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I mean, really, who needs fiction?

All you need to do is read the latest Societe Generale headlines!

Société Générale says it lost 4.9 billion Euros ($7.17 billion) at the hands of 31-year-old trader Jérôme Kerviel. Now, the embattled French bank could face another financial hit — this time from the tax man.

As they pore over the trades, financial books and mobile-phone records of Mr. Kerviel, Société Générale officials have discovered that the trader booked a real gain for the bank of €1.4 billion by the end of last year…

That profit now “is subject to corporate tax,” according to one person close to the bank. “We will argue against it, but fiscal authorities will want their share,” this person said…

When it announced the world’s biggest trading loss on Jan. 24, Société Générale said that Mr. Kerviel for several months had engaged in risky and fraudulent trading that at one point had left the bank exposed by 50 billion Euros. The bank at that time said that Mr. Kerviel’s trading positions had fluctuated and that as of late last year, his portfolio showed a “virtual” gain of 1.4 billion Euros.

The bank said it hadn’t noticed the gain because the trader had hidden it by creating a set of fake positions that generated a 1.4 billion Euros loss.

Now, however, officials have discovered that as of the end of last year, Mr. Kerviel had unwound almost all of his trading positions — and in fact had locked in a real gain of 1.4 billion Euros for the bank…

Source: Wall Street Journal.

Department of split-second golden ages, Henry Kravis edition

Bloomberg, July 2 2007:

In April [2007], [buyout mogul Henry Kravis] stood in a ballroom of the Waldorf-Astoria hotel in New York, telling [people] that the private equity industry he had helped invent was hotter than ever.

“We’re in, right now, the golden age,” Kravis, 63, told a gathering of prominent… executives.

In May, Kravis was in Halifax, Nova Scotia, saying, again, that the takeover arena had never looked better.

“The private equity world is in its golden era right now,” Kravis told a conference of bankers and investors. “The stars are aligned.”

Wall Street Journal, February 6 2008:

A new problem is rippling through credit markets: Many of the corporate loans used to finance giant buyouts in the past few years are reeling in secondary market trading…

The loans of First Data Corp., which was taken private in September by Kohlberg Kravis Roberts & Co. for about $28 billion, were sold into the market this past fall at a 4% discount to their par value; they now trade in the market at a steep 11.5% discount to par value…

Loans of Freescale Semiconductor Inc., taken private by a consortium of private-equity firms in December 2006 for about $28 billion, are trading at a 15.5% discount to their original value; Tribune Co., which was taken private in April by investor Sam Zell for $8.2 billion, issued loans now trading a 26% discount…

The loans are known by investors as “leveraged loans,” used by companies often with low credit ratings to raise money, often for buyouts…

Double-digit declines in the market value of these loans are very unusual, and a big problem for many banks, which sit on a pipeline of $152 billion in loans that they have promised to make but have yet to sell to investors.

With the prices of existing loans tumbling, investors have little incentive to buy new loans unless they are sold at steep discounts, something banks are reluctant to do…

The crisis started last summer, when investors turned up their noses at billions of dollars in buyout debt, just after many buyout firms and their bankers made commitments to history-making megadeals. Many investors say January was the worst performance for this market since those summer months…

The saga of Harrah’s Entertainment Inc.’s loan sale is a sign of the distress in the market. Credit Suisse broke from a group of banks lined up to sell $7.25 billion in loans tied to Harrah’s buyout. It offloaded its commitment of about $1 billion through derivatives transactions in December, says a person briefed on the transaction. The move sent other banks scrambling to sell some of their own Harrah’s loan commitments in January…

Last week a Lehman Brothers-led group abandoned its three-week effort to sell CDW Corp.’s $2.2 billion loan to buyers. The deal failed to generate interest even though they were offering to sell the loans in the low 90s. In October, Madison Dearborn Partners LLC and Providence Equity Partners acquired CDW, one of the country’s largest technology-equipment resellers, for $7.3 billion.

Silicon Valley after a Microsoft/Yahoo merger: a contrarian view

This post is not about the potential Microsoft/Yahoo merger.

