Alphabet Will Soup Up Google

Yesterday Google announced it's transformation to become a subsidiary of a new holding company called Alphabet.  Today's papers and broadcasts have had extensive coverage of this new corporate structure with an emphasis on the new transparency for Google.  While that is true and Google "proper" generates the bulk of the revenue and cash flow, I believe Alphabet will energize the entire entity for the future.  Google is one of the largest tech companies in the United States and many tech driven engineers would like to have Google on their resume.  However, with a market cap of $465 billion, are their stock options that attractive to really ambitious computer science jocks or jockets? Sure, the old Google was an exciting place to work but was there as much economic upside as a startup or a smaller tech entity like Tesla, or many emerging big data and healthcare companies?

I would argue no.  Alphabet brings new excitement into the Google workforce and its recruiting department.  Of course, this is just speculation on my part. There are probably 40 to 50 companies that exist within Alphabet that won't be part of Google.  The new structure will allow each unit to have it's own stock like a startup and recruiting can now consist of offering equity in each of these units or emerging companies.  If one is interested in working for Nest, they can now have Nest stock or if Drones is your thing, there is a startup for you.  Each new entity can attract the best talent, some of which may come from Google, but also from Apple or Facebook or other emerging tech companies.  The talent pool has just expanded to include any rising star in tech because the opportunities within Alphabet are endless.  Perhaps Google Ventures will now seed a bunch of new startups within Alphabet or will there be a new Alphabet Incubator created to compete with Y Combinator?

Many commentators can't understand why Google's stock is up dramatically today as nothing has changed except transparency.  I think time will  make it apparent that Google and Alphabet are different.  Yes, the Google entity has the same value but the optionality for the Big Ideas has just added tons of value to the whole entity.

What Steve Jobs Will Do: The Future of Apple

Steve Jobs was the greatest inventor of our lifetime. He transformed many industries and obviously viewed business disruption as one of his primary goals. It seems clear that if he were to live another thirty years, there would have been many other inventions that would have likely changed our lives. As such, he probably has contemplated a bunch of other products and designs that he would have liked to create over the next five to ten years. These are likely stored in the Apple road map.

As I contemplate the future for Apple, it seems apparent that new bold ideas are in store so I will take a shot of thinking, what would Steve do? The key premise is that all electronics and appliances of the future will be created with computer capabilities. We know Apple is focused on the TV which likely implies a sleek box which controls all media and music related to the living room/family room. The TV of the future is also likely to be wireless and communicate with one's iPhone, iPad and iPod. This could be the device that plays your music in stereo while enabling easy surfing of TV channels and the web while making the TV more social. Advertisers are also going to have many more opportunities to target their audience with these new capabilities. It might even have touch screen ability but from your couch, an iPad control seems more likely. Of course, when you are in a remote location, one will be able to Tivo programs from the iPod, iPad, and the iPhone.

Once Apple has conquered the TV and all its uses, it may be on to the kitchen. Shouldn't the refrigerator, microwave, stove, blender, toaster, and all other appliances be controlled by an Apple device from a remote location. Every refrigerator may have a computer screen to surf the web or pull up the weekly menu or find a recipe. It is hard to imagine the kitchen of the future but the possibilities are endless. Why wouldn't Steve want his little computer company to create an interactive kitchen?

If Steve Jobs became the king of the living room and the kitchen, the rest of the house must also be in the cards. I can envision computer controls of the heating and air conditioning, electricity, lights, alarms, and even the doors. These might not be the typical consumer products we have come to expect from Apple but they will be big and bold ideas that will be controlled by iPods, iPads, and iPhones. The House of the Future will certainly allow many more comparisons of Steve Jobs and Thomas Edison.

Finally, once Apple has created products to control the whole house, I think another big opportunity Steve probably has studied is the car. Every car will likely be equipped with some type of computer or iPad in the front passenger seat as well as in the back seats. The car of the future will clearly be more computer driven and the web will be a standard feature. It is also likely that consumers will be able to turn on their cars with a remote Apple device and of course regulate the heat before they step out of the house. If we want to compare Steve Jobs to Henry Ford, the car of the future will likely do just that.

Of course the future product road map for Apple is anybody's guess but since the company has indicated that the best products to come from them, haven't been produced yet, we can expect some great revolutionary ideas. Steve Jobs has seen the future before and it is likely he saw it again. We just need to patiently wait for the brilliance to shine in the years to come.

