Browsed by
Month: July 2012

Review – Billion Dollar Lessons (#failure, #strategy, #review)

Review – Billion Dollar Lessons (#failure, #strategy, #review)

Billion Dollar Lessons: What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years
by Paul B. Carroll and Chunka Mui, published 2008, 2009

The seven deadly business sins

The authors of Billion Dollar Lessons identified seven “failure patterns” that typify the path to downfall of most businesses:

  1. synergy; overestimating the cost savings or the profit-enhancement of synergy
  2. aggressive accounting; becoming addicted to creative accounting practices which eventually invites outright fraud to keep up with
  3. rollup acquisitions; assuming the whole is greater than the sum of the parts
  4. blindness to catastrophe; dancing on the deck of the Titanic, ignoring that the ship is sinking
  5. uneconomic adjacency acquisitions; assuming there are benefits to combining similar businesses which are actually dissimilar
  6. disruptive technology; committing oneself to the wrong technology and betting it all
  7. consolidation indigestion; assuming that consolidation is always the right answer and that it solves all corporate problems

In Part I, each chapter addresses one of these failure patterns, explaining the principles and problems of the failure pattern, giving numerous real-world examples of the pattern in action and finishing with a list of tough questions for managers and shareholders/board members to ask before pursuing one of the potentially flawed strategies mentioned.

In Part II, the authors offer a behavioral/psychological explanation for why companies and individuals routinely make these same mistakes, basing their assertions on the idea of “human universals.” The idea is that being aware of them is not enough– one must also put into place processes and self-check systems that are independent of any one person’s self-honesty (or lack thereof) to allow a company to essentially “check itself before it wrecks itself.” The most important corporate institution suggested is the Devil’s Advocate.

Illusions of synergy

According to the text,

A McKinsey study of 124 mergers found that only 30 percent generated synergies on the revenue side that were even close to what the acquirer had predicted… Some 60 percent of the cases met the forecasts on cost synergies

In general, there are three main reasons why synergy strategies fail:

  1. synergy may exist only in the minds of strategists, not in the minds of customers
  2. companies typically overpay for an acquisition, meaning the benefits from synergies realized are not enough to overcome the initial investment cost
  3. clashes of culture, skills or systems often develop following an acquisition, killing the potential for synergies

Double-check your synergy strategy by asking yourself the following tough questions:

  • Do you need to buy a company to get the synergies, or could you just form a partnership?
  • How do you know that customers will flock to a new product, service or sales channel?
  • If you think you’re going to improve customer service, then how exactly will that look from the customer’s perspective?
  • What could competitors do to hurt you, especially during the transition while you integrate the company you’re taking over?
  • Who in the combined organization will resist the attempts for revenue synergies? Whose compensation will be hurt?
  • What are the chances you’re right about revenue synergies?
  • What percent of your customer base might go elsewhere following this corporate change?
  • Acquisition cost:
    • What is the target company worth on a stand-alone basis?
    • What would the business be worth if you achieved all synergies mapped out?
    • What would the business be worth if you discounted the synergies, based on the fact that few companies achieve all the synergies planned?

Faulty financial engineering

Many companies find themselves in hot water because they believe their own creative accounting too much. They let sophisticated financial legerdemain conceal the uneconomic nature or riskiness of their business. Managers often become addicted to this accounting, finding themselves stuck on the “treadmill of expectations” and give in to the temptation to commit outright fraud to keep it going, destroying the business in the process.

There are four primary risks to financial engineering strategies:

  1. encourage flawed financial products which are attractive to customers in the short-term but expose the seller to incommensurate risk of failure over time
  2. hopelessly optimistic levels of leverage
  3. aggressive and unsustainable financial reporting
  4. positive feedback loops which cause the system to implode

Double-check your financial engineering strategy by asking yourself the following tough questions:

  • Can the strategy withstand sunshine? (Would you be embarrassed if it was widely known and understood?)
  • Can the strategy withstand storms? (Is it fragile and susceptible to being tipped over by less-than-perfect conditions?)
  • Will that accounting generate positive cash flow or just make the profit-and-loss statement look better?
  • Does the strategy make any sense? (ex, does it make sense to offer long-term financing on short-term depreciating assets?)
  • When does it stop?