Instead, let’s just assume for the moment that Microsoft succeeds in its bid for Yahoo.

What would a Microsoft/Yahoo merger mean for startups in Silicon Valley?

Some smart people whom I respect a great deal believe that a Microsoft/Yahoo merger would be bad for Silicon Valley startups.

Says Bill Burnham, for example: “By swallowing up Yahoo, Microsoft will be removing one of the biggest and most active acquirors of start-ups in Silicon Valley… [making] M&A less competitive in general and [reducing] the # of potential exits… [which is] bad news for Internet [startups] and their VC backers anyway you look at it.”

I respectfully disagree; I think that a Microsoft/Yahoo merger would have practically no impact on any high-quality Silicon Valley startup.

And here’s why:

First, Yahoo has simply not been all that active in buying Silicon Valley Internet startups — nor, for that matter, has Microsoft and Google — contrary to popular perception.

Since Terry Semel’s arrival as CEO, and continuing since his departure, Yahoo has become quite conservative when it comes to buying startups.

Yahoo only bought a relative handful of companies in 2007. The big ones were Right Media and Blue Lithium in the advertising space — where Yahoo was highly motivated to make progress — and Zimbra in the email space. The small number of other acquisitions (three in the US, I believe — Mybloglog, Rivals, and Buzztracker) were tiny enough that Yahoo didn’t even have to disclose the purchase prices.

Similarly, Microsoft bought surprisingly few companies in 2007. aQuantive was the big dog, and Microsoft was similarly motivated by a high degree of urgency to get on the advertising bus. Apart from that, you’re looking at a very small number of very small deals, such as Screentronic and Jellyfish — fine companies, I am sure, but tiny deals.

And even Google, which did more deals than Microsoft and Yahoo combined in 2007, only did a coule of sizeable ones — Doubleclick (again that advertising thing), and Postini in email. And, Feedburner got a fine exit from Google given that it hadn’t raised much equity funding. But most of the other companies Google bought largely to acquire engineers, and perhaps nascent products that hadn’t yet shipped — not doubles or triples or even necessarily singles from the perspective of venture-funded Valley startups.

Microsoft, Yahoo, and Google are only buying a relatively small number of smaller companies at all today — so given that, taking Yahoo, or even Microsoft for that matter, out of the M&A races isn’t going to reduce the number of deals going down each year by very much.

Second, the spectrum of companies that are doing Internet M&A is surprisingly broad, and, drawing from lists of deals from just 2005-2007, includes names like:

  • Akamai
  • Amazon
  • American Greetings
  • AOL
  • CBS
  • Cisco
  • CNet
  • Comcast
  • Digital River
  • Disney
  • eBay
  • Expedia
  • HP
  • IAC
  • Jupiter Media
  • Liberty Media
  • Marchex
  • MercadoLibre
  • Monster
  • Motricity
  • NBC Universal
  • New York Times
  • News Corp
  • Omniture
  • Priceline
  • Publicis
  • Real
  • Sabre
  • Scripps
  • Shutterfly
  • Sony
  • Valueclick
  • Viacom
  • WPP

So the base of buyers for Internet startups is considerably more diversified than you might think.

Third, consider what’s likely to happen next.

Many of the traditional media companies — in the US and overseas — are looking at their core businesses today and seeing either rapid or imminent deterioration. This is certainly true for television, radio, music, newspapers, and magazines, and quite possibly also true for movies (given the decline in ticket sales and the recent apparent stalling out of the DVD market). And this is also true — or will be true — for a pretty broad range of various other businesses that are getting touched by the Internet.

For historical reasons — skepticism about the potential of the Internet, combined with the false hope presented to many traditional businesses by the dot com crash of 2000-2002 — many of these traditional companies are not yet appropriately positioned for an Internet-dominated future.

And now, if the Microsoft/Yahoo deal does go through, those same companies in many cases will be looking down a very scary double-barreled shotgun of an ascendant Google and an armored-up Microsoft, aimed right at their lunch, if you know what I mean.

