I came across this blog entry in the WSJ last week (see The Credit Crunch Hits Bristol-Myers). The article details how BMY was forced to write-down $275M on an $811M investment in subprime holdings.

I’m not intentionally trying to single out Bristol-Myers. I recognize that firms need to do something with excess short-term liquidity where they anticipate some near-term need for their cash. In such cases it is better to hold onto the funds than it is to disburse them in the form of dividends. However, holding pure cash is counter-productive. Firms therefore often invest their cash in money markets, treasuries, or other “tradeable” securities.

I understand that it has been standard practice for some time among many firms to hold auction-rate securities. These holdings, like money market funds and treasuries, generally fall under the “cash and marketable securities” line items. However, this episode stands out as a poignant example of what happens when supposedly “marketable” securities suddenly are no longer marketable. I therefore wonder:

1. Was the extra return promised by these auction-rate securities worth the added risk? BMY acknowledged holding securities of this sort for the better part of a decade (see Bristol-Myers, Ciena Losses Show Subprime Infection). So, did the additional interest revenue that they captured over those 10 years (the spread between auction-rate securities and its next best alternative, like treasuries or money market funds) exceed the $275M write-down?

2. Were corporate treasurers adequately equipped to assess the risks associated with the securities they were purchasing? One of the arguments made by many economists was that the subprime-backed derivatives were opaque and difficult to accurately value. If professionals in finance who’s job it is to actually trade and value these assets had difficulty doing so, could we reasonably have expected corporate treasures to be qualified to do so?

3. If a large pharma firm such as BMY holds securities such as these, that begs the question – what other firms are holding such securities, and does this simply represent the first of many such announcements? We’ve heard about the bank write-downs. We’ve heard about the hedge funds. We’ve heard about the monoline insurers and counter-party risk. But now this??

And finally, with respect to corporate strategy…

4. How will this impact the operations of firms moving forward? With fewer discretionary resources at their disposal, it certainly hinders their ability to pursue their strategies (see Strategy in a Recessionary Environment). And I have to admit, although I readily expected business conditions to deteriorate as a result of tightening credit on the supply side and a struggling consumer on the demand side, I was not quite anticipating this spillover mechanism. If this effect is more the norm than the exception, I anticipate the outlook for corporate performance to be even bleaker than I had suggested in previous posts (see The Future of Corporate Performance).

Again, I do not mean to single out Bristol-Myers. Their only fault is that they just happened to be among the first firms to acknowledge the problem, thereby drawing attention. Come to think of it, maybe we should actually be applauding BMY for being proactive in recognizing the problem and writing-down those assets as quickly as possible in an effort to move past it. As such, they are likely ahead of the curve. Should that be the case, we certainly shouldn’t be surprised to see others follow in their wake (in fact, see Bristol-Myers, Ciena Losses Show Subprime Infection for corroborating evidence).

This entry was posted on Monday, February 4th, 2008 at 11:27 pm and is filed under Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.