Deflated rollups

According to business research,

more than two-thirds of rollups fail to create any value for investors

The rollup strategy is initially attractive because

the concept makes sense, growth is unbelievable, and problems haven’t surfaced yet

But they rely a lot on positive momentum to succeed because

Rollups have to keep growing by leaps and bounds, or investors disappear, and the financing for the rollup goes with them

There are four major risks to a rollup strategy:

  1. rollups often wind up with diseconomies of scale
  2. they require an unsustainably fast rate of acquisition
  3. the acquiring company doesn’t allow for tough times in their calculations
  4. companies assume they’ll get the benefits of both decentralization and integration, when in reality they must choose between one or the other

Double-check your rollup strategy by asking yourself the following tough questions:

  • Will your information systems break down if you increase the size of your business by a large factor?
  • What other systems might break down at the new scale?
  • How much of senior management’s time is going to go to putting out fires, coordinating activities, etc.?
  • How much business will you lose in the short run as competitors use takeover confusion to try to poach business?
  • What regulations might change and how will they affect the business?
  • Will your cost of capital really decline? If so, how much? How do you know?
  • If you think your pricing power will increase, why?
  • What will you have to spend, both in time and money, to get the efficiencies you expect from a takeover?
  • Who has a vested interest in keeping you from achieving all the efficiencies you expect?
  • How much will prices of acquisitions rise over time, as your rollup intentions become clear?
  • If you’re financing with debt, just how big a hit to your business can you withstand? What if you take a hit to cash flow for a period of years? If you’re buying with stock, what do you do if your stock price falls by 50%?
  • How do you prevent people from cooking the books when the bad times come?
  • Have you discounted the gains you expect to get from integration?
  • How much loss of revenue are you assuming if you replace local managers and systems?
  • What is the end game? How big do you need to get?
  • How slowly can you go?
  • Do you have to be a national rollup, or would a regional one make sense? Can you at least start as a regional rollup and work out the kinks?

Staying the (misguided) course

Businesses often adhere to a failed strategy or a dying technology because they either can’t envision how they’d adapt or can’t admit that they’re on a failed business course.

The three main risks to staying the course are:

  1. tend to see the future as a variant of the present
  2. tend to consider whether to adopt a new technology or business practice based on how the economics compare with those of the existing business
  3. tend not to consider all their options

Double-check your core strategy by asking yourself the following tough questions:

  • Are you considering all your options?
  • Declining business model, based upon Michael Porter’s five forces:
    • does your industry have a favorable structure for decline, where, like steel, it will provide profits even as it declines? Or, is your industry like traditional photography, which would mostly disappear once digital took hold?
    • can you compete successfully for the remaining demand, like Kodak, with a great brand? Or do you not only lack a brand but also lack other assets, such as a low cost structure?

Misjudged adjacencies

Adjacent market expansion entails attempting to sell new products to existing customers, or existing products to new customers, by building on a core organizational strength to expand the business in a significant way.

But sometimes, businesses expand into markets that seem adjacent, but are not– just because your branded-sunglasses customers like your sunglasses brand, doesn’t mean they’ll necessarily like it on their sportscar tires, or on their surfboards, because you imagine your market is “sport lifestyle.”

There are four fundamental risks to an adjacency strategy to be aware of:

  1. the move is driven more by a change in a company’s core business rather than by some great opportunity in the adjacent market
  2. lack of expertise in the adjacent market, causing misjudgment of acquisitions and mismanagement of the competitive challenges of the new market
  3. overestimation of the strengths of importance of core business capabilities in the new market
  4. overestimation of the hold on customers, creating expectations of cross-selling or up-selling that won’t materialize

Double-check your adjacencies strategy by asking yourself the following tough questions:

  • How do the sales channels differ in the new market?
  • How do the customers differ?
  • How do the products differ?
  • Are the regulatory environments differ?
  • Do you have at least a 30% advantage on costs before entering the new market?
  • What if the economy goes seriously south?
  • What if the sector you’re moving into goes into decline?
  • What if your expectations about opportunities for efficiency and revenue growth don’t happen?
  • How much do you have to be off in your estimates of cost savings or revenue increases for the adjacency strategy to be a bad idea?
  • What don’t you know about your new market?
  • What don’t you know about making acquisitions?
  • How many of your acquisitions will be lemons?
  • Will your customers really follow you into your new market?

Fumbling technology

Businesses often bet the farm on a technology that turns out to be nowhere close to as profitable and revolutionary as they initially expect it to. Often, market research is created which suffers from “confirmation bias”.