I’m pretty confident guessing that the level of concern and even panic among many traditional companies — particularly media companies — is only going to escalate from here, as traditional non-Internet businesses in various sectors deteriorate and consumers continue moving en masse to the Internet.

And from there, it’s not hard to guess that Internet M&A is likely to heat upconsiderably over the next several years, compared to the last several years, across a very interesting and surprisingly diverse cross-section of buyers.

Fourth, new buyers appear on a regular basis.

It wasn’t that long ago that Google would not have gone on anyone’s list as a significant buyer of other companies.

In the meantime, Facebook has emerged as a company with considerable financial firepower and is already starting to do M&A.

If past is prologue, several new buyers of one form or another will pop up over the next five years, and one or two of them will probably be on the “top buyers” list in 2010 or 2012 — when you’d be selling a company you start today — even though we probably haven’t even heard their names yet.

Think also about the telecom companies, the mobile carriers, the Japanese consumer electronics companies, the Korean conglomerates, the mobile handset makers — Nokia is ramping up their Internet M&A efforts right now, European media companies… not to mention the Chinese Internet companies. Any of these could emerge as meaningful buyers of Silicon Valley Internet companies of various forms in the years ahead.

After all, in a world where Cisco is buying social networking startups, anything is possible.

Fifth, building your startup with a goal of getting acquired is foolishness anyway, in my opinion. Smart people disagree with me on this, but I’ll make my case in two points:

  • Big companies don’t want to buy startups that want to get bought. Instead, big companies buy startups that have built something of value that they decide is important to them.
  •  

  • You can’t possibly guess what things of value big companies are going to want to own in one or two or three years. The world is changing too fast — witness the Microsoft hostile bid for Yahoo itself! — and besides, big companies are Moby Dick and you can’t understand the reasoning behind their decisions anyway.
  •  

Combine those two points with the fact that no big company buys that many startups each year anyway, and it’s easy to see that the odds of you successfully anticipating something that a big company is going to want in the future and then actually selling your company to them — as your strategy — is a very risky proposition that is highly prone to failure.

And in fact, in my experience, most startups that start with the goal of getting bought, fail.

The formula for success in startups is the same today as it’s always been, and it will be the same post-Microsoft/Yahoo:

Build something of value — something that people want, and something that will be profitable at the appropriate point — and the world is yours.

Successful companies — companies that have built something of value — have many options. They can stay private and throw off dividends. They can go public. They can get acquired by big companies who suddenly decide, hey, that looks really valuable, let’s buy that. They can sell minority stakes to big investors or strategic partners at very high valuations. All options that are typically not open to the startup that started with the goal of getting bought and didn’t build something of independent value.

Or, reduced to a phrase: the best way to get bought is to not be for sale.

Because of this, even if Microsoft, Yahoo, and Google stopped doing M&A completely, the strategy of any high-quality startup in the valley would not change one bit.

Sixth, I believe that a Microsoft/Yahoo merger would actually be a net positive for many high-quality Silicon Valley Internet startups, for a completely different reason.

Again, suppose the takeover bid succeeds. You’re looking at probably a year of government approvals, followed by at least a year of integration.

You can’t speed up the first part, because that’s up to the government, and they don’t react well when you scream “hurry up!” at them. And you don’t want to speed up the second part, because integrating two companies of the scale and scope of Microsoft and Yahoo is an absolutely enormous undertaking and you want to make sure you do it right, or you’re not going to get any of the benefits.

In practice, that will be two years in which both Microsoft and Yahoo will most likely be considerably less aggressive on rolling out new products and new initiatives — because the key people at both companies will be consumed with the merger.

And, just think, if they are buying fewer companies as a consequence, that also means they’re less likely to buy one of your competitors and come after you while you are building your thing of value.

I think this merger, if it happens, will help clear the field for a whole new generation of Silicon Valley Internet startups to create and scale the next set of killer consumer services that will go mainstream and be used by hundreds of millions of people worldwide.

Where does that leave us?

