In a previous post, I discussed some of the virtues of globalization and the dangers of what I saw as increasing protectionism in the United States (see here).

A colleague of mine called my attention to a more recent article in Foreign Affairs on the topic (see A New Deal for Globalization). The article is authored by Kenneth Scheve (a political scientist from Yale) and Matthew Slaughter (an economist from Dartmouth). I do not know Kenneth personally, but I have met Matthew on several occasions and I am familiar with his work. In my opinion, Matt has done some excellent work at the interface of international business and international economics.

But that is neither here nor there. The issue at hand is their article. I quite liked the piece, and our opinions converge on many issues. Kenneth and Matthew likewise raise concerns about increasing protectionist sentiment in the U.S., and they agree that policymakers must address those issues.

I suggested that a well-implemented trade adjustment assistance (TAA) program might go a long way in addressing those challenges. I think they agree that TAA programs help, but they believe that TAA programs alone are not the solution. Practically, they argue, it would take too long to retrain displaced workers. That makes sense. As an alternative, they raise a novel solution - countering protectionist sentiment through changes in tax policy.

They write:

Given that globalization delivers tremendous benefits to the U.S. economy as a whole, the rise in protectionism brings many economic dangers. To avert them, U.S. policymakers must recognize and then address the fundamental cause of opposition to freer trade and investment. They must also recognize that the two most commonly proposed responses — more investment in education and more trade adjustment assistance for dislocated workers — are nowhere near adequate. Significant payoffs from educational investment will take decades to be realized, and trade adjustment assistance is too small and too narrowly targeted on specific industries to have much effect.

The best way to avert the rise in protectionism is by instituting a New Deal for globalization — one that links engagement with the world economy to a substantial redistribution of income. In the United States, that would mean adopting a fundamentally more progressive federal tax system. The notion of more aggressively redistributing income may sound radical, but ensuring that most American workers are benefiting is the best way of saving globalization from a protectionist backlash.

The economic gains from globalization are immense. In the United States, according to estimates from the Peter G. Peterson Institute for International Economics and others, trade and investment liberalization over the past decades has added between $500 billion and $1 trillion in annual income — between $1,650 and $3,300 a year for every American. A Doha agreement on global free trade in goods and services would generate, according to similar studies, $500 billion a year in additional income in the United States.

International trade and investment have spurred productivity growth, the foundation of rising average living standards. Gains from globalization have been similarly large in the rest of the world…lifting hundreds of millions of people out of poverty.

I absolutely agree.

They go on to argue that while the gains of globalization to the U.S. have been great, they view those gains as having been unevenly distributed. Specifically, they contend that globalization has resulted in a widening gap between rich and poor because poorer, low-skilled workers are at greater risk of having their jobs outsourced to low cost countries, resulting in decreased real wages for low-skilled workers compared to high-skilled workers (where real wages have been increasing).

They claim that the reason sentiment is becoming more protectionist is because:

Individuals are asking themselves, “Is globalization good for me?” and, in a growing number of cases, arriving at the conclusion that it is not.

I agree that more people now believe that globalization is not good for them. However, I have one minor quibble with their argument in this respect. Although it may be true that people believe that globalization is not good for them, it may not be the case that it is actually bad for them. The authors argue:

If workers in a sector such as automobile manufacturing lose their jobs, they compete for new positions across sectors — and thereby put pressure on pay in the entire economy.

While it is true that if workers lose their jobs in one sector they may have to look for jobs in others, it is not necessarily true that they put pressure on the pay of the entire economy as a result. This is true in a static world where the number of jobs and opportunities in the world are fixed; however, one job lost in the automobile industry might result in one ADDITIONAL job created in the robotics industry - a higher margin, higher value-added industry. In this scenario, if labor coming into an industry leads to greater innovation and greater future growth for that industry, it’s not necessarily clear that salaries will go down for all.

I raise a similar objection to those who argue that outsourcing jobs to developing countries necessarily leads to bad outcomes for those displaced workers. Generally, I believe that we tend to outsource low value-added activities. If we outsource low value-added activities to other countries, this may allow us the flexibility to re-deploy existing resources (people) to alternative, high growth, high value-added activities.

In Kenneth and Matthew’s defense however, they recognize that:

Economists do not yet understand exactly what has caused this skewed pattern of income growth and to what extent globalization itself is implicated, nor do they know how long it will persist.

In my opinion, determining this is the key!!