There are three important technological “laws” to be mindful of, which are often ignored, as well:

  1. Moore’s Law; computer processors double in power every eighteen to twenty-four months
  2. Metcalfe’s Law; the value of a network is proportional to the square of the number of users
  3. Reed’s Law; new members increase a network’s utility even faster in networks that allow arbitrary group formation

There are four major mistakes businesses make when evaluating a technological strategy:

  1. evaluate their offering in isolation, rather than in the context of how alternatives will evolve over time
  2. confuse market research with marketing
  3. false security in competition, believing the presence of rivals equates to a validation of the potential market
  4. design the effort to be a front-loaded gamble instead of developing it piece-by-piece

Double-check your technology strategy by asking yourself the following tough questions:

  • What will your competition look like by the time you get to market? What if you’re six months late? A year?
  • How does your performance trajectory compare with the competition’s?
  • Do your projections incorporate Moore’s Law, for both yourself and your competition?
  • Have you allowed for Metcalfe’s Law and what it says about the relative value of networks? Is Reed’s Law relevant?
  • Is the market real?
  • Do you have to do it all at once? Or can you try things a bit at a time and learn as you go along?

Consolidation blues

Consolidation seems to be a fact of maturing industries. As an industry matures, smaller companies go out of business or are acquired. Most business people figure they want to be the acquirer; in the process, they ignore the possibility that they might be more valuable as a target, or by sitting and doing nothing (neither consolidating, nor selling out).

There are four main issues that tend to muck up consolidation strategies:

  1. you don’t just buy assets as a consolidator, you buy problems
  2. there may be diseconomies of scale
  3. assumption that the customers of the acquired company will be held
  4. may not consider all options (being an acquisition target, doing nothing)

Double-check your consolidation strategy by asking yourself the following tough questions:

  • What systems might fail under the weight of increased size? How much would it cost to fix them? How long would it take? What revenue might be lost in the interim?
  • What relationships might be harmed?
  • What departments are too small, or are for some other reason not up to the task of handling the new size? Which people aren’t up to the task?
  • How much will be lost as people jockey for position in the new organization?
  • How much drag will develop as you try to find efficiencies by standardizing processes?
  • Who will resist change? How effective will they be?
  • What are all the reasons why customers might defect?
  • How does consolidation benefit the customers?
  • What percentage of customers do you think might leave? How much do you think you’ll have to pay to entice these customers to stick around?
  • What are some potential results if you sold out or did nothing, instead of consolidating?

Coda

In summary, the most common problems that result in business failure are:

  • Underestimating the complexity that comes with scale
  • Overstating the increased purchasing power or pricing power or other types of power that come from growing in size (beware of “critical mass” strategies)
  • Overestimating your hold on customers
  • Playing semantic games (any strategy that relies on a turn of phrase is open to challenge)
  • Not considering all the options
  • Overpaying for acquisitions

Avoiding these mistakes: the Devil’s Advocate

How can you avoid these mistakes?

Put in place a process for reviewing the quality of past decisions.

Watch out for cohesive teams who develop the traits of dehumanizing the enemy and thinking they’re incompetent; limiting the number of alternatives they will consider; show even more overconfidence than members would as individuals; create “mind guards” who stomp out dissent.

Probably most important, establish the institution of Devil’s Advocate. Either assign an in-house, permanent DA (who gains experience with each episode, but carries the risk of being labeled as the “naysayer” and ignored) or assign the role on a rotating basis with each new decision (preferable).

The Devil’s Advocate is a powerful tool for avoiding business failure because

More often than not, failure in innovation is rooted in not having asked an important question, rather than having arrived at an incorrect answer

3/5

The Total Vapidity Of Modern Economic Thinkers (#economics)

The Total Vapidity Of Modern Economic Thinkers (#economics)

Here are three responses to the prompt, “Identify the biggest unanswered questions in economics and predict what breakthroughs will define it a decade or two hence” from some of the so-called brightest young minds in economic thinking today. But beware– one of the three is a parody, not a sincere response.

Response #1

I see a big payback to integrating psychology, anthropology, and history into economics more directly, using real-world data to understand how prices, output, and inequality relate to institutions, norms, education, and taxes. And vice versa.