The Microsoft/Yahoo deal, if it happens, means very little for the entrepreneurial climate in Silicon Valley, or the opportunities available to you and your startup.

Your job is exactly the same as before: build something people want, scale it up, make sure it’s defensible, and make sure you can make money with it.

Build a company you are proud of.

If you do those things, you’ll do just fine; if you don’t, neither Microsoft nor Yahoo nor any other big company were going to rescue you anyway.

Nobody ever said this was easy, but in a world moving this fast and this much in flux, it certainly is fun!

Inaugurating the New York Times Deathwatch

[With apologies in advance to Martin Nisenholtz, who I believe is genuinely fighting the good fight, and who will no doubt end up with a great job at some fine Internet company.]

The hiring of Bill Kristol was the last straw.

I can’t take it anymore.

I hereby inaugurate my New York Times Deathwatch, which will continue until the last Sulzberger has left the building.

Recent dispatches that are fit to print:

Leading the way [in terrible end-of-year news from the newspaper industry] was The New York Times Company, where total [quarterly] revenues fell 1.7% to $865.8 million, due mostly to a 4.1% drop in ad revenues… Advertising revenues at the news media group in particular fell 5.6%.

Source: Media Daily News.

Actually, that’s being perhaps overly fair, since it takes into account an extra week last year. The straight year over year performance was:

[F]ourth-quarter revenue totaled $865.8 million, down 7.1% from $931.5 million a year earlier. The decline included a 9.1% drop in advertising revenue and a 4% fall in circulation revenue… [T]he company had an extra week in the final quarter of 2006, which boosted the year-earlier quarter’s revenue by $50.8 million and its pretax income by $14.3 million.

Yes, we are dealing with a business where missing a single week means the difference between revenue falling 1.7% and 7.1%, and advertising revenue falling 4.1% and 9.1%. Go figure.

Source: Forbes.

Now, normally, beating up on someone like this isn’t very much fun. But we are talking about a profession that specializes in passing judgment, often snide, on everyone else. And so, onward…

Turns out that December 2007 was particularly bad, and things may be getting even worse:

Separately, the [New York Times] reported that December ad revenue dropped 25.2%. Excluding an additional week in December 2006, ad revenue declined 12% for the month.

…[W]eakness across several national [advertising] categories including health care, books, technology products and transportation hampered results in the month. Classified ads, the traditional lifeblood of newspapers, saw steep declines in help-wanted, real estate and automotive sales. [Craig, you bad bad boy…]

“To date in January, the percentage decline in advertising revenue is trending similar to that of December…” said Janet Robinson, chief executive of New York Times…

As they say, sometimes it’s darkest right before it goes pitch black.

Source: Marketwatch.

How are the company’s other papers doing?

The [New York Times-owned] Boston Globe will soon announce cutbacks at the newspaper, including hundreds of layoffs, and an increase in the per copy price of the paper to 75 cents as of Feb. 1…

The Globe saw a nearly 7 percent decrease — from 386,417 to 360,695 — in its daily circulation between Sept. 2006 and Sept. 2007, according to numbers released in November by the Audit Bureau of Circulations. That report showed the paper’s Sunday circulation down about 6.5 percent…

When you have an obsolete, inconvenient physical product that nobody wants in an era of universal online access, the appropriate strategy is clearly to raise the price.

Source: Metro Boston, which amusingly itself is 49 percent owned by the Boston Globe, which is owned by the New York Times.

How about revenue at the Globe?

At the New England Media Group, which includes the Boston Globe, ad revenue fell nearly 16%. Circulation revenue fell 7%.

Source: Marketwatch.

How about the company’s smaller newspapers?

The company’s regional-media group, including papers in medium-sized markets such as Wilmington, N.C., and Santa Rosa, Calif., saw ad revenue decline almost 17%, while circulation fell 7.4%.

Source: Marketwatch.

Meanwhile, the Times faces its second assault from a major hedge fund in the last two years:

A hedge fund manager who acquired a stake in the New York Times Company and is pushing to gain seats on its board sent a letter to the company on Sunday in which he criticised directors as “ineffective” and called for it to shed more non-core assets.

