From the humor category, BNET recently published its list of Business Blunders of 2009. Some were amusing. For example:

Mistake #3: The “Smart Choice” food label

In August, 14 of the country’s largest food companies — including PepsiCo, Kellogg’s, Kraft, and General Mills — join forces to launch a multimillion-dollar food-labeling program, dubbed “Smart Choices,” to guide consumers in selecting nutritious foods amid the nation’s obesity epidemic. Soon, however, the program’s green checkmark logo is seen popping up on jars of fat-laden mayonnaise and boxes of Froot Loops cereal, a product that lists sugar as its top ingredient. In October, after the FDA announces plans to crack down on misleading labeling, the program is voluntarily halted.

Mistsake #5: IBM offers foreign assignments to its laid off employees

IBM lays off thousands of North American workers, and then gives them the opportunity to apply for similar jobs in countries such as Brazil, India, Nigeria, and Slovenia — if they’re “willing to work on local terms and conditions.” Big Blue magnanimously offers to help with moving costs and provide visa assistance.

Mistake #6: Unions firing their own employees

The powerful, 1.7-million-member Service Employees International Union announces a layoff involving 75 national field staffers and organizers. The union representing those employees, the Union of Union Representatives, quickly files a complaint with the National Labor Relations Board, accusing the SEIU of engaging in unfair practices such as unilaterally laying off UUR members without proper notice, outsourcing their jobs to non-union workers, and selecting workers for layoffs “because of their [UUR] membership and/or activities.”

Mistake #12: Now here’s an incentive

In July, jobless citizens seeking benefit information from the Web site of the Brazilian Labor Ministry must type in the passwords “shameless” and “bum” to access the relevant details. The ministry blames the prank on a private Internet security firm whose contract with the government had not been renewed.

Mistake #20: Now this is REO

After a couple hit by the Bernie Madoff ponzi scheme is forced to surrender its $12 million beachfront home in Malibu, Calif., to Wells Fargo, neighbors notice something odd: a large party being thrown in the presumably vacant house. After an investigation, Wells Fargo admits that the house was being used by an employee, identified by the Los Angeles Times as Cheronda Guyton, a senior vice president in charge of foreclosed commercial properties. The employee, who neighbors say had been spending weekends at the house with her family, is fired for violating bank rules against personal use of bank-owned property.

There are some other good ones in there. To see the full list, click through to Business Blunders of 2009. Some funny stuff!

On my way out of town for a much needed break. Here are a few things that caught my attention:

1. American Graduates Finding Jobs in China
2. Hints of a Rebound in Global Trade
3. Interest Fizzles in Cash for Clunkers
4. Volkswagen and Porsche Close In on Deal to Combine
5. The Pay at the Top (Compensation for 200 Chief Executives)
6. Life without Landlines
7. An Early Stab at Quantitative Easing
8. US Homeowners Cut Asking Prices
9. GM and Chrysler in Different Paths to Recovery
10. Asia’s Astonishing Rebound?
11. A Debate over Cause and Effect (kind of geeky, but how can I not include an article that mentions instrumental variables)

Happy Weekend!

Now that we are largely out of Q1 earnings season, it might be helpful to take stock of the health of the corporate sector. By many accounts, Q1 earnings were better than expected. The better-than-expected earnings has led some to suggest that economic recovery might be right around the corner – you know, “green shoots” and all (see First Quarter Shows Hint of Recovery). A deeper look at those earnings, however, reveals that they are not all that they are cracked up to be.

It is true that many firms reported earnings that were better than analyst expectations. However, this stylized fact is not necessarily indicative of a recovery in corporate earnings, for the following reasons:

