Agenda-Setting Financial Insight.

Feb. 6 2013 2:40 PM

The Unsexiest Media Company Alive: Time Warner

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The long-term question for Chief Executive Jeff Bewkes is whether he can continue to make boring beautiful

Photo by Stephen Lovekin/Getty Images for Time Warner

Time Warner deserves the top spot in one of its glossy weeklies as the unsexiest media company alive. In five years under Chief Executive Jeff Bewkes, the owner of Warner Brothers, HBO and People magazine has delivered investors a 70 percent return, keeping pace with its wheeling and dealing media rivals. The longer-term question is whether Bewkes can continue to make boring beautiful.

His 20th set of quarterly results, released on Wednesday, exemplifies Time Warner’s approach. Revenue was flat, but adjusted operating income still grew 16 percent. The company expects earnings per share to increase at least 10 percent in 2013, suggesting improved film box office, TV advertising and carriage fees for its networks.

Bewkes lived through the empire-building era that culminated in Time Warner’s epically destructive merger with AOL. That might explain why early in his tenure as CEO he hived off the company’s cable operations and AOL to refocus on movies, magazines and TV shows.

As a result, the buzz surrounding content like HBO’s “Girls” and Oscar-nominated “Argo” is louder than for the company itself. Yet the total return for Time Warner’s stock with Bewkes at the helm dwarfs the 16 percent investors could have achieved with the S&P 500 Index, according to Datastream. The shares have performed in the middle of the media pack, beating News Corp and Viacom but lagging Disney and CBS.

Time Warner isn’t exactly standing still by shopping its shiny New York headquarters, slashing publishing jobs and installing a new studio boss. Competitors, however, are making more radical changes. News Corp is carving out newspapers and CBS is separating billboards. Bewkes has done smaller deals like Flixster that add up to some $3 billion, but Disney splashed out more than that on each of Marvel and Lucasfilm alone.

For now, Time Warner sees the best value in its own shares. A new $4 billion buyback plan follows last year’s $3.3 billion program. Slow advertising growth and pressure on TV margins could eventually force Bewkes to make bolder moves. Spinning off the magazine division or buying full control of Central European Media, for example, could titillate shareholders without being so provocative as to compromise Time Warner’s unsexy appeal.

Read more at Reuters Breakingviews.

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Feb. 5 2013 3:11 PM

Apple and Exxon May Not Be So Different After All

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Apple: actually, not too different from Exxon.

Photo by TIMOTHY A. CLARY/AFP/Getty Images

Apple and Exxon Mobil may not be so different, after all. The two seemingly disparate companies share more than nearly identical U.S. market-leading values of about $400 billion. Both are threatened by shrinking margins and the struggle to replace their precious wares. Exxon in various iterations has survived four times longer than Apple, but is just as vulnerable.

The mortality rate in technology is high. Rapid advances in hardware and software regularly buffet the sector. Firms rarely survive more than one wave of technology, leaving their intellectual property with a short shelf life. Energy companies are more durable. Exxon’s roots stretch back to 1870. Oil explorers in particular sit on supplies of a commodity that is hard to replace.

Investors are starting to worry that Apple will succumb to the industry’s life-cycle squeeze. After soaring past $650 billion, its market capitalization has tumbled by more than a third in the past five months. Rival smartphones are gaining ground on the iPhone, which accounts for more than half of Apple’s sales and an even greater slug of profit. Operating margins slipped five percentage points to 32 percent in the last full quarter. If price becomes the next battleground, they may slide further still. Apple will have to innovate anew to reverse the trend.

Exxon faces a similar dilemma. The Texas-based company must be increasingly creative to extract oil from rocks, ocean depths and frigid arctic wastes. That explains a 90 percent surge in capital spending since 2007, to about $40 billion annually. Even so, Exxon has barely replaced its reserves. It also must contend with an additional pressure that Apple doesn’t: government actions discouraging the use of oil and fostering more competitive substitutes. It’s a recipe for slimmer margins or, in an extreme case, extinction.

In that sense, Apple’s problems may be easier to solve. If it can develop a new blockbuster, like a TV that already is anticipated, investors could rediscover their enthusiasm for the company, valued at 10 times estimated 2013 earnings. Exxon trades at a similar multiple, though its problems are arguably less tractable, with easily available oil already tapped. Either way, Apple and Exxon find themselves strangely in the same boat. 