Scott Galloway, founder of Firebrand Capital, who sent the letter, has joined with another hedge fund, Harbinger, to try to put forward their own nominees for the four independent seats on the media company’s 13-member board at its meeting in April. The funds have amassed a combined 4.9 per cent stake in Times’ shares.

Source: Financial Times.

An ineffective board? What could they be talking about?

 

Hmmmmm. That’s not the direction you want to see those things go.

Well, given that the Internet is the central force dismantling the company’s business, I’m sure that by now they’ve stocked their board with noted Internet experts. Let’s see:

  • Brenda C. Barnes — CEO of Sara Lee; noted snack cake expert
  •  

  • Raul E. Cesan — former CEO of Schering-Plough; noted Levitra expert
  •  

  • Daniel H. Cohen — president of DeepSee LLC, “an oceanic exploration and submarine leasing company”; noted Jacques Cousteau expert
  •  

  • Lynn G. Dolnick — former head of exhibits for the National Zoologic Park in Washington DC; noted marsupial expert
  •  

  • Michael Golden — current publisher of the International Herald Tribune; former head of the company’s Women’s Publishing Division; noted sundress expert
  •  

  • William E. Kennard — former head of the FCC; noted “seven dirty words” expert
  •  

  • James M. Kilts — former CEO of Gillette; noted smooth, smooth shave expert; prior to that, unindicted coconspirator at Philip Morris; noted expert on your grandfather’s hacking cough
  •  

  • David E. Liddle — here I have to take a pause as I actually know this one; based on what’s happening at the company, it could be reasonably asked whether he’s actually attending the board meetings.
  •  

  • Ellen R. Marram — former CEO of Nabisco; noted Oreo expert. Oh, wait, she actually ran an Internet company: “From 1999 until 2000, Ms. Marram was president and chief executive officer of efdex Inc. (the Electronic Food & Drink Exchange), an Internet-based commodities exchange for the food and beverage industry.” Ooh. I wonder if that ended well.
  •  

  • Thomas Middelhoff — former CEO of Bertelsmann; noted expert on complicated family politics — well, that’s probably coming in handy…
  •  

  • Janet L. Robinson — current CEO of the New York Times Company; noted expert on horrific business implosions
  •  

  • Doreen A. Toben — CFO of Verizon; noted 30-year debenture expert
  •  

  • And finally, Arthur O. Sulzberger, Jr. — the Big Kahuna — the Man — the Guy In Charge — the chairman and scion — the dude with the cojones to actually defend Judy Miller. Not noted Internet expert.

So, if you want to issue bonds to pay for FCC-approved snack cake manufacturing in a submarine on display at a national park by a sundress-wearing cigarette-puffing Levitra-popping Judy Miller, you’re pretty much set.

Go team!

Now the SEC is just plain screwing with the magic

No, no, don’t dig into this, you’ll take down all of Wall Street…

Federal criminal prosecutors in New York are investigating whether UBS AG misled investors by booking inflated prices of mortgage bonds it held despite knowledge that the valuations had dropped…

The SEC, deepening its own set of investigations into whether Wall Street firms improperly mispriced mortgage securities, recently upgraded probes of UBS and Merrill Lynch & Co. into formal investigations, people familiar with the matter say. This step, which requires approval of the full commission, gives the SEC broad subpoena power, or the authority to require firms and individuals to produce information…

The investigations could raise the stakes for Wall Street in the multiple probes examining whether financial firms deliberately misvalued, or “mismarked,” massive holdings of mortgage securities. Most of the current investigations into mortgage matters involve civil authorities; the U.S. attorney launches criminal investigations and has a history of prosecuting Wall Street-related matters. Last summer, federal criminal prosecutors began investigating the collapse of two internal hedge funds at Wall Street firm Bear Stearns Cos…

To bring fraud charges, “prosecutors need proof to convince a jury beyond a reasonable doubt that the banks made materially misleading statements about securities, and proof that they did it with the intent to deceive,” says Christopher J. Clark, a New York white-collar lawyer and former assistant U.S. attorney in Manhattan in the securities and commodities fraud unit. [Now what possible motive could anyone have had to do that?]