1. Analyst expectations were unrealistically low. Many companies hedged when giving guidance, preparing analysts for the absolute worst. Some companies even refused to give guidance, leaving analysts to founder with their projections.
2. Earnings were down 30% or so from a year-ago level, and nearly 90% over the past two years (see S&P Earnings Decline). No sugar coating it. This was a horrible quarter.
3. Corporations were able to report better-than-expected earnings in large part because they engaged in greater-than-expected cost cutting (see Is Cost Cutting Throat Slitting, ht Anuja). Although cost cutting through layoffs and slashing expenditures can increase earnings in the near term, they can be deleterious in the long run. For example, reducing R&D budgets today can result in a compromised product pipeline down the road. Although cutting costs is the natural (and rational) response to economic malaise, the question remains whether companies cut costs by too much. And it’s not just the firm-specific consequences, cost cutting has systemic implications as well. Many analysts are overlooking the higher order effects of layoffs and capital expenditure reductions on the broader economy. This manifests as the dreaded negative feedback loop – fewer jobs leads to reduced consumer spending which then reduces demand for firms’ products resulting in decreased corporate profits leading to fewer jobs (wash, rinse, repeat).

The key then to the future of corporate profitability lies in whether you believe corporate earnings have bottomed out and will now begin to increase from a lower base, or whether you believe that there is still substantial downside risk that increasing unemployment and decreased consumer spending will continue to put a crimp in profitability. Given the nearly 40% rally in equity markets over the past several months, market participants clearly believe the former. I fear that the latter might be more representative.

All this makes me wonder whether the current rally has legs…

If it weren’t enough that Fiat is trying to expand on the North American front via its alliance with Chrysler (see Now Introducing Fiat/Chrysler), it now seems as if Fiat wants to simultaneously expand its empire closer to home (via an acquisition of Opel). According to various media reports, Fiat is likely to make an attempt to acquire Opel, GM’s European arm (see Fiat Turns to Opel or Fiat Aims for Opel Deal). From the Wall Street Journal:

Fiat SpA Chief Executive Sergio Marchionne is stepping up his plan to acquire a majority stake in General Motors Corp.’s German unit Opel, the next phase of his ambitious campaign to forge one of the world’s biggest auto makers by crafting a three-way alliance among Fiat, Chrysler and Opel.

Mr. Marchionne is expected to meet senior German government officials in Berlin on Monday, according to people familiar with the matter, in an attempt to get support for a potential alliance with Opel. Mr. Marchionne signed a partnership with Chrysler LLC in Washington last week.

Fiat’s board of directors met Sunday and authorized Mr. Marchionne to seek a potential merger between Fiat and GM’s European operations, including Opel and its U.K. unit Vauxhall, according to a statement issued by Fiat on Sunday.

My Comment: Are they nuts??? It is hard enough to pull off one integration the size of Chrysler, but now they are going to try to pull off two? And to top it all off, we’re talking about foreign integrations, where economic, political, and cultural differences compound the complexity. Frankly, I am surprised that Fiat’s board would give Marchionne the approval to simultaneously attempt both deals. A prudent board would counsel Marchionne to eat one cookie at a time, lest he get indigestion. So much for corporate governance.

From the Associated Press:

Marchionne’s proposal is part of a Fiat plan to put together the biggest European auto maker and the world’s No. 2.

Marchionne reckons that the only automakers to survive the crisis will need to be able to churn out between 5 and 6 million vehicles a year.

“From an engineering and industrial point of view, this is a marriage made in heaven,” he was quoted as telling the Financial Times on Monday.

My Comment: Or an integration made in hell. I just don’t get it. Why the preoccupation with size? I remain unconvinced that largess is a means to success. Just ask Jurgen Schrempp and the folks at Daimler, who ran around spewing the same nonsense about scale and survival before their acquisition of Chrysler.

Size certainly leads to increased revenues, which helps justify exorbitant managerial pay. But given the organizational complexities that go hand in hand with size, size does not always translate into increased profitability.

In order to truly benefit from size, there must exist extremely large economies of scale and scope. Perhaps such economies (the ability to economize on platforms, dealerships, suppliers, etc.) exist in theory in the auto industry. However, the power of the auto unions, coupled with the structural characteristics of the countries in which Fiat, Chrysler, and Opel operate make capturing synergies very difficult. As reported in the WSJ:

Mr. Marchionne has suggested that closing down plants isn’t a realistic option in Europe, where many workers are shielded by contracts that make it costly for companies to lay off workers.

My comment: This is a microcosm of the problems that Fiat would likely face in any deal with Chrysler (which would be 55% owned by the auto union), and especially with Opel (given European/German labor law).