Response #2

The modeling of agents with bounded rationality will help us build economic models (in particular, macroeconomic and financial models) and institutions that better take into account the limitations of human reason.

Reason #3

In an increasingly globalized world, the search for answers will necessarily require a much deeper understanding of three areas that interest me. One, we need a better understanding of the interlinkages across countries in trade, finance, and macroeconomic policy.

Which is which? For the answer, visit Eric Falkenstein’s blog.

What Does The Future Hold For Gaming? Interview With Gabe Newell ($NTDOY)

What Does The Future Hold For Gaming? Interview With Gabe Newell ($NTDOY)

Gabe Newell, head of the innovative and successful game software-plus-gaming platform developer Steam, was interviewed at a recent shindig put on by Silicon Valley venture capital and technologist sponsors (is Valve in play?!).

Somehow, the world of app-gaming and smartphones-as-game-platforms haven’t torpedoed Valve’s growth and financial success. More cold water thrown on that unsophisticated theory. Meanwhile, Newell had some interesting concepts on the future of game distribution and design:

Everything we are doing is not going to matter in the future. … We think about knitting together a platform for productivity, which sounds kind of weird, but what we are interested in is bringing together a platform where people’s actions create value for other people when they play. That’s the reason we hired an economist.

We think the future is very different [from] successes we’ve had in the past. When you are playing a game, you are trying to think about creating value for other players, so the line between content player and creator is really fuzzy. We have a kid in Kansas making $150,000 a year making [virtual] hats. But that’s just a starting point.

Now, this is something Apple has figured out and it’s something Nintendo has figured out but is still in the early stages of implementing– users as content-creators and value-adders. I will have my review of “Nintendo Magic” up soon which goes into this a bit more but one of the most interesting takeaways I had was the fact that Iwata discussed empowering users themselves to create content and experiences with their hardware and software that would add infinite replayability to their games. This was part of their strategy for addressing the main challenge of game-making, which is that over time your game becomes stale and boring.

Related to this, Newell discussed creating open-platforms:

In order for innovation to happen, a bunch of things that aren’t happening on closed platforms need to occur. Valve wouldn’t exist today without the PC, or Epic, or Zynga, or Google. They all wouldn’t have existed without the openness of the platform. There’s a strong tempation to close the platform, because they look at what they can accomplish when they limit the competitors’ access to the platform, and they say ‘That’s really exciting.’

Part of creating an open platform means designing something that is easy to develop for. Nintendo struggled with this with the N64 and Gamecube, systems which were technologically sophisticated and powerful, but not easy to develop games for. Meanwhile, the Sony Playstation and Playstation 2 were relatively simple to develop for. The end result? Much wider software library on the Sony systems. And it is software desirability that drives hardware adoption.

Finally, the Wiimote and its new control scheme was central to the Wii’s success and Nintendo’s strategy to expand the gaming population and allow users to enjoy new experiences. The smartphone/iPad revolution has introduced the value of touchscreen control (which, by the way, the Nintendo DS adopted prior to the smartphone revolution) which has continued with the Nintendo 3DS and which is now coming to the Wii U with the touchscreen, tablet-style game controller to be packaged with the system.

But Newell actually thinks touch is a temporary control measure and that it’s “back to the future” when it comes to the next evolution, which he sees as being more motion control-oriented again:

We think touch is short-term. The mouse and keyboard were stable for 25 years, but I think touch will be stable for 10 years. Post-touch will be stable for a really long time, longer than 25 years.

Post touch, depending on how sci-fi you want to get, is a couple of different technologies combined together. The two problems are input and output. I haven’t had to do any presentations on this because I’m not a public company, so I don’t have any pretty slides.

There’s some crazy speculative stuff. This is super nerdy, and you can tease us years from now, but as it turns out, your tongue is one of the best mechanical systems to your brain, but it’s disconcerting to have the person sitting next you go blah, blah, blah, blah.

I don’t think tongue input will happen, but I do think we will have bands on our wrists, and you’ll be doing something with your hands, which are really expressive.

Was Nintendo ahead of its time? Will Nintendo “return to its roots” on this? Perhaps the design team is already thinking this way? They haven’t abandoned the Wiimote with the next-gen Wii U.