The United States will Follow in Europe's Path

I am in Washington DC and decided to see the Newseum. One of the great exhibits they have is on a daily basis they post the front page of 800 newspapers from the U.S. and abroad. All the papers cover local news but every paper in this country today mentioned the debt fiasco going on in Congress. The Republicans have proposed to take away Congress's ability to raise the debt ceiling and leave the decision in the President's hands. This is just another political game.

The Republicans want to cut this country's debt load by at least $4 trillion over 10 years strictly though cost cutting measures while the President is willing to also have the same level of debt reduction as long as we increase taxes. This battle is at a stalemate and the Republican suggestion to try and pass a $2 trillion bill will not be sufficient.

The United States is a bankrupt nation but nobody in Government wants to admit it. Last year Ireland needed to be rescued and today Greece is spewing debt and facing a possible default. This week Italy's financial condition caused the markets to tumble. Portugal and Spain could be next in line. If the United States were a member of the EU, the financial gurus would be pounding on their debt and yields on treasuries would be much higher. Nobody would be as concerned with the technical default of our debt limit because the true worry would be too much debt and not enough revenues. Sound familiar?

The U.S. has been a financial powerhouse for the last 70 years and we have been the world's lender of last resort. Times have changed and we need to clean up our own fiscal mess. We can't pay our current bills and our kids won't be able to pay the future bills. Congress needs to wake up and forget politics before the United States becomes Greece. Social Security is broken and so is Medicare and Medicaid. We can no longer afford to protect the world so let's cut defense. Let's re-examine subsidies like ethanol and other farm subsidies. In this light, oil tax preferences may also have to be chopped. With our economy floundering and Bernanke discussing QE3, it might not make sense to raise tax rates but moving to a flat tax could clearly generate more revenues.

Washington needs to change and somebody needs to sit Nancy Pelosi down and teach her basic economics. Today's headlines have her fighting with her own party by telling the President that she won't cut any of the entitlement programs. Where does she think the money is coming to pay Social Security? Can someone possibly be so blind to reality or just so self-serving that it is worth sacrificing her own country's future?

The United States looks like one of those troubled European countries and unless Congress gets it's act together, the dollar will crash, treasury prices will plummet, a default will be in the cards, and the next financial crises will be upon us.

The Internet Leads to Disintermediation

2011 could be the year of disintermediation. In the 90's, the internet became a place where many entrepreneurs created new etail businesses with high expectations to grow forever at astronomical rates. Many of those expectations were not met and we had the .com crash. Of course, some of those enterprises are still around and thriving today while others have survived but remain a shadow of their original businesses. The first decade of 2000 resulted in the creation of many internet enterprises that enabled ecommerce companies to thrive. The use of analytics, data, search, consumer generated content, social networks, and other technology became a focus to drive the growth of retailer's sites and consumer brands, while dramatically expanding the usage of the internet globally. 2010 brought us the social network explosion and the growth in location based services and couponing.

Where do we go from here? I suspect the old trends will continue but mobile and video will become a bigger focus. In 2008, the United States and much of the rest of the world suffered through a financial crisis not seen since the Great Depression. The psychology of the consumer has been damaged for many years to come. No longer are people frivolously spending money and most consumers are looking for a bargain. This should propel the internet to become the driving force behind the "disintermediation of business". Traditional business has a supply chain that moves from manufacturing floor, to shipper, to wholesaler, to retailer, to consumer. 2011 will lead to the squashing of the supply chain and new fears will develop among the brick and mortar crowd. Entrepreneurs will develop ventures that either eliminate some of the supply chain or they will look to fill a need for lower prices for the consumer. In some cases, lower prices could result in expanding the customer base of a retailer so that overall their revenues rise as excess inventory gets depleted.

