UPDATE: The Wall Street Journal published the third part of a three-part series on Bear’s collapse today. In the aggregate, the three parts made for a fascinating account of the events. I cannot recommend them more highly. In the third part, the authors discussed some of the events leading up to JP Morgan’s agreement to raise the final price for Bear from $2 to nearly $10 (see Bear Stearns Neared Collapse Twice).

According to WSJ’s account, the reason JP Morgan agreed to raise it’s price was that

The hurried deal had a loophole that could give angry Bear Stearns investors powerful leverage to seek a higher price: J.P. Morgan had pledged to finance Bear Stearns’s trades for a year — even if shareholders rejected the deal.

Their explanation seems to suggest that their was a legal clause in the contract that made JP Morgan liable for Bear’s trades in the event that the deal did not go through. That would fall under the “bad lawyering on the part of JP Morgan” explanation.

While that may be partially true, I still believe that JP Morgan’s exposure to Bear as its counterparty on a variety of trades had a little something to do with it too (read on for my take).

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I do not know how many of you have continued to follow this story, but Bear Stearns shareholders are set to meet tomorrow to consider, and vote on, the proposed acquisition of Bear by JP Morgan. I was recently interviewed on the subject by German Public Radio. They asked my opinion of the acquisition and the likely outcome of the shareholder meeting. The interview is scheduled to air sometime tomorrow (I will provide an update if a link or a transcript becomes available).

Most of you are likely aware of my opinion of the deal. At the time, I actually saw the transaction as a bailout of JP Morgan more so than a bailout of Bear Stearns (see original post). Although some thought my ideas outrageous at the time, Nouriel Roubini recently expressed similar sentiment, as did Christopher Alleva in a recent post on the blog American Thinker (see Ex-Treasury Department Economist Says Bear Bailout was for JP Morgan).

But I digress. Back to the topic at hand.

The interview began innocuously enough. I was first asked how I thought Bear shareholders should vote. To me, this was a no-brainer. I unambiguously believe that Bear shareholders ought to approve the deal. What’s the alternative - bankruptcy and a share price of $0? At this point no other suitors are likely to emerge, the Fed is unlikely to provide as sweet a deal to any other interested party, and it is unlikely that Bear Stearns could ever restore the Street’s faith in it if it were to try to continue as an independent entity. So I say, just get it over with and accept the terms of the deal. 

We then began to discuss winners and losers in the deal. I thought that quite clearly, JP Morgan came out the winner. They were able to acquire some pretty valuable assets on the cheap, and with the Fed agreeing to absorb up to $29 Billion in losses. Not too shabby a deal if you can find one like it. For me, the losers are the employees of Bear Stearns (the ones who did not have a hand in creating their mess - and my sense is that there were many). These are smart and talented folks who find themselves either out of work, or in limbo, but whichever the case, certainly worse off.

Finally, we touched upon the specifics of the deal itself. The interviewer asked me why JP Morgan raised it’s bid from $2 to $10 per share. My response (and supportive of the sentiment that I expressed in my initial post) was that they likely felt compelled to raise their bid. If, as I argued, JP Morgan had a lot to lose if Bear went bankrupt (in the form of assets that JP Morgan would have been forced to take back onto its own books), JP Morgan had to capitulate and pay up. As long as the potential losses from the troubled assets that JP Morgan would have been forced to take back onto its books were greater than the additional cash that JP Morgan would have to pay, it made sense for them.

Think about it, if JP Morgan had little or no exposure to Bear, why would it have budged? JP Morgan could have easily responded by saying, “$2 is our final offer, and if Bear shareholders don’t like it, too bad, Bear can go bankrupt.” Why did JP Morgan add $8 per share (several billion dollars more) to a deal where without it, the target (Bear) was sure to fail? I’m not sure I can come up with any other explanation than, they had to.

So now that I’ve had the time to decompress and think carefully about my experience at the 2nd Sumantra Ghoshal Conference on Managerially Relevant Research (see Off to London for background), I’m more convinced that my time was well spent.

It was nice to be part of a conference with the explicit intention of bringing academics and practitioners together to discuss research papers, and the role of academic research in the everyday lives of managers. The conference was attended by academics from various of the top business schools in both Europe and the U.S. Moreover, there was ample managerial representation from firms such as Accenture, Hoffman-LaRoche, McKinsey, Saatchi & Saatchi, RBC, and the Financial Times (to name a few).