Good thing Fiat doesn’t intend to put any of its own capital at risk in either deal:

Fiat is also likely to seek government aid from Berlin to prop up the potential alliance while Fiat retools Opel’s operations, according to a person familiar with the matter. Fiat, which is saddled with €6.6 billion, or $8.8 billion, in debt, doesn’t have the money to finance potential partners.

My comment: Great, so let’s take stock. Fiat almost went bankrupt in 2004. It took a massive debt restructuring to rescue them from the brink. Now, after only a few short years of operating as a quasi-healthy automobile manufacturer, they want to take on two near-bankrupt companies that would nearly triple their current size, …and do it simultaneously. They have very little cash available to make capital investments. And to top it all off, they still have nearly $9 Billion worth of debt they need to service on their own.

I am left to conclude that there only are few plausible explanations for such a set of maneuvers:

1. Fiat is trying to acquire assets in a down market, when valuations are cheap. In so doing, they can take advantage of governments that do not want to be in the position of running large automobile manufacturers. They are thereby engaging in a low risk/high reward strategy in which they are trying to acquire access to products/brands/markets for next to nothing in the off-chance that they can magically make the Fiat/Chrysler/Opel combination work. Given that they will put very little capital at risk up front, if the deals fail, so be it.
2. Marchionne is trying to create another automobile firm that is too-big-to-fail, but in the process, too-big-to-succeed.
3. Marchionne, aided by a board of directors that he has in his back pocket, is engaging in a form of empire building whereby his own personal interests in building the world’s second largest automaker are taking precedence over the best interests of Fiat’s long-term health and prosperity.

Fiat’s stock reacted positively to the deal announcement, which suggests that shareholders favor the first explanation. However, Fiat should not underestimate the potential to get bogged down in such a strategy and get stuck with a money pit.

In addition, given the histories of similarly troubled super-sized deals (e.g., DaimlerChrysler, RenaultNissan) and a preponderence of evidence to the contrary, I remain skeptical of what’s behind door #1.

In previous posts (see Chrysler Still Needs a Miracle or Chrysler/Fiat Update) I suggested that the Fiat/Chrysler deal looked increasingly like a longshot. Fiat was asking for deep concessions from both the auto union and Chrysler’s creditors, and it seemed unlikely that Fiat was going to receive those concessions.

But over the past few days, the Obama Administration, the auto union, and Chrysler’s creditors seemed to have come to some sort of understanding (see Treasury Close to Deal with Chrysler Creditors, Chrysler Reaches Agreement with UAW, and UAW Gets 55%).

Hallelujah??

Maybe, but not so fast. Several issues remain:

1. Creditors must agree to the debt cancellation.

According to the NY Times:

Chrysler has about $6.9 billion in secured debt owned by big banks like Citigroup and JPMorgan Chase and a group of hedge funds. Under the proposal, all of the debt would be canceled in exchange for $2 billion in cash…

The Treasury drew up the latest proposal in consultation with Chrysler’s biggest secured creditors, which hold about 70 percent of the company’s secured debt. It requires approval by almost all of the secured lenders. That could be difficult as some lenders, including several hedge funds, may hold their ground and reject it.

2. The issue of pay for union workers must still be resolved. Although Chrysler, the federal government, and the union have come to terms with respect to pension and benefits, my understanding is that they have not yet reached a meaningful agreement to reduce wages. Just how important are wage reductions to Fiat? That remains to be seen. According to the Michigan Messenger:

The new agreement does not cut wages, but it does apparently reduce Chrysler’s commitment to pay into the UAW-run retiree health care fund.

3. According to the latest accord, the auto union will get a 55% equity share in Chrysler. The US government will get a 10% share. Fiat would get a 20% share. Where does the other 15% go? Is this 15% set aside for Fiat depending upon whether it meets performance goals? Will this 15%, or a portion of it, get doled out to Chrysler’s creditors? This was not entirely clear to me.

4. Ultimately, Fiat needs to agree to be party to the alliance. Until that happens, there is no deal. Time will tell if these concessions are enough to convince Fiat that the deal is worthwhile.