Personally, what Newell is saying makes sense to me. I think touch has been innovative, and for certain applications it is both clean, intuitive and as complicated as control need be. But it is not deep enough. You will not be playing Call of Duty or a modern shooter with touch alone. RPGs could be handled with touch but it would restrict some. A 3D platformer would be a boring disaster with touch. I don’t think critics of Nintendo (gamers and non-gamers alike) pay attention to details like this.

Gary North On Time Management, 80/20 Rule (#timemanagement)

Gary North On Time Management, 80/20 Rule (#timemanagement)

I am posting this for future reference. Gary North’s point isn’t original (it isn’t even his alone), but he has managed to articulate it succinctly, yet again, in “Putter, Fritter and Guess“:

It turns out that the best way for a businessman to spend his time is the 20% of his hours in a day that produce 80% of his net income. It may not be easy to identify these activities, but for a successful career, a person must do this.

What we find is that even when people do this, they do not have the self-discipline to ruthlessly abandon the 80%. They keep doing these low-return tasks. This may be pure habit. It may be a commitment to the ideal of perfectionism: to be sure that everything gets done right. The person refuses to decentralize and delegate. He cannot bring himself to let go. The result is that the person does not attain his maximum output/income.

The person who steadfastly refuses to delegate and decentralize is violating the principle of the division of labor. This principle says: “You can’t do it all.” In some cases, it says; “You can’t do it at all.” A task may not be a one-person task.

The person who is a perfectionist and who insists on doing an entire project is asking to minimize his output. If, by hiring an assistant, he can double his output and reduce quality only (say) 4% (20% of 20%), this will not matter, if the 4% is related to the 80% of the product’s functions that people rarely use.

Geoff Gannon Digest #5 – A Compilation Of Ideas On Investing (@geoffgannon)

Geoff Gannon Digest #5 – A Compilation Of Ideas On Investing (@geoffgannon)

Why I Concentrate On Clear Favorites And Soggy Cigar Butts

  • Graham and Schloss had >50 stocks in their portfolio for much of their career
  • They turned over their portfolios infrequently; probably added one position a month
  • To avoid running a portfolio that requires constant good ideas:
    • increase concentration
    • increase hold time
    • buy entire groups of stocks at once
  • With his JNets, Gannon purchased a “basket” because he could not easily discriminate between Japanese firms which were both:
    • profitable
    • selling for less than their net cash
  • Portfolio concentration when investing abroad is based upon:
    • which countries do I invest in?
    • how many cheap companies can I find in industries I understand?
    • how many family controlled companies can I find?
  • Interesting businesses are often unique

How Today’s Profits Fuel Tomorrow’s Growth

  • To elements to consider with any business’s returns:
    • How much can you make per dollar of sales?
    • How much can you sell per dollar of capital you tie up?
  • Quantitative check: Gross Profit/ ((Receivables + Inventory + PP&E) – (Payables + Accrued Expenses))
  • Once an industry matures, self-funding through retained earnings becomes a critical part of future growth; it’s the fuel that drives growth
  • A company with high ROIC isn’t just more profitable, it can more reliably grow its own business
  • Maintaining market share usually means increasing capital at the same rate at which the overall market is growing
  • Higher ROIC allows for the charting of a more reliable growth path
  • Industries where ROIC increases with market share present dangers to companies with low market share or low ROIC
  • The easiest place to get capital is from your own successful operations; tomorrow’s capital comes from today’s profits

Why Capital Turns Matter — And What Warren Buffett Means When He Talks About Them

  • Capital turns = Sales/Net Tangible Assets
  • Buffett nets tangible assets against A/P and accrued expenses; gives companies credit for these zero-interest liabilities, rather than assuming shareholders pay for all of a company’s assets
  • Buffett’s businesses tend to have higher sales per dollar of assets
  • Companies with higher sales per dollar of assets have higher ROIC than competitors even if they have the same margins
  • There’s more safety in a business in an industry with:
    • adequate gross margins
    • adequate capital turns
  • Industries dependent upon margins or turns open themselves to devastating attacks from the player who can maximize key variables you control:
    • price
    • cost
    • working capital management
    • etc.
  • Companies often compete on a specific trait; it has to be a trait that is variable and can be targeted for change

How to Lose Money in Stocks: Look Where Everyone Else Looks — Ignore Stocks Like These 15