Some highlights from the conference included:

• The organizers of the conference administered a survey before the conference began and presented some interesting data on the most important issues managers and scholars believe are facing businesses moving forward (credit concerns aside). What I found most interesting is that managers generally agreed about the most critical issues facing their businesses. They identified the following strategic issues as crucial: How to attract and retain talent; How to build and leverage knowledge; How to Identify the next area of growth for the corporation; How to align the organization toward common goals; and, How to draw up an appropriate mission statement. The academics, by contrast, were all over the map. We didn’t agree on much of anything. About the most you could take away from the data for the academics is that all of us in attendance have very different research interests. Some of us thought that “Building and leveraging knowledge” was important, some thought that “Identifying the next area of growth for the corporation” was important, some thought that “governance” was important. But for the most part, there was little agreement among us.
• There was general agreement among most of us that academics influence practice in a multitude of ways, and that influencing practice is not always about getting our research directly in front of the eyeballs of managers. In fact, if anything, this is probably a small part of how we influence managers. We obviously have the greatest impact through our teaching, at the undergraduate, MBA, and executive levels. We also influence managers through consultants (who borrow and implement our ideas), and on occasion, by consulting directly with firms. Scholars also influence practice through our impact on policy - by proffering informed opinions to politicians or testifying on business practice. In this sense then, we help shape the game and inform the agenda - helping decide which issues are important and which are not.
• One of the McKinsey representatives suggested that she (and other management consultants) routinely scan and read academic research to extract the latest ideas, concepts, and tools to apply on client engagements. Interestingly, one research paper presented at the conference suggested that those ideas, concepts, and tools are often applied inappropriately, and sometimes without effect. However, the research also suggested that although sometimes applied incorrectly, they get people within the organization to openly communicate about strategic issues, thereby generating some value, if not exactly that originally intended.
• With respect to our research, there was considerable debate on the type of research we ought to be doing - whether research that directly addresses specific management problems, or research that we ourselves consider important, irrespective of whether it’s managerial relevance is immediately obvious. One view expressed (with which I must say I agree) was that we must not lose site of the fact that as business school faculty, we are a part of an applied, vocational program with a mandate to train business leaders. We therefore cannot lose sight of, or become completely detached from, our audience when conducting our own research, for taken to an extreme, research that is disconnected with the interests of our constituents will ultimately repay us with lower enrollments.

All in all, I got a lot out of the conference. It was fun to spend a few days interacting with a bunch of really smart folks (both academics and managers) discussing some really interesting issues.

The 2nd Sumantra Ghoshal Conference on Managerially Relevant Research officially wrapped-up last night. A very worthwhile endeavor again this year! I’ll provide more detail in a follow-up post later in the week, but I just wanted to pass along what I thought was the best quote of the conference. Mark Spelman, the head of Global Strategy at Accenture, had the following nugget of insight to pass along:

The most problematic relationship for the Chief Strategist is the one with the CFO

What a great line. It makes complete sense to me. According to Spelman, the strategist often does not have control, or decision-making authority, over the deployment of any actual resources. Rather, it’s the CFO that holds the purse strings. In this sense then, the Chief Strategist can only influence decisions. So the best strategists are not only keen, intelligent types, but those who can make an influential case that leads others in the organization to take actions consistent with his or her recommendations.

…some food for thought.

More to come as soon as I’ve finished collecting my thoughts.

I will be heading to London tomorrow to attend the 2nd Sumantra Ghoshal Conference on Managerially Relevant Research at the London Business School (LBS). I’m really looking forward to attending again this year. Last year’s conference was interesting, …and London is always fun (the painful £1:$2 exchange rate notwithstanding).

But back to the conference. The purpose of the conference is to address one salient issue facing business schools today - specifically, the relevance of research produced by business scholars. The central question of interest is, “Does our research matter to practice?” (see On Managerial Relevance for my insights from last year’s conference). I will report back again this year.

In addition to any insights I may glean from the conference, I also plan to write next week about private equity, and how the folks from that industry have been passing their idle time in the absence of any meaningful dealmaking activity. Until then…

It’s not about what’s happening in Vegas that makes things exciting right now. Rather, it’s what’s not happening in Vegas that makes things interesting. I came across the following from last week’s issue of Newsweek (see Recession Hits Las Vegas):

Las Vegas…was once thought to be impervious to the economic swings suffered by the rest of the country. Not anymore. According to the Las Vegas Convention and Visitors Authority (LVCVA), Las Vegas has seen gambling revenues fall only once since 1970: in the aftermath of the Sept. 11 terror attacks they dropped 1 percent in 2002 from 2001. So far this year they’ve fallen 4 percent, the number of conventions held has dropped 10.4 percent, and average daily room rates were off 3.8 percent in the first two months of 2008, according to the most recent data available.