Nevertheless, given the concessions that all parties have made to help Chrysler avert bankruptcy, a Fiat alliance seems far more likely today than it did as little as one week ago. Chrysler is no longer looking for a miracle. Perhaps now just a random act of kindness.

But assuming a Fiat/Chrysler deal goes through, the question then becomes: Is this the best outcome for Fiat, Chrysler, and the auto industry? It is not entirely clear. The global auto industry continues to be plagued by massive overcapacity. Keeping a weak competitor around will certainly not resolve systemic overcapacity.

For Fiat, it might be a bit premature to re-enter the U.S. market (the most competitive auto market in the world) and sign on for a complicated global expansion/integration (see Fiasco for Fiat?). Let’s also not forget that Fiat is a firm that, as little as two years ago, was on the verge of bankruptcy itself.

Finally, for Chrysler, it is not clear that its products (even with technology infusions from Fiat) can improve quickly enough for it to once again become a profitable enterprise. For this reason, and as I’ve mentioned before, Chrysler likely needs more than Fiat and an additional $6 Billion infusion from the federal government to survive.

So even if the deal goes through this week, it is entirely possible that Chrysler might end up right back in the same place – on the verge of bankruptcy.

And we wait…

I had been asked to write an Op Ed for the IB Times, an on-line only newspaper with a fairly impressive circulation of about 4 million readers. Honestly, I had never heard of the publication until they reached out to me. But I have to say, I was impressed with what I saw. It even made me hopeful for the future of the on-line only newspaper format.

But that is neither here nor there. The matter at hand is the Op Ed piece.

The piece that I penned for them dealt with executive pay, and was loosely based on a blog post (see Revisiting Executive Pay) from several years ago. In the Op Ed (see Executive Pay: The Problem is Systemic) I argued that simple band-aid type solutions such as increasing the proportion of independent directors and allowing shareholders to vote on pay do not address the root cause of the problem. I wrote:

The issue of executive pay has resurfaced again in the wake of questionable AIG bonuses, and exorbitant compensation packages for banking executives. Pundits see the problem largely as a consequence of a lack of independence among boards of directors. They criticize compensation committees for being too cozy with top management – showering them with lavish pay, outsize option packages, and a host of other perquisites. The solution, they argue, is to increase the percentage of independent directors serving on the board, and to provide shareholders the right to vote on executive compensation.

I agree that boards ought to share some of the blame for a system that has seen executive compensation rise from about 30 times the average employee’s salary in the 1970’s to over 100 times the average employee’s salary today…But boards are not wholly to blame.

The reasons for the spectacular rise in executive compensation are complex. The problems are endemic to a market and institutional system which has radically changed over the last half century. Therefore, to arrive at an appropriate solution, we must start by asking ourselves some fundamental questions…

I’ll leave you with that teaser. To read the Op Ed in its entirety, please visit Executive Pay: The Problem is Systemic.

(Disclosure: I was not remunerated for having written the Op Ed, …or for that matter, to drive traffic to the IB Times or speak highly of the publication. I have no relationship with them other than their request for an Op Ed, and my agreement to write it.)

Thomas Oliver recently penned a piece for the Atlanta Journal Constitution in which he referred to my post Notable Bankruptcies of 2008. In The Year of Bankruptcy Mr. Oliver notes:

It has to happen. As painful as it is.

And there is no magic wand or legislative action or Federal Reserve printing press that can make it all right.

The laws of economics are stronger than any policy…

And so the deleveraging, or debt reduction, of the American economy continues…

Twenty years of excess leveraging can’t be worked out of the system in a normal recession…

I could not agree more with Mr. Oliver. As I explained in my post, I fully expect business bankruptcy filings to increase in 2009. Bankruptcies will likely increase to around 55,000. And as I expressed to Mr. Oliver, I would not be surprised to see bankruptcies surprise to the upside.

As with banks and financial institutions, for many firms in the broader economy, it’s not just a liquidity problem. It’s a solvency problem. Firms borrowed excessively, and at rates that were too cheap – not reflective of their inherent risk. All was fine as long as they were able to refinance the debt, and delay the day of reckoning.