  • It’s risky to act like everyone else, looking at the same stocks everyone else looks at, or by entering and exiting with the crowd
  • Don’t worry about which diet is best, worry about which diet you can stick to; find an adequate approach you can see through forever
  • Having Buffett-like success requires every day commitment
  • You should aim to earn 7% to 15% a year for the rest of your investing life if you aren’t going to fully commit like Buffett did
  • A good investment:
    • reliable history of past profitability
    • cheap in terms of EV/EBITDA
    • less analyst coverage
  • A list of such stocks:
    • The Eastern Company (EML)
    • Arden (ARDNA)
    • Weis Markets (WMK)
    • Oil-Dri (ODC)
    • Sauer-Danfoss (SHS)
    • Village Supermarket (VLGEA)
    • U.S. Lime (USLM)    
    • Daily Journal (DJCO)
    • Seaboard (SEB)
    • American Greetings (AM)
    • Ampco-Pittsburgh (AP)
    • International Wire (ITWG)
    • Terra Nitrogen (TNH)
    • Performed Line Products (PLPC)
    • GT Advanced Technologies (GTAT)
What Is The True Significance Of Obama’s Gaffe? (@BarackObama, #obama, #tlot, #tcot)

What Is The True Significance Of Obama’s Gaffe? (@BarackObama, #obama, #tlot, #tcot)

Obama’s recent gaffe about how people with businesses didn’t do anything to build them themselves (attacking the “every man an island”, strict-individualism philosophy-caricature) has been in the news and trending through the blogosphere as of late. It won’t be important for long– some other outrage or trivial incident will soon replace it, as always happens — so I’ve got to get my commentary in now and strike while the iron is still hot.

The common response to this is predictable in that it follows the dialog of the false dichotomy perfectly. If you like Obama and what he represents, you get an opportunity to get pissed off at the naive idiocy of conservatives who “really believe that everyone does everything on their own” and who ignore that we live in a society of other people! Your view that we really are interconnected on a fundamental level is reinforced and you can then make any logical jumps to policy recommendations based off this premise that you desire.

If you don’t like Obama and what he represents, you get an opportunity to get pissed off at the naive idiocy of liberals who “really believe that no one is capable of excellence and achievement on their own” and who ignore that some people like Steve Jobs, or even a lonely small business owner, largely stand alone in society as they quest after accomplishment! Your view that entrepreneurial decisions which create wealth and opportunity for all are never made collectively is reinforced and you can then make any logical jumps to policy recommendations based off this premise that you desire.

Thesis, antithesis… synthesis? The false dichotomy reigns supreme and serves its ultimate purpose, which is to “divide” society so that it may be “conquered” by the elites straddling atop it. Everyone is so busy fighting one another about formalistic issues, “Is every man an island or does it take a village?”, that no one notices the masked-villain with his hand in the cookie jar and his grip on the whip.

The question is not individualism versus collectivism? It may surprise you to hear it, but it doesn’t matter. The important question is, whether members of society largely organize as individuals or collectives, should their interactions be constructed on the basis of coercion or voluntaryism?

Should you be free to choose, or guided by the invisible, omnipotent and omniscient hand?

The other important observation to make here is this: Obama is a politician, and as a politician, he is a puppet of perceived public interest. Everything he says, he says to cater to a part of society that agrees with him and is willing to support him politically.

If you watch the clips of Obama’s gaffe, you can tell from the hoots of “YEAH!” and the clapping that for many in his audience, it wasn’t a gaffe. It was “truth.” It was something they identify with and connect with.

Again, a false dichotomy. We can all fight about Obama versus Romney, Republican versus Democrat, etc. But meanwhile, our friends and neighbors are captured by this philosophy of coercion.

That’s the real problem to face and solve. Save your anger and disgust toward the puppets for the people who nominally control the strings. Ask not, “How will we get rid of Obama?” but instead, “Why do some of my fellow members of society believe this, and how can I change their mind?”

Ask yourself, “If I can’t change their mind, what then?”