Read more at Reuters Breakingviews.

Feb. 4 2013 2:53 PM

U.S. Venture Capital Needs a Reboot

U.S. venture capital needs a reboot. A decade of insufficient shrinkage hasn’t fixed wimpy performance. At 6.1 percent annually over 10 years to September, according to Cambridge Associates and the National Venture Capital Association, VC fund returns undershoot boring stock indexes like the Nasdaq and the Russell 2000.

Last year, VC outfits raised $20.6 billion of new committed funds, according to the NVCA and Thomson Reuters. That’s about 10 percent more than in 2011. Unfortunately, distributions from funds have lagged the cash put in since 1999. Last year’s tally is also more than five times the average amount raised annually by VC firms in the decade leading up to the dot-com bubble. The bust happened, but the venture capitalists’ appetites never took the same dive.

In addition, it has become much cheaper for startups to become established in areas such as internet services and software. Add the ability to look beyond VC firms for funds, and there’s a mismatch between the supply of capital and upstart companies’ need for it.

That said, performance is highly dispersed, and a few well connected, marquee VC firms like Andreessen Horowitz still do very well. Founded in 2009, the fund has had several lucrative exits thanks to hits like Nicira, Groupon and Zynga. Its first fund is on track to return well over twice its initial capital. Most rivals, however, fall far short of that benchmark. The Kauffman Foundation said in a paper last year that half the VC funds in its portfolio failed even to return the capital investors put in.

VC firms face the same temptations that afflict hedge funds and private equity. If investors are willing, management fees can be attractive even if that means backing less-than-stellar performers. Rather than closing shop, they can persist for years. The giant California Public Employees’ Retirement System lists 24 funds that started prior to the turn of the millennium and have not yet wound down, despite the majority providing negative returns to investors.

Calpers has now reduced its holding in VC firms to 1 percent of its $234 billion of assets as of last June. And the Kaufman Foundation’s paper is something of a call to arms. Yet VC firms still seem to have little trouble raising new funds. A few big names aside, the least investors need to do is strip the industry of its mystique and demand greater transparency and a better deal.

Read more at Reuters Breakingviews.

Feb. 1 2013 3:57 PM

2012 May Be As Good As It Gets for Exxon

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Unless oil prices jump, Exxon may have peaked

Photo by Brian Harkin/Getty Images

2012 may be as good as it gets for Exxon Mobil. America’s largest oil company pumped out a near-record profit and its best earnings per share ever. But Exxon, like Chevron, is spending huge sums – almost $40 billion last year - to find and extract reserves. Holding output steady is tough enough. Unless oil prices jump, Exxon may have peaked.

The big boost to the bottom line for America’s two top oil titans didn’t come from their main exploration and production divisions, but from processing and refining. That’s because the oil and gas needed to run this side of the business was cheap and plentiful in the United States, driving down costs. That helped Exxon as a whole generate $44.9 billion of net income - within a whisker of 2008’s $45.2 billion record.

Topping this feat in the future won’t be easy. Earnings from its refining and chemical operations account for just a third of Exxon’s profit and a tenth of Chevron’s. What would move the needle is an improvement in their two main businesses - both companies suffered a decline in production last year despite years of escalating outlays.

Reversing that trend looks hard, though. Oil-rich nations are becoming more protective of their natural resources, so the likes of Exxon have to resort to drilling for more expensive oil trapped in rocks, the ocean depths or the frigid Arctic.

That requires spending much more money, which helps explain why Exxon’s capital spending has jumped by almost a quarter since 2010. Worse, in some instances costs are running ahead of expectations – by 10 percent at its oil-sands project in Canada, the company admitted on Friday. That’s a rare embarrassment for a company obsessed with operational discipline. Chevron’s spending, meanwhile, leapt by 17 percent last year - in large part due to ramping up its liquefied natural gas operations in Australia.

Getting its operations Down Under online should at least provide some relief for Chevron. Exxon, though, has no spurt in output in sight. Aggressive share buybacks may keep earnings-per-share performance high. But boosting net income will require higher oil prices. With global growth tepid, that looks too much for shareholders to hope for.

