47000 Hourly workers leave GM

June 27, 2006

Today, GM announced that over 47,000 of the 137,000 hourly workers at GM and Delphi have opted to take the buyout offered by the company. That’s about a third of the hourly workforce.

A few (under 5000) took a large cash payment (between $70K and $140K) and gave up their perpetual health coverage [perhaps they’re covered by a spouse’s plan]. The majority took the smaller payouts [upto $35K] but retained GM health benefits.

Evidently, this plan does not solve one GM problem: a huge healthcare liability stretching into the future. However, it does solve another important problem: too many workers, that the company could not fire because of the stupid contract they negotiated. (Many workers were staying home because the company did not need them, but were still being paid upto 90% of their wages!) Some analysts are now saying that too many workers left — and GM will have to hire temps, at higher costs. Instead, I think GM should “embrace their loss of market share”, by trimming low-margin products in the US.

GM has already done a lot to cut non-labor costs.

On its own, cutting costs cannot save a business. GM has to look to the revenue side of the P&L. That part of their move started in 2001, with the hiring of Bob Lutz. Recently, that has started to show results, with quite a few new models hitting the lots.

As a (itsy-bitsy) shareholder, I mostly like the way GM is attacking their problems (not everything about it). The change is not going to be easy, and there are many things that can bring it down. The two most important things for GM now are: to negotiate a good union contract in 2007; and, to continue to bring out interesting vehicles at ever lower prices.

Meanwhile, the story at Ford does not appear quite so full of possibilities. GM is in bad shape, but at least it is trying to do something meaningful about it. If it fails, it won’t be for lack of one last valiant effort. On the other hand, Bill Ford is telling people to cut the bureaucracy… all well and good, but hardly turnaround stuff. Recently they also have been hyping “work at Ford, buy a Ford”, which is truly an ominous sign. I wonder if Bill Ford Jr. will be the one to finally send the family firm into bankruptcy. Indeed, if Toyota buys Ford in a fire-sale (post-bankruptcy, with union contracts voided) SE Michigan may see an end to years of lagging the country economically. [I wonder of Toyota will keep Bill’s roof!]  [Update: Sept 5th. Bill Ford has stepped down as CEO of Ford.]


P to P lending

June 27, 2006

An interesting new internet business is “Peer-to-Peer Micro-Lending” where borrowers can get personal loans (i.e. without offering collateral) and lenders can bid to lend them the money. E.g. Prosper.Com,

Example:

  1. A borrower wants a $2,000 loan. He states a maximum interest rate that he’ll pay (say 15%).
  2. “Lender A” might offer to lend $200 at that rate, “Lender B” may offer to lend $100, and so on.
  3. If the borrower stated a low rate, he’ll find that lenders aren’t willing to lend. On the other hand, if the requested amount (e.g. $2,000) is reached, other lenders may still come in and out-bid. So, a lender may come in an offer to lend $200 @ 14%.

The borrowers participate because they’re getting terms that banks etc. will not give them. It definitely makes sense from their perspective, particularly at the riskier end of the spectrum.

Lenders participate because they expect a better return than they can get on other investments. Why would anyone want to lend money to strangers who are unable to raise money elsewhere? The reasoning is along the lines of Milken’s junk-bonds pitch: while the average default rate is higher, the average interest rate more than compensates; and, if you spread your loans — giving a few $100’s to each of several borrowers — you are only taking on an average credit risk for that group of borrowers, rather than the risk in trusting a single borrower.

The folk at Prosper.com publish average industry default rates for various risk categories (each category is a range of credit-score). Every borrowers risk-category is made public to potential lenders. If a loan goes into default, Prosper will send it to collections. From what I can tell, the site charges 1% to service the loan. So, the math works something like this: the last 3 “D-rated” borrowers are paying about 19%. Prosper’s stats say that the average default rate in this group is about 6%. Prosper keeps 1%. So, the net expected interest to the lender is 12% [=19% – 6% – 1%].

The big assumption is that the default rates will be near the Prosper estimate. There are good reasons they need not be so. The published default rates are averages. A credit score is a good predictor of average default rate, only in the context of a particular lender’s recovery procedures. Some credit card companies are better at keeping defaults down (within the same credit-score band) than others. Will Proper be about average in it’s attempts to collect from defaulters?

Too risky for my blood!

(Update Feb 2, 2007: One thing I wonder about is the default rates that Proper.com lists. Presumably, they’re showing average default rates from the general population.  Are these default rates annual rates, or rates over the lifetime of a loan? I’ve never thought about it before, but recent news-articles speak of 20% foreclosure rate among the lowest-quality mortgages. I assume people will default faster on their credit-cards and on Prosper loans than on their home, so I’d assume that the highest default rates should be over 30% if one considers a long enough period: say 5 years.)


C

June 26, 2006

C is around $49 and paying $2 as dividend.
The Jan 2008 $45 calls are around $7.40
So, best-case scenario (if one buys the stock and sells a covered call, and if the stock stays or goes up), would be:

Outflow: ($48.55 – $7.30=) $ 41.25 [This is after deducting commissions]
Inflows: Dividends (June 2006 through Jan 2008=) $ 3.00
Final Inflow (Jan 2008 option assignment=) $45
Profit ($45 + $3 – $41.25=) $ 6.75
That’s about 16% on the original outflow

Obviously, downside risk if it goes below $45.