But then the party ended.

We can analyze the situation and pretend that the problem affecting many of these firms is the lack of available credit; or, we can recognize the reality that, for many, their business strategies have serious flaws. I look at firms like Sirius XM (see So Long Sirius), Circuit City, Trump Entertainment, and Bearingpoint (among others) and can only conclude that these are not good firms suffering from unfortunate short-term liquidity problems. Rather, they are poorly managed firms in incredibly competitive markets. This makes their overall value propositions, market positions – or both – extremely unattractive.

Those are problems of the more permanent kind.

Today GM and Chrysler provided interim plans to the US Government in hopes of receiving additional aid (see GM and Chrysler Seek More Aid or GM and Chrysler Release Plans). According to reports, Chrysler is seeking an additional $5B in aid, while GM is currently asking for $16.6B.

You can read a copy of their respective plans here:

GM Restructuring Plan

Chrysler Restructuring Plan

I was impressed with GM’s offering. Truthfully, I expected far less. GM’s plan reads as if management believes it has something left to fight for: The plan is detailed, carefully constructed, and thoughtful. Certainly, GM faces significant hurdles in the form of the UAW, and its bondholders. In addition, the jury is out on whether current management deserves to remain in place. But that said, based on this proposal, I would be inclined to support some additional aid package for GM, …but with more strict provisions (see my previous posts Pre-Packaged Bankruptcy and Preventing Moral Hazard for details).

As for Chrysler, I am inclined to agree with Calculated Risk on this one. Chrysler’s plan is a sham. Chrysler is toast, and Cerberus knows it. Based on this plan, I see the likelihood of the US Government providing additional aid for Chrysler as remote. I would be shocked if the US Government were to continue to put taxpayer money at risk to prop up Cerberus, and its failed enterprise (see Aid for Chrysler? Just say No! and Is the End Nigh for Chrysler? for details).

But now that Chrysler and GM have submitted their plans, the real work for Team Obama begins here…

Several sources are reporting that Sirius XM Radio is on the precipice (see Sirius XM Prepares for Bankruptcy or Satellite Radio a Bad Business Model). This is not surprising news, as both Sirius and XM had been on the ropes predating their merger. As the New York Times reports:

Sirius XM…has hired advisers to prepare for a possible bankruptcy filing, people involved in the process said.

Sirius XM, which never turned a profit when both companies were independent, is laden with $3.25 billion in debt. Its business model has been dependent, in part, on the ability to roll over its enormous debts…at low rates for the foreseeable future until it could turn a profit.

MY COMMENT: Excessive debt was not unique to Sirius XM. It is an economy-wide epidemic. Expect to see many more bankruptcy stories with a similar plot as the year goes on (see my posts Notable Bankruptcies or Corporate Defaults).

Sirius XM hired Joseph A. Bondi of Alvarez & Marsal and Mark J. Thompson, a bankruptcy lawyer with Simpson, Thacher & Bartlett, to help prepare a Chapter 11 filing, these people said.

Documents and analysis are close to completion and a filing could come in days, according to a person familiar with the matter.

According to MarketWatch:

Sirius XM Radio, which reportedly is on the verge of declaring bankruptcy, has problems that go far beyond the dismal state of the economy.

The idea of charging consumers a modest fee in return for superior programming and sterling reception quality may not be viable. Perhaps the industry’s entire business model was flawed from the start and the nation had to experience this devastating recession before people reached that conclusion.

The Wall Street Journal reported on Wednesday that satellite mogul Charles Ergen of Dish Network Corp. has offered to restructure Sirius’ debt and inject several hundreds of millions of funding into the company if it will yield control to him.

I’ve blogged about Sirius Satellite Radio on several occasions (see Sirius-XM Merger, Sirius-XM Merger Update, or Lessons for Sirius for background). It was my opinion that the deal made a great deal of strategic sense. I wrote:

…there are some real cost saving opportunities to this merger. The synergies are real and tangible. Not only do the firms have the ability to economize on administrative costs (e.g., why do we need two sets of management to run these firms), but there are some obvious synergies in production (e.g., why do we need two sets of alternative rock stations when one will suffice).

