of lawsuits aimed at the Yahoo! board by angry shareholders. Yahoo! turned in a good Q1, but many believed that was smoke and mirrors. If they can’t show continuing improvement, expect even more hell to break loose later in the year.

On the other hand, this could be a new beginning for Yahoo!. Many companies have been tested by failed mergers and come out stronger, like Goodyear in the 80s. But today the Microsoft hand grenade has finally gone off and Yahoo! has a lot of cleanup ahead.

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What does 1 + 1 equal? Well, if you’re Delta and Northwest, the answer is Delta. The two companies have agreed to combine, but in the world of Mergers and Acquisitions (frequently called M&A among business geeks), there’s always a whole lot of ‘A’ and never that much ‘M’. MOEs or Mergers of Equals are rare, and when they do happen they fail even more often that plain old acquisitions (which fail pretty darn often themselves).

So what’s up with DAL and NWA? Well, according to Dealbook, Delta wins for a lot of reasons:

• The CEO of the new company will be Delta’s CEO
• The Northwest CEO “won’t have a role in daily operations…”
• The chairman of the board of the new company will be Delta’s chairman
• The Northwest pilots are getting screwed in the deal (and may obstruct it)
• Northwest’s shareholders are getting Delta stock
• The new company will be called…Delta

From a business point of view, there’s a lot to like and dislike about airline consolidation right now. The biggest dislike is that it’s not clear that consolidation works. America West survived buying US Air (no, it wasn’t the other way around), but I’m not really sure that deal worked out for shareholders. On the other hand, Delta’s shareholders would have been a whole lot better off had they been bought by US Air/America West back in 2007.

The biggest advantages to consolidation are the cost savings and the sharing of valuable landing slots at major airports. The latter is very important right now as European air carriers begin entering the US market. American air carriers will have to raise their own efficiencies to compete, and improving airport access is one way to do that. We’ll see if any of this actually works out or not for Delta.

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Well Brian Firestone, I guess you win. You’re getting $10 a share instead of $2. Better now?

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For anyone who follows the financial press, the meltdown at Bear Stearns shouldn’t be news. On Sunday, JPMorgan Chase stepped in and purchased the beleaguered investment bank for $2 a share, or $236 million, after acting as an intermediary to a Federal Reserve bailout on Friday. JPMorgan’s actions brought to mind the Banking Panic of 1907, when the real John Pierpont Morgan stepped in and calmed the financial markets after the collapse of the Knickerbocker Trust Company. The price paid for Bear Stearns was a bit of a shock to everyone, especially since their share price closed at $30 at the end of trading on Friday. In all honesty, when I first read the news I thought the reporter had accidentally left off a 0 and that the deal was actually $20 a share.

So how could a bank go from having a share price of $170 a share to $2 a share in the matter of a few months? Well, the answers are complicated. Bear had a lot of exposure to the mortgage market in a number of its businesses, and last summer the company bailed out two of its subprime mortgage hedge funds. The storm that followed grew, combined with some others, and eventually became the mortgage mess we have today.

What brought down Bear Stearns yesterday, however, was something else entirely. Bear frequently participates in a certain kind of transaction called a Repurchase Agreement or “repo” for short. This is essentially a type of short-term loan where two people (called a counterparties), one with cash and the other with assets, get together and swap. The asset holder takes the cash and extends their assets as collateral for the deal. These kinds of arrangements can be very short (overnight) or somewhat long (a couple of years), but by and large they are meant to be very liquid transactions. The cash holders are usually large money market funds, hedge funds, or corporations; while the asset holders can be just about everything from governments with bonds to other corporations to mortgage companies.

Bear Stearns was both a repo borrower and a repo lender, but they were more of one than the other. The difference between their borrowing and lending was $74.5 billion, with more borrowing than lending. That’s quite the substantial sum but not necessarily bad. Bear’s real problem was a lack of faith in their assets: mortgage securities. Over the past several weeks, the markets for these assets have simply stopped moving, meaning that in many cases buying and selling them is very difficult.

For Bear Stearns, the problem was simply that some of their creditors wanted repayment on their repos (they wanted their money they had lent to Bear back), but Bear was unable to find enough liquidity in the market using its large portfolio of mortgage securities. In other words, Bear couldn’t find enough money through additional repos and nobody would buy their mortgage securities outright. Other creditors, sensing trouble, began piling on and trying to get their money back as well. Since Bear Stearns had $75 billion more borrowed than lent, they were ultimately screwed without extra financing.

Obviously, this carries greater implications for the market than just mortgages. Repos are incredibly common, and a breakdown in that market would have created repercussions that extended all over the place. Ordinary investors would have seen their money market accounts mysteriously shrink while major corporations would begin running out of cash and face liquidity issues. When the Fed said it wanted to prevent financial panic from spreading, they damn well meant it.

A few other tidbits:

• During the JP Morgan conference call, an individual investor named Brian Firestone somehow managed to get through the screeners and ask a question. These calls are usually reserved for analysts who are well versed in the minutia of the deals, and Mr. Firestone’s question clearly demonstrates why. “I vote not to approve this sale,” he said after having his question about why a sale was preferable to bankruptcy rebuffed. He seemed to think that individual investors actually mattered here, but in reality he was rejecting a $2 a share deal in favor of Bear Stearns entering bankruptcy which would have netted him a whopping $0 a share.
• Go read that bail out article again that I mentioned above. Note the companies listed as helping Bear with their hedge fund mess: Merrill Lynch, Lehman Brothers, and JPMorgan Chase. Today, JPMorgan owns Bear while Merrill and Lehman are both suffering their own mortgage meltdowns. Lehman in particular may be the next to go (again), even though they claim otherwise.

Update: The Wall Street Journal has a nice run down of the events of the weekend.

Update 2: Brian Firestone responds and he has some great thoughts!

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I haven’t written anything about the Yahoo!/Microsoft deal yet, but this post on TechCrunch sums up some of the problems nicely.

In short, Yahoo! still has some very popular properties, and this is one of the reasons Microsoft feels like the two companies are a match. They can place ads on Yahoo!’s popular sites. Yet the question remains: can Microsoft retain the profitability of these properties given a very ugly and difficult merger? Internet companies are driven by the talent of their people, and without the right leaders providing vision for product, design, or engineering, Internet products can get really stagnant really fast. There’s some stickiness to some of Yahoo!’s products, like Flickr and mail, but customers will switch if they think their platform is dead or dying.

If this gets ugly, both Microsoft and Yahoo! will have a hard time retaining talent. That’s good for competitors, but bad for this deal and the shareholders of both companies. Ultimately, the lesson here is that hostile takeovers of Internet companies are really, really hard because the valuable assets are mostly intellectual and talent related. Microsoft may prove this wrong, but somehow I doubt it.

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