We recently have seen a trend of disintermiediation where some interesting businesses are starting to pop up. The combination of couponing and location based services may become a normal offering for every retailer if it wants to remain competitive. On the other hand, we find a company like http://www.jhilburn.com/ recognizing a niche to eliminate the supply chain for expensive men's shirts and using multi-level marketing to drive growth. The result is custom-made clothes at 1/3 the price of the retail store's off the rack designer shirts. It sounds crazy but how can a retailer compete? How about http://www.hbloom.com/? Many individuals order flowers weekly for their homes while businesses like to display flowers in their lobbies or reception areas. For those who buy flowers on a regular basis, this is not a cheap proposition. H Bloom has figured that out and they offer a weekly subscription for flowers. As a large buyer of flowers, they can offer customers this service cheaper than the local florist while guaranteeing fresh peddles conveniently delivered to your door. What is going to happen to the local florist? How about http://www.amazon.com/ and its new bar code App? Go to a store, scan the bar code, and Amazon will show you their price for that item which you can order immediately on-line, IF the price is cheaper. My guess is there is no IF. Amazon is likely using location based services in combination with their price optimization algorithm to guarantee they always have a compelling offer. Lookout retail?

The above three companies represent a new trend to displace or at least steal plenty of business from the good old brick and mortar retailer. We expect to see many more emerging companies that will cater to the thrifty consumer. Nobody wants lower quality goods but if one can use technology or remove the supply chain to lower prices, the move towards the disinetmediation of old line businesses will continue well into this new decade.

The Cayneing of Jimmy

Yesterday, Congress resumed their investigations of Wall Street and the financial crisis. It was Bear Stearn's turn on the hot seat as five former employees including Jimmy Cayne, the Chairman and CEO and Alan Schwartz the CEO for the last two months of the firm's life. Jimmy Cayne was not a man of many words when responding to the questions thrown at him. It may have appeared to be short and direct responses, which they were, but the man is not capable of being eloquent in public. Speaking was not his strength. In fact, his true strengths were probably selling municipal bonds and playing bridge. As a former member of the Bear family, we could never understand how Mr Cayne was elevated to the top of a major Wall Street firm during a time where financial instruments became much more sophisticated and complex. Of course to be a world class bridge player, he must be smart but that doesn't mean he was capable of managing a global financial empire.

Bear Stearns came crumbling down as it was clearly caught up in the housing collapse. Its history of strong risk management remained a focus within the firm but under Jimmy's leadership, attention to detail waned from the days of Ace Greenberg. Ace lived and died the firm and was always present. On the day before a holiday, one could always find Ace roaming the trading floors at 4pm to keep all the traders and salespeople on their toes. In 14 years at the firm, we never saw Jimmy Cayne once mingle with employees except at a cocktail party after the monthly Senior Managing Director meeting. Jimmy Cayne was arrogant and ran the business his way. The best managers are those who hire smarter people than themselves and expect them to bring fresh ideas and challenge the current operating procedures when necessary.

Jimmy Cayne had his small Executive Committee that raped the firm and its shareholders. Warren Spector and Alan Schwartz were certainly deserving of some big pay days. However, there wasn't an employee in the firm who could ever justify why Jimmy got paid the enormous sums year after year. The only bigger sin was paying the weakest CFO on Wall Street the highest compensation of any public firm's Chief Financial Officer. Sam was Jimmy's boy but it is hard to go from an average public accountant (maybe a good one) to CFO unless you have some great risk management skills and an ability to influence the firm's decisions. Sam did what Jimmy wanted and unfortunately, most Senior Managing Directors didn't believe Sam or Jimmy had a strong understanding of the complex nature of this global franchise.

For years, Jimmy Cayne either pushed out highly qualified employees as they gained power or refused to adequately compensate very skilled managers who in turn left the firm. The executive committee and their rich pay packages needed to be spread around to many talented people who eventually left Bear Stearns. It is ironic that two very senior people, who Jimmy Cayne refused to give more authority and power, left to become very very senior Partners at Goldman Sachs. This was Jimmy's way.

Congress asked Jimmy Cayne what he would have changed in his business model if he could do it all over again? Would it be the equity base, the leverage, and/or the short-term funding. The answer should have been all three. Jimmy said in retrospect maybe the leverage was too high. He couldn't answer the short-term funding as he probably didn't truly understand that much of the 1-day Repo loans were secured by longer-term assets. If one loses the short-term funding and the assets can't be sold in a day, a liquidity squeeze occurs, especially if the leverage is too high. My Cayne said he never would have issued equity as it was too cheap and he would have had to sell a big piece of the firm to do so.

Let's go back to September 2007. There were rumors that Bear was working on a partnership with a Chinese bank. We had a pretty good understanding of Bear Stearns at the time and began to feel uncomfortable with its financial position. The collapse of the two Bear Mortgage Hedge Funds put added pressure on the firm's balance