$41.50 + 5% = $43.30 … So, as long as C does not drop another $6 (11%) from it’s current position, I should make 5%.

If it goes back to the $40 level, I should consider repeating a scaled down version of the above — as long as dividends appear safe.

(Updated– July 23rd): I should add that I prefer Chase to Citi, but already own Chase. Also, I expect Chase to be more than a place to “park” money for a few years.

(Updated– Oct 10, ’06): C is $50.80 and the $45-call is $7.80 [net holding = $43] . So, my capital gains are about $3.50 per share if I cash out today. The dividend for the last 5 months adds a little over $.50 to that.
Next question is, should I continue to hold it? Since the combination is now worth $43 (as opposed to $41.25), the remaining dividend @$2 and the $2 increment from $43 (current value) to $45 (call strike) comes to a sum of $4, which a year works out to 9.3%, which isn’t as good as the original, but still good enough to keep me holding the stock.


Businessman Interview: Infosys CEO

June 16, 2006

Interesting interview with the CEO of Infosys.

…when we sat down in the bedroom of my apartment in 1981, we discussed
for four hours what our objective should be. Should it be revenues, profits,
market capitalization?

No, we said it should be none of
those. We will seek respect from every one of the stakeholders. My view was if
we sought respect we’d automatically do the right thing by each of them. We’d
satisfy our customers, be fair to our employees, and follow the finest
principles with respect to investors, we would not violate laws, and, finally,
we’d make a difference to society. And then I said automatically you’ll get
revenues and profits and all that.


Modern Investment Theory

June 2, 2006

While this is about the epistemological foundations of Investment Theory, I think it might be of wider interest…

Most students of “Modern Investment theory” (as taught in most business schools) come away with the idea that above-average returns [known as “positive alpha“] are not possible to any investor (or, at very least, are not possible to most).

This is not about students being told that knowledge of investing is still in its infancy; that’s not the point. Rather, they’re taught that in principle, regardless of such knowledge, it is impossible to make above-average investment decisions. Indeed, if anything, further improvements in knowledge actually reduce the chances of making above-average decisions. In effect, the knowledge is futile in this particular field.

This post is not a critique of modern theory. Instead, I want to make the positive case for modern theory, to explain its plausibility. I also invite comment on the accuracy with which I portray it — for I do not intend to build a strawman. At this point, I am not interested in explanations about what’s wrong with the theory. I want to understand it before launching into criticism.

Context-setting: The context here is the buying and selling of tradable financial instruments, in a non-managerial fashion. Things like starting one’s own business or owning art-work include other factors and are outside the scope of this discussion.

The “modern” position: The futility of making investment decisions is simple to explain with an example. Suppose there are two companies: A and B. For the sake of argument, suppose that Investment Science has reached a stage where we can make excellent estimates about how the shares of each company are going to perform.Can we then use this knowledge and buy shares in the better company (say, Company-A)? I submit that we cannot. This is because enough investors would have gone to college and learnt the same Investment Science. They too will know that Company-A is better and will have reached similar conclusions as to the relative worth of the shares of these two companies.

In this situation, the prices of the shares of these companies will reflect the underlying estimates of their worth. So, if the shares of A are estimated to be worth twice the shares of B, then the price will reflect this. Therefore, with a given amount of cash, one would be able to buy a certain number of shares of A, or twice the number of shares of B.

Paradoxically, a person who knows nothing about investment theory could do just as well as the experts because the price at which the shares sell are always fairly close to the best-estimated value as calculated by the experts of Wall Street.

A common metaphor is that a “monkey throwing darts” at the stock-listing page of the Wall Street Journal can come up with a portfolio that will do “just average”. Even if experts are a little better than average, we are told, one has to pay them for their services. Doing so, brings the net result back to average. We’re also told that most Wall-Street funds do worse than average after one deducts the commissions of the experts. This has led to the advocacy of index funds. Importantly, while modern theory might lead one to index-funds, rejecting modern-theory does not mean that one must reject index-funds.

At this point, my questions are as follow:

  • Have I represented the modern position correctly?
  • Is there a better pro-Modern position to be made?

Buffett cites Passion as top requirement for CEO job

June 1, 2006

Warren Buffett, of Berkshire Hathaway is eminently quotable. Janet Lowe even has a small book full of quotes from Buffett. His business partner, Charles Munger, is very perceptive too. Here are some snippets from this year’s annual meeting.

Buffett, speaking of investors with short time-horizons: “The only way you can leave your seat in burning financial markets is to find someone else to take your seat, and that is not always easy….”

And Charles Munger’s comment on short-term thinking is witty: “If you jump out the window at the 42nd floor and you’re still doing fine as you pass the 27th floor, that doesn’t mean you don’t have a serious problem.”

When asked what he looks for when choosing a CEO to run one of his companies, Buffett said that the first thing he looks for is passion for the job. This is followed by: intelligence, energy, and integrity. Then, with characteristic wit, he added: “If you’re dealing with someone who doesn’t have integrity, you’d better hope he’s dumb and lazy, too,…”