Several major construction projects on the Strip are delayed due to financing problems, including a second tower for Donald Trump’s new condo-hotel. Also delayed is a plan to build a $6 billion version of New York City’s famed Plaza Hotel. And while construction continues on the half-built $3 billion Cosmopolitan Resort and Casino next to the Bellagio, the project may be in jeopardy after developer Bruce Eichner’s company defaulted on a $760 million loan from Deutsche Bank.

As if that weren’t enough, there’s also a gambling-related bankruptcy to report this week. Tropicana Entertainment, the operator of numerous casino properties, filed for Chapter 11 bankruptcy protection (see Tropicana Casinos Files for Bankruptcy). We can now safely add Tropicana Entertainment to the list of prominent bankruptcies so far this year (see More Failure for Fodder).

And it’s not limited to Vegas, or even gambling. Other portions of the sin sector are slumping as well. From last month’s Variety (see Hard Times Ahead as Porn Goes Soft, via Big Picture):

Economists are citing some dire portents of a recession these days, but they’ve missed one indicator I find especially disturbing: The porn business has suddenly gone flaccid.

The drop in porn rentals and sales is worrisome on several fronts: Till now, porn has been a recession-proof business. Further, with the country already in a dispirited mood, the fact that porn has gone limp may indicate a true plunge in consumer confidence.

DVD porn is down between 10% and 30%…

Bottom line: When the sin industry struggles, …look out below!

I don’t know how many of you caught the news last week about the acquisition of Wrigley by Mars (see A Sugary Mouthful for background). It was a pretty high profile deal, so I trust many of you have heard something about it. After all, it has garnered its fair share of attention in the popular press - having been analyzed in various ways by various people.

Most observers (at least in the opinions that I’ve read) seem to believe that the combination of Mars and Wrigley is a good one. The two are complementary on many dimensions - product, distribution, marketing, and manufacturing. On this I do not disagree. I therefore see the strategic logic for their combination, and there are certainly opportunities for synergies.

There are two potential problem areas that remain. First, did Mars overpay for Wrigley? Unfortunately, because Mars is a private company, I was not able to observe the stock market’s reaction to its bid. In the absence of that, I cannot make a meaningfully informed judgment. However, I will say that the 28% premium didn’t strike me as outlandish, although it might prove a little pricey (at 4 times sales) for a company Wrigley. Second, will Mars’ intentions to keep Wrigley’s headquarters in Chicago (and make Chicago the headquarters for all non-chocolate products) limit managerial synergies and keep the cost structure of the combined entity higher than it ought to be? After all, why not consolidate management in either McLean or Chicago?

Taking all that into account however, I still tend to side with those who believe this is a good, sound deal.

But that’s not why I’m writing this post. The real reason I decided to write this post is because of its non-traditional mode of financing - with Warren Buffett kicking in $4.4B. Far fewer have written about Buffett’s role in this deal, and I was hoping to shed a little light on that aspect of the story.

My sense on Buffett’s participation is that in different (non credit crunchy) times, this deal would probably have been financed via the standard routes - using an I-Banking firm as an underwriter that would have provided the bridge financing to complete the deal until the debt could be sold. However, my guess is that given the difficulties that the banking industry has been experiencing, either the I-Banks did not have the cash available to underwrite the deal, or were unwilling to do so with reasonable terms. Enter Buffett.

Now I’m not sure how or why this deal ended up on Buffett’s desk, but replete with cash when lots of others find themselves liquidity-constrained, Buffett was likely more than happy to take advantage of a relatively attractive opportunity. To me then, it looks like Buffett’s play is a pure arbitrage play - looking to arb the difference between the price at which the banks were willing to offer financing and the fair price of that capital given the risk inherent in the purchase of Wrigely.

This could be win-win for all parties involved. Buffett gets an attractive return for financing of the deal. Mars gets Wrigley on better terms than it would have (or not at all) had it been been forced to rely on the banks for financing, and the Wrigley family and its shareholders get cash. The only quibble could be that had the banks had healthier balance sheets, Mars might have been able to get financing on slightly better terms from a bank instead of Buffett.

But all this goes to show that it’s still a buyer’s market out there for some, …those with CASH.