Nevertheless, they do offer one novel alternative solution to protectionism through tax policy. They offer:

…policymakers should remember that workers do not pay only income taxes; they also pay the FICA (Federal Insurance Contributions Act) payroll tax for social insurance. This tax offers the best way to redistribute income…A New Deal for globalization would combine further trade and investment liberalization with eliminating the full payroll tax for all workers earning below the national median…67 million workers would receive a tax cut of about $3,800 each.

At the end of the analysis, I think this is an interesting proposal, provided that it is a complement to (and not a substitute for) TAA and retraining programs. By the authors’ estimates, the total program would cost around $256 Billion per year to implement. But then again, with the potential gains from Doha alone around $500 Billion per year, it might just be worth a try.

I’ve simplified their arguments for the purposes of this blog, but for those of you interested, I would encourage you to read the entire piece.

Several months ago (in April to be precise) I blogged about what I saw as the profligate investment ways of private equity firms - acquiring everything in sight at eye-popping multiples (see here and here and here for background). At the time, I argued that as credit contracted due to the repricing of risk, default rates would rise and result in an increase in the rate of business failure. I saw private equity acquisitions as especially vulnerable given that they were “overpaying” for targets and burdening the individual businesses in their portfolios with massive amounts of debt.

Well, it looks like some of these problems are finally coming to roost.

In an interesting article published today in the Wall Street Journal online (see Chrysler Loan Sale Likely Postponed, hat tip CalculatedRisk), Dana Cimilluca discusses some of the difficulties that Cerberus has been having selling Chrysler’s debt.

What does this article have to do with the more general, systematic collapse of recent private equity acquisitions?

Although the article is focused on one specific case (Cerberus and Chrysler), the last paragraph summarizes the process by which deals of this type go bad and some of the larger problems endemic to private equity purchases over the last few years. The article states:

Chrysler’s woes are the latest setback for Cerberus, which went on a buying binge early in the year when the credit markets were booming. Now it faces a rough road at Chrysler and the GMAC auto-finance business it bought from General Motors last year, not to mention its effort to walk away from its pending buyout of United Rentals.

First, the article aptly describes actions of private equity players as “binge buying”, indicative of a bubble. Second, the article discusses effects that are consistent with the backside of such a binge/bubble - credit dries up leaving credit commitments unfunded forcing private equity buyers to look for a way to back out of the deal (as with United Rentals) or causing temporary bridge financing to convert long-term pier financing (as with Chysler). Finally, the article discusses what happens on the backside of a deal gone bad - the “rough road” that Cerberus faces after an ill-advised purchase (as with Rescap, which faces insolvency).

I would expect to see more of these kinds of effects over the next year or so as more and more private equity deals start to go bad. At the beginning of this cycle we will generally hear (as we have) about firms trying to back out of their deals. Toward the end of the cycle, we will hear more about default, insolvency, and eventually, bankruptcy.

The market for private equity activity (and M&A activity in general) is clearly on the decline. Let’s hope that the damage isn’t too great, but at the very least, it’s clear that it will be tough going for the next year or more…

I trust many of you have seen the news from a few weeks back about SAB and Molson Coors’s joint venture - Miller Coors (for background see here and here).

I’ve been meaning to write about this deal for some time. When I first saw it, the structure of the transaction struck me as somewhat odd. Unfortunately, I got carried away doing some other things. Hope it isn’t too late to add my two cents (for the half-a-penny or so that they’re worth).

First, the fact that SAB was exploring strategic options for its Miller arm to begin with looks like an explicit admission of defeat. SAB never seemed able to extract value from Miller and was not able to make inroads in the U.S. in its battle against Anheuser-Busch. That Miller’s performance was not stellar under SAB’s ownership should not have been entirely surprising. It’s very difficult for firms to acquire and successfully run foreign businesses, and SAB was no exception. OK, that’s fine, the deal didn’t work out for SAB, so maybe consider selling it. That, to a certain extent, explains SAB’s motivation for wanting to divorce itself from Miller.

From Molson Coors’s perspective, I can see an interest in combining operations with Miller. Molson Coors is a distant third in the U.S. beer market - a market that is mature, and growing at an increasingly slow rate. Teaming up with the second largest American brand just makes sense. It allows the combined entity to enjoy greater pricing power, exploit operational and distributional synergies, and create a more formidable competitor vis-a-vis Anheuser-Busch.

For these reasons, this union didn’t shock me at all. Quite frankly, it even makes some strategic sense.

What did shock me, however, was how the deal was structured. As a joint venture???