More Interviews With David Baran Of Symphony Fund (#JNets)

More Interviews With David Baran Of Symphony Fund (#JNets)

For reference purposes, here are three more recent interviews with David Baran of the Tokyo-based Symphony Fund, which is involved in shareholder activism and management buyouts of undervalued (especially net-net and net cash bargain) Japanese equities:

Investing in a ZIRP environment:

I’ve been trading Japanese equities since 1990, so I’ve seen it all twice [laughs]…

I think [it’s influenced] our views on how the world is going to look as a result of, not just the current sovereign debt crisis in Europe, but the entire cycle of over-leveraging in the world and the shifting to an almost perpetual low interest rate, low growth scenario.  We’ve lived it in Japan already—we know what it’s like, we know what it does to asset prices, we know you’re going to get attractive bull market runs but you’re still going to be in a long-term bear market. Being able to look back at our own experiences of having dealt with that in Japan gives us a completely different perspective, I think, from other managers who would be relatively new to the market—by relatively new, I mean, they’ve got 10 years experience—and they’ve only seen bull markets with some deep corrections that are reversed by policy.

I don’t think there’s a policy solution for what we have now. You’ve got to get rid of all the debt. The global debt overhang is huge, it’s historic. The amount of unfunded liability in the U.S. can cripple the country. And you have that situation amplified in Europe with fewer policy tools to rectify the problem.

The M&A trend in Japan:

MBOs [management buyouts] first came to prominence in Japan in 2006 with the Skylark MBO. This caused corporate Japan to first sit up and take notice that this was a possible road that management could take. At the same time, there began a series of changes to Japanese corporate governance that aimed to increased corporate disclosure and increase transparency. The most recent of these came out in 2010 and included requirements for director/statutory auditor independence, disclosure of executive compensation, and explanations for cross shareholdings. All of these are hard to swallow for many Japanese companies. In addition, with all these new rules, including IFRS accounting rules that will soon be introduced, the costs of being a listed company was getting high. Too high particularly for smaller cap companies for whom these costs were now of a material size relative to earnings. It is no coincidence that we have seen a steady increase in MBO activity in Japan, with 2011 on track to be the highest in five years.

They’re not activists, they’re advisors:

We are not activists. The whole activist approach doesn’t work in Japan. It probably works better in the U.S. because the shareholder base is more diversified and economically motivated. Shareholders in Japan may not necessarily use the same formula. The activists who tried a hostile approach here before, and this is where the cultural biases come in, they never had the ability to force management to do anything because they never had control. So they were requesting management to do something but doing it in such a way that management would just turn their back on them and say, ‘Well, we don’t even really need to talk to you,’ and the other shareholders really didn’t care, and would side with management.

We take a much more cooperative approach with management…We’ll act more as their counsel, their consigliere, guys they can talk to about things as opposed to the squeaky wheel.  We’re not interested in being the squeaky wheel.

Interview With David Baran Of Tokyo-Based LBO Fund Symphony (#JNets, #valueinvesting)

Interview With David Baran Of Tokyo-Based LBO Fund Symphony (#JNets, #valueinvesting)

This is worth watching if you’re a value-investor interested in the Japanese equity market.

Description of the video from YouTube:

David Baran, Co-Founder of Symphony Financial Partners, has over 20 years of experience investing in Asia. He has lived in Asia and Japan for nearly 3 decades and is fluent in Japanese.

Baran’s SFP Value Realization Fund was launched in September 2003 when Nikkei was about 9,500. The index has fallen since then, yet his fund is still up 56% after fees.

The secret to achieving returns in Japan is that you’ll have to do more than just long-only investing. The unloved, under-covered nature of the Japanese market creates opportunities that ordinary fund managers are not capable of pursuing because it’s too hard to extract the value. Many Japanese firms, particularly the smaller ones, can boast about 40+% operating profits and 30+% EBITDA margins. They can have net cash positions and trade at 50+% net cash to market cap. Hundreds actually trade at over 100% net cash to market — which means the market is valuing these viable businesses at zero.

“Investors in the U.S. equity markets would be falling over themselves to invest in a company like these – net cash, strong business moat and growth prospects,” says Baran. But being “cheap” isn’t enough — you need catalysts to unlock the value.

M&A activity flourishing in Japan

Corporate activity is such a catalyst. MBOs have an average premium of 50% (!) and sometimes reach triple digit numbers. Many of the large Japanese conglomerates started to buy back listed subsidiaries. Baran also advises on the Sinfonietta Asia Macro hedge fund, one of the best performing Asian hedge funds in 2001.

Hear David speak about:

* The 8 reasons why management buyouts are gaining popularity

* Why you need catalysts to unlock value in Japan equities

* What investors are missing by considering Japan as an “asset class”

* How to avoid “value traps”

* Considering tail risk: Why Baran’s Sinfonietta hedge fund is “geared towards a disorderly market”