…it [also] adds value for customers. Exclusivity contracts negotiated by these separate firms locked-in consumers. For example, fans of Major League Baseball were forced to choose XM while fans of Howard Stern only had Sirius as an option. Combining the firms allows fans of both to resolve issues of which service to choose…consumers who have chosen to wait for the uncertainty to resolve over which service would become the standard because they did not like having to choose between two options that are second-best (e.g., I want both Howard Stern and MLB, but I won’t choose until things get resolved) will no longer have to agonize over the decision of which service to select. With Sirius and XM merged…more consumers will likely opt for satellite radio.

Irrespective of today’s news, I still believe the deal makes sense, for as independent entities, Sirius and XM would be far worse off.

In addition, I argued at the time that the DOJ and the FCC were barking up the wrong tree by trying to prevent their union on the grounds that the deal was anti-competitive.

…they [Sirius/XM] do face substantial competition, not in the form of competitors in their existing space, but in the form of substitutes. They face threats from HD radio, traditional radio, iPod connectivity, internet streaming, etc. So this…will put a ceiling on their pricing power.

The initial DOJ and FCC objections now seem misguided, as Sirius XM certainly was not able to flex its pricing muscle, especially in a market in which consumers have a bevy of alternatives, in an economy mired in recession, and in an environment in which auto sales have fallen off a cliff.

Despite all its difficulties, I still believe that Sirius XM has a fighting chance. But the road ahead will not be an easy one, even with a debt reset. Sirius XM still faces the daunting task of convincing consumers that it offers a fairly priced service that provides value vis-a-vis its competitors. And as the MarketWatch article aptly concludes:

Hopefully Ergen — or someone else — can find a miracle cure for an industry that threatens to vanish right before our eyes.

Yesterday, the Wall Street Journal reported that Fiat will take a stake in Chrysler (see Fiat Nears Stake in Chrysler). The WSJ is reporting that Fiat will receive a 35% stake in Chrysler, without having to commit any capital to the deal. Instead, Fiat has agreed to retool an existing Chrysler plant to be able to manufacture Fiat vehicles for sale in the U.S. In addition, Chrysler will receive engine, transmission, and small-car platform technology from Fiat.

Prima facie, the deal looks like it makes some sense – Fiat gets access to U.S. markets (a market it exited in failure years ago) without having to incur the investment of starting up an operation from scratch, and Chrysler gets better access to European markets (which it lost after its failed deal with Daimler). Moreover, Chrysler gets access to small-car, and fuel efficient engine technology while Fiat gains access to Chrysler’s Jeep and Minivan brands.

As a Chrysler creditor (a U.S. taxpayer), anything that increases the likelihood, even infinitesimally, of receiving a return on my investment makes me happy. The U.S. taxpayer (and by corollary, the U.S. government) should therefore be positively predisposed toward this deal, taking comfort in the fact that, at the very least, in exchange for a 35% ownership stake in Chrysler, Fiat should be commensurately responsible for 35% of the liabilities. This should come as welcome news, assuming Fiat can keep Chrysler viable long enough to repay the U.S. government.

So that’s my take on the deal from a U.S. taxpayer perspective, …although I am awaiting more details to be able to better evaluate the terms of the deal.

As an organizational scholar however, I can’t help but wonder if the deal improves either, or both, firms in the long run. As I have mentioned before, I am generally not a fan of deals that combine two weak firms. And this is exactly what you would have in this instance (see GM + Chrysler = Ugh! and Near an Agreement for background). For this reason, the ex ante probability of success is low.

While on the surface there seem to be some synergies, you are effectively wedding a firm that as little as two years ago seemed to be on the brink of extinction (Fiat) with one that is now on life support (Chrysler). Although Fiat has produced some interesting products over the past few years, it is still in too fragile a state to tackle another entry into the U.S. market (the most competitive auto market in the world). Moreover, Fiat is not prepared for what it is about to get into by acquiring a stake in Chrysler.

Personally, I can’t believe that signing up for 35% of the liabilities of Chrysler would not be enough to scare off Fiat, …or any other potential investor for that matter.

But who am I to object. Caveat Emptor.