…In its investigations, the SEC also is delving into whether Wall Street firms placed higher values on securities they own than those they placed in customer holdings…

Source: Wall Street Journal.

Department of making my brain hurt, Clinton/McCain edition

New York Times, January 25 2008:

And then [Bill Clinton] painted this scene: “[Hillary] and John McCain are very close,” he said. “They always laugh that if they wound up being the nominees of their party, it would be the most civilized election in American history and they’re afraid they’d put the voters to sleep because they like and respect each other.”

David Corn in Salon, June 25 1998:

Earlier this month, at a Republican Senate fund-raiser, McCain told a… joke…

The joke [appeared] in McCain’s hometown paper, the Arizona Republic, and the Associated Press [reported] the joke in full…

“Why is Chelsea Clinton so ugly? Because her father is Janet Reno.”

Yeah, I’m paying attention… what?

Via Mediapost, new research from market research firm BIGresearch:

Regular activities engaged in by viewers during TV commercials:

  • 41.2% channel-surf
  • 33.5% talk with others in the room or by phone
  • 30.2% mentally tune out [I’ve met them]
  • 5.5% regularly fully attend to commercials [I haven’t met them]

Rank ordering of activities engaged in by people while “using media”, in order of declining popularity:

  • Eating
  • Doing housework
  • Doing laundry
  • Cooking
  • Talking on phone

Top simultaneous media used when reading a newspaper are:

  • TV
  • Radio
  • Internet

Top simultaneous media used when listening to radio are:

  • “Engage in other activities”
  • Internet
  • Newspaper

Fun with mark-to-make-believe, Morgan Stanley edition

Here we go…

If you thought the fog surrounding the value of debt securities was starting to lift, think again.

For a reality check, we would direct you to a brief but illuminating nugget that appeared in Morgan Stanley’s year-end financial results, which it filed Tuesday with regulators. Deep in the 10-K, the securities firm disclosed that during its fourth quarter, it “reclassified” about $7 billion in assets to what is known in accounting circles as “Level 3″ status. Level 3 assets are things on a balance sheet whose value on a given day is more or less a big, fat question mark — or, to put it more scientifically, whose valuation is “based on inputs that are unknowable.”

[In turn, that means that the owner of the Level 3 assets gets to value them according to a hypothetical model that the owner gets to create. Wouldn’t you like to be able to do that when, say, filing your personal tax return?]

The fourth-quarter reclassification doesn’t necessarily [yes, “necessarily” is the key word in this sentence] mean that these assets are worth less today than they were yesterday. Morgan Stanley hasn’t taken a charge because of the accounting change.

But it does mean that Morgan Stanley felt a lot less confident than it did just three months earlier about how to put a price tag on those assets. That, in turn, could imply that the debt markets are becoming more opaque instead of less — which might reasonably raise questions about the accuracy of the recent spate of multibillion-dollar write-downs at Morgan Stanley and other Wall Street firms.

In its filing, Morgan Stanley put most of the blame for the latest reclassification on “continued market and liquidity deterioration in the mortgage markets.” [I.e. none of these things we own are trading, so we have no idea what they’re worth, or how many pennies on the dollar we will eventually be able to get for them.]

Morgan Stanley said its new Level 3 assets included commercial whole loans — which is potentially disturbing in itself, because these assets are outside the residential-mortgage market when the subprime troubles began — as well as residuals from the securitization of residential mortgages.

On the bright side, the total value of Morgan Stanley’s Level 3 assets actually declined in the period between Aug. 31 and Nov. 30, regulatory filings show. For example, its debt-related Level 3 assets were $37 billion [!!!] at the end of November, down from $43.3 billion at the end of August.

[Source: New York Times Dealbook.]

Faithful readers of this blog will recall a prior post on Level 3 assets.