In my opinion, this should have been an acquisition. Molson Coors should have acquired Miller, or alternatively, Miller should have been spun-off from SAB and then acquired Molson Coors. That the new entity (Miller Coors) was structured as 50/50 joint venture between the two parent firms (Molson Coors and SAB) didn’t make much sense to me.

Technically, Miller Coors is not a 50/50 joint venture. With respect to capitalization, it’s actually a 42/58 joint venture. SAB retains 58% of the rights to the residuals while Molson Coors’s contribution entitles it to 42% of the residuals. That said however, Molson Coors was able to command 50% of the decision-making power, effectively making it a 50/50 joint venture with respect to control and decision rights. Guess who’s management (in the form of intangible contribution to the deal) was more highly valued? Rhetorical question!

In my opinion, a joint venture between SAB and Molson Coors in which each shares equally in the decision rights will run into many conflicts, not unlike an acquisition that is billed as a "merger of equals" (see here for a description of problems associated with these types of mergers). Sharing power across firms in a joint venture can lead to conflicts over the appropriate way to go about running the new business, can result in delays in achieving synergies, can lead to greater staff defections, and can result in greater than necessary managerial costs. All this ultimately stands to hurt the performance of the new venture, and these kinds of deals can quickly devolve into an ugly power struggle between senior managers from two companies that don’t understand each other’s culture.

Because the potential for synergies, the opportunity for pricing power, and the ability to create a more formidable competitor vis-a-vis Anheuser-Busch are all so great between Miller and Coors, centralized ownership (with one firm and one set of managers calling the shots) would be a more effective way to achieve those benefits. I therefore have this uneasy feeling that "management problems" will plague this joint venture in the months and years to come.

But I’m still trying to figure out why this deal was ultimately structured as a JV and not an outright acquisition of one party by the other (e.g., Moslon Coors buys Miller from SAB, or SAB spins of Miller and later acquires Molson Coors). I’ve come up with several potential explanations. It could be a simple resource constraint story. That is, Molson Coors may have wanted to buy Miller, but either they did not have the money to do it (their balance sheet wasn’t strong enough) or liquidity has dried up in the market such that they couldn’t get the financing to underwrite it (as a result of the credit crunch). As an alternative, SAB could have acted as the bank, I guess, and provided Molson Coors the financing to get the deal done, but maybe they were unwilling to accept that risk. As for Miller buying Molson Coors, my guess is that a solution of that sort would have been unpalatable to the Coors family (which still controls a large portion of the voting rights of Molson Coors).

Anyhow, it’s too bad we won’t get to witness it (unless future plans are in the offing for Molson Coors to acquire Miller), because I think Miller and Coors could have made for a really interesting combination as an acquisition…

I trust everyone had a nice Halloween! Apparently the markets were a little spooked today, …must have been those scary costumes (I can swear I saw a few Ben Bernankes wandering the streets of New York last night).

In other news, several months ago I blogged about IHOP’s acquisition of Applebee’s (see here). If I remember correctly, I was relatively upbeat about the whole ordeal. I thought that Julia Stewart (IHOP’s CEO) would be in a privileged position when it comes to righting Applebee’s strategy given her prior experience as an executive at Applebee’s. Moreover, I felt that her experience at Applebee’s would help the integration go more smoothly. Given the market’s reaction on the day of the announcement, it seemed to agree.

So I found it interesting that the WSJ published an article today detailing the difficulty that IHOP will likely face in righting Applebee’s (see IHOP’s Tall Order: Reviving Applebee’s, hat tip Sandra Chang). The journal writes:

Now that shareholders have approved IHOP Corp.’s approximately $2.1 billion purchase of Applebee’s International Inc., the pancake chain has to overcome skepticism as to whether it can pull off a turnaround of the nation’s largest sit-down restaurant chain.

…reviving Applebee’s will be a more difficult task given the size of the chain and the depth of its problems. Applebee’s said same-store sales at company-owned locations have fallen 1.1% so far in October. CIBC World Markets analyst John Glass said that Applebee’s profit margins at the restaurant level during the third quarter were the worst in the company’s history, calling it a “fundamental meltdown.”

It’s quite possible Applebee’s is too sick for anyone to cure. My point simply is that if anyone has a chance to turn Applebee’s around, I think Julia Stewart is in the best possible position. Moreover, given the recent broad-based downturn in consumption in the U.S. economy, Applebee’s performance doesn’t strike me as out of the ordinary. For these reasons I remain cautiously optimistic about the deal. We shall see…