Read more at Reuters Breakingviews

Jan. 31 2013 12:59 PM

Facebook's Heavy Investment is Worth it

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Facebook deserves the benefit of the doubt about its rocketing costs.

Photo by Stephen Lam/Getty Images

Facebook deserves the benefit of the doubt about its rocketing costs. The social network’s bills jumped about 80 percent in the fourth quarter. That’s worrying - it’s twice as much as the top line grew. But all-important mobile advertising revenue doubled in 90 days. The potential profit justifies heavy investment.

The proliferation of small screens was the biggest threat facing Facebook. But there increasingly are signs that it is turning this into an even bigger opportunity. Advertisers had been reluctant to promote their wares or services on tablets and smartphones. And Facebook didn’t even bother trying to entice them until last spring.

But increasingly slick mobile devices and better metrics for measuring the effectiveness of campaigns - and the fact that people now spend so much time on their devices - is attracting advertisers. Facebook, along with Google, appears to be one of the biggest benefactors.  Mobile accounted for 14 percent of advertising in the third quarter, but 23 percent in the three months to December. Throw in the fact that overall advertising, which accounts for most revenue, is growing, and mobile just about doubled.

But this didn’t come free. Operating profit was actually slightly lower. Facebook has boosted spending on R&D, increased headcount by 40 percent over the course of a year and increased capital expenditure by 45 percent. And the splurge isn’t over: the firm will increase investments in areas like search and spend more on IT infrastructure this year.

That’s a smart choice. Facebook now has more users on mobile devices than desktops and the number should grow quickly. Advertisers are growing more likely to target such users. And mobile ads still cost less than desktop ads, even though mobile users are probably worth more - reaching people locally is the holy grail of advertising.

Sure, with the stock priced at nearly 50 times estimated earnings, investors may be baking in too much future profit. But seizing the mobile opportunity is the best way for Facebook to justify its high valuation.

Read more at Reuters Breakingviews.

Jan. 31 2013 10:38 AM

Surpisingly Weak U.S. GDP Has Silver Linings

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Personal consumption increased at a 2.2 percent rate, slightly faster than in the previous quarter

Photo by Allison Joyce/Getty Images

The surprisingly weak U.S. economic output in the fourth quarter contains more than a few silver linings. The nation’s GDP declined at an annualized rate of 0.1 percent, defying expectations of at least 1 percent growth, according to economists polled by Thomson Reuters. Lower government spending accounted for a big slug of the contraction while private consumption and income improved. There’s really little cause for alarm.

Tighter budgets in state capitals and Washington, especially in the Defense Department where outlays fell by $11 billion, excised 1.3 percentage points of growth. So too did inventories, whose growth probably slowed over fears of a looming fiscal crisis. Had both those items been flat, U.S. GDP would have grown at an annualized rate of 2.5 percent instead. Excluding the same factors in the previous quarter would have meant the economy grew by 1.6 percent.

Consumers, who account for the biggest portion of the country’s economic activity, showed signs of strength, too. Personal consumption increased at a 2.2 percent rate, slightly faster than in the previous quarter. Investment in housing, factories and equipment also rebounded from a slack July-September period to a growth rate of 9.7 percent from October-December. That all squares with the quarter’s relatively robust employment data and suggests a modest U.S. recovery remains on track.

What’s more, real disposable personal income was particularly strong. The annualized increase of 6.8 percent was among the fastest rates of growth since before the crisis struck. By outpacing consumption, it helped elevate the savings rate, to 4.7 percent, even if the sharp end-of-year jump in dividend payouts to get ahead of tax hikes probably will cause this trajectory to reverse in the first three months of 2013.

The headline GDP figure may nevertheless have the power to reinforce the Federal Reserve’s bias toward low rates and $85 billion of monthly bond buying. That would be an unfortunate result given the underlying trends. The decline in public spending is unlikely to remain so sharp. And inventories are bound to start building anew. Most signs still point to at least a stabilizing economy, one that can sustain itself without so much of the central bank’s helping hand.

Read more at Reuters Breakingviews.