For some time I’ve suggested (see most recently NY Times on Retail Bankruptcies) that the credit crisis - in addition its impact on the U.S. economy - would likewise negatively impact the world economy. In last week’s post I wrote:

Moving forward, the real action will be in how these effects reverberate throughout our economy, and then spillover to the broader world economy. Outside of housing and financial firms (the epicenter of this crisis), the next obvious lurch downward, which we’ve already begun to see, is in durables (autos, appliances, etc.); retail; and travel. In essence the recession is now beginning to impact those businesses closest to the struggling consumer. From there, just follow the supply chain upstream to the manufacturers of intermediate goods and providers of intermediate services. And as it so happens, many of those providers of intermediate goods and services are foreign.

And this is how a U.S. recession effectively turns into a worldwide recession.

Recently, the stock market has rallied (up about 7% in April alone) leading some to conclude that the worst of the crisis is behind us, and that the chances for a broader worldwide slowdown are slim.

I am skeptical.

In my view, market participants are erroneously pricing in a short and shallow recession (based on a handful of better than expected Q1 earnings reports) when, in fact, there is mounting, consistent, and convincing evidence to the contrary. Market participants therefore would be better off (and probably more accurate) pricing in a longer and deeper recession.

As with any economic slowdown, it takes time for the effects the fully play out. However, given the spate of recent bad news and my best estimates for the likely trajectory, I am concerned about the current health of the overall corporate sector (outside a few pockets of strength).

For example, CFO magazine reports Credit Cost Hikes Know No Boundaries:

A majority of companies in Asia, Europe, and the United States are paying higher prices for bank credit lines and long-term debt issues, and are being forced to accept tighter terms and covenant restrictions on loans…

…60 percent to 65 percent of the companies said pricing for revolving credit facilities has increased since the collapse of the U.S. subprime-mortgage market last summer, and 65 percent to 70 percent said costs have risen on bank term loans as well.

More than 50 percent of companies said they are paying higher rates on commercial-paper programs. In addition, 70 percent said the cost of issuing long-term debt has increased, including more than a quarter that reported the cost has risen “significantly.”

The survey also found that about 60 percent of companies said it has become more expensive to issue asset-backed securities, and about 70 percent said costs associated with structured finance transactions have increased since the start of the global credit crisis. For example, U.S. companies estimated that commitment fees on revolving credit lines have increased 15 to 20 basis points since the start of the crisis, and spreads have widened 55 to 60 basis points. Term loan commitment fees appear to have increased roughly 25 basis points on average, while spreads have widened by more than 100 basis points.

Meanwhile, many companies are trying to avoid borrowing under any circumstances. (emphasis added)

In addition to that article, Financial Week reports (see Manufacturing Execs Downright Gloomy):

U.S. manufacturers are much more pessimistic about the U.S. economy and the direction of their businesses than they were three months ago, according to a quarterly survey of senior industrial executives released Tuesday.

Only 12% of manufacturing executives said they are optimistic about the U.S. economy over the next 12 months…

Executives have lowered their estimates for sales and industry growth this calendar year, and more of them said gross margins are falling, while almost two-thirds said their costs are rising. (emphasis added)

“The question becomes: How long is the downturn and how far will it reach across the seas?” Mr. Misthal said. “To the extent that it starts to hit their international markets, then they can be in for a difficult time.” (emphasis added)

This is the key - how weakness in the U.S. economy translates into weakness in foreign economies. Recently, there has been some indication that the effects are starting to spillover, at least to Europe (see European Confidence Declines to Lowest Since 2005).

Confidence among European executives and consumers declined to the lowest in more than two years in April, suggesting the euro’s gains and record oil and food prices are hurting economic growth.

German and French business confidence slumped in April as higher costs squeezed margins, while Spanish workday-adjusted retail sales fell 5.5 percent on the year in March.

“We are living through uncertain times, which makes obviously the exercise of predicting how the economy is going to evolve in the present year and even more in the next year more difficult,” Amelia Torres, spokeswoman for European Union Economic and Monetary Affairs Commissioner Joaquin Almunia, said today in Brussels. (emphasis added)

To me, things seem to be worsening both at home and abroad. And in my opinion, the current U.S. recession (which is practically a certainty at this point) seems likely to result, at the very least, in a significant worldwide economic slowdown, and potentially, an outright worldwide recession.

While it is clear that some European countries are now struggling (e.g., Spain and the U.K.), we should keep an eye out for weakness to spillover to the other EU economies, Japan, China, and India too. Should that happen, we should be especially concerned about the effects on U.S. corporate earnings moving into Q2, Q3, and Q4; as the cheap dollar and foreign sales that have been propping up the earnings of U.S. multinationals would almost certainly disappear.

The markets seem to be unduly discounting such a scenario.