Jan. 29 2013 3:09 PM

Activist Exposes Hess as Latest Governance Villain

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An activist investor has exposed Hess as the latest governance villain in the energy patch

Photo by CHARLY TRIBALLEAU/AFP/GettyImages

An activist investor has exposed Hess as the latest governance villain in the energy patch. Hedge fund Elliott Associates reckons the U.S. oil company could be worth more than double its current $20 billion-plus value. But as at other energy groups, like Chesapeake Energy and SandRidge Energy, a too-cozy board has brought waste and strategic blunders.

Being a Hess director looks like a pretty safe job. Typically board members stick around 50 percent longer than the average for S&P 500 companies, according to Elliott. Thomas Kean, for example, has been a director for 23 years. Three other non-executive directors, including 82-year-old former U.S. Treasury Secretary Nicholas Brady, boast tenures approaching 20 years.

They don’t even offer industry expertise or much independence. Nobody on the Hess board has drilling experience outside the company, and only the three executive directors have any at all. Several directors also have connections to the founding family - from which Chief Executive John Hess, in situ for 17 years, hails - and its charity.

It’s no coincidence that Hess has a record of inefficient operations. It spends far more as a proportion of revenue on its exploration efforts than big rivals like Exxon Mobil. And Elliott reckons its wells in North Dakota’s Bakken shale cost about a third more to drill than those of its peers.

The CEO also looks overpaid considering the company’s performance. Over the past five years he has earned $96 million, according to Thomson Reuters data, making him well above averagely remunerated for his sector by Elliott’s analysis. Yet even after this week’s gains, Hess’s shares are down 30 percent over the same period, among the oil business laggards. Anadarko Petroleum, by contrast, is up 40 percent.

Hess has been doing some sensible housekeeping, like closing money-losing refineries. But it’s not enough. As at Chesapeake and SandRidge, shareholders are starting to challenge the complacent boardroom status quo. With some prime assets in areas like the Bakken and limited exposure to painfully low U.S. natural gas prices, there’s a case that the company could, or even should, have been among the star performers in its industry. New broom directors, like the five industry heavyweights put forward on Tuesday by Elliott, would make that more likely to happen.

Read more at Reuters Breakingviews.

Jan. 28 2013 7:08 PM

Markets' New-Year Euphoria Looks Overdone

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Investors should take a deep breath and feel good – just not excessively so.

Photo by Spencer Platt/Getty Images

The new-year euphoria in financial markets looks overdone. The S&P 500 is up 5 percent, investors are throwing record sums into equities and Treasuries are flirting with 2 percent yields. But fiscal cliff diving can still hurt the economy and at least one incentive to put money to work may wear off.

There are reasons for optimism. Two-thirds of the S&P 500 companies that have reported quarterly earnings have beaten profit estimates, according to Thomson Reuters I/B/E/S. That, and Congress’s decision to make many Bush-era tax cuts permanent, has helped embolden retail investors, who poured a record $55 billion into equity mutual and exchanged-traded funds this month.

The last time such inflows reached an all-time high, though, was in February 2000 after the economy had grown at a 7 percent clip. That’s hardly the case today. BNP Paribas reckons the economy grew just 1.3 percent in the fourth quarter and will expand a mere 1.0 percent in the first three months of this year.

That’s largely because Congress didn’t walk far enough away from the fiscal cliff. Cuts slated for the defense budget along with the 2-percentage-point hike in payroll taxes will be a significant drag on the economy, potentially knocking nearly 1 percentage point off output, according to the French bank.

Americans aren’t likely to dip into their cash stashes that frequently unless there’s a decisive turn in the economy. Sure, depositors withdrew a whopping $76 billion from commercial banks in the first two weeks of the year, according to the Fed. But that was after a significant buildup before December’s fiscal cliff deadline. That suggests investors are simply relieved that matters aren’t getting worse.

Moreover, the expiration of a government guarantee scheme for noninterest-bearing accounts could also explain why some depositors decided to put long-dormant money to work. The Federal Reserve’s printing press is also playing a role as bond funds, which typically lose investors when stocks improve, swelled nearly $13.2 billion over the past three weeks, according to Lipper.

But a reality check looms in February when post-fiscal cliff economic data start rolling in. While it might not crash markets, if should quell some of the excessive enthusiasm. Investors should take a deep breath and feel good – just not excessively so. 

Read more at Reuters Breakingviews.

Jan. 25 2013 3:14 PM

Wall Street Finds New Way To Put Investors Second

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Goldman Sachs and JPMorgan are now trying to stifle investors from voting on legitimate matters at their upcoming annual meetings

Photo by Chris Hondros/Getty Images

Wall Street has found a new way to put shareholders second. While many banks are finally bowing to pressure to restrain compensation, Goldman Sachs and JPMorgan are now trying to stifle investors from voting on legitimate matters at their upcoming annual meetings.

Goldman asked the Securities and Exchange Commission for permission to omit a proposal that would require it to appoint an independent chairman. JPMorgan, meanwhile, wants the regulator to let it remove from its proxy an initiative to have the board of directors explore “extraordinary transactions that could enhance stockholder value” - in other words, a breakup.

Both suggestions are rational topics for debate. Calling for a bank to split the roles of chairman and chief executive is hardly a new concept. Last year, Goldman and Lloyd Blankfein, who holds both titles, negotiated their way out of putting the issue to shareholders by striking an agreement with aggrieved investors to revise slightly board oversight of executives.

Meanwhile, shareholders seeking ways to improve returns aren’t revolutionary either. Headline-making activists like Bill Ackman and Dan Loeb do it all the time. Sure, JPMorgan performs better than many of its rivals, delivering an 11 percent return on equity last year despite a whopping $6.2 billion trading loss. Even so, the bank’s shares still trade just below book value, a figure that essentially represents what the disparate parts should fetch if sold off.

Yet both Goldman and JPMorgan are claiming the ballot initiatives are, among other things, too “vague.” That can happen with flighty individual investors, but isn’t typically the case from established investors like union adviser CtW and the AFL-CIO, which put forward the two questions this year.

What’s odd is that both banks have made their cases before. JPMorgan boss Jamie Dimon regularly addresses why he thinks carving up big institutions isn’t the answer, including in his annual missives to shareholders. Goldman, like others, reviews its leadership structure each year.

If the crisis made anything clear, it’s that banks should be forced to defend their business models and corporate governance - regularly. Fighting to suppress such questions only makes it sound like these supposedly master sellers are afraid they can’t close. 

Read more at Reuters Breakingviews.

Jan. 24 2013 3:28 PM

Davos Desperately Seeking the Next Internet

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In the echo chamber of Davos, the notion that shale gas is a reason to be bullish has become common wisdom

Photo by JOHANNES EISELE/AFP/Getty Images

To feel good again, the world’s financial elite need a growth catalyst like the Internet. America’s shale gas revolution fits the bill. Ask delegates at the World Economic Forum in Davos for their 2013 outlook, and that simple idea features in most answers. It may only surface as a passing reference in conversations around the Swiss ski resort. But in the echo chamber of Davos, the notion that shale gas is a reason to be bullish has become common wisdom.

The argument is familiar. As fracking – the technique to extract gas from shale – takes off, that benefits satellite businesses that serve the industry. That stimulates the broader economy. What’s more, shale lowers energy costs, benefiting American industry by lowering expenses. Factor in a healthier housing market, and you have the makings of a durable recovery in a region accounting for about a quarter of the global economy.

In one form or another, this thesis is being touted by corporate executives, bank bosses and politicians navigating the icy byways of this mountain village. It’s easy to see why. This year, the WEF takes place when the world is more composed than it has been for ages – the acute phase of the sovereign debt crisis is past, yet there is no exuberance either. Masters of the universe feel things are looking up, but they’re mindful of latent risks.

Shale supplies grounds for reasoned optimism. Lower energy prices thanks to abundant natural gas in the United States saved $107 billion, or $926 per household, last year, according to research by IHS. The boom has created 1.7 million jobs already.

But it’s a big leap from this to believe shale will lead a global recovery. Shale is still a small element of the overall U.S. economy. The U.S. oil and gas sector is only 1 percent of GDP, according to Credit Suisse. While it brings advantages, it is more of a mini stimulus than a saving grace, which would require the side effects of shale to be both large and entirely positive. In reality, only a handful of industries – like petrochemicals or fertiliser – will enjoy game-changing benefits.

Then again, maybe the details of the shale thesis aren’t so important. The assurance expressed among business leaders and their entourages in Davos may be misplaced. But confidence, even one derived from gas, can be self-perpetuating. Let them keep believing.

Read more at Reuters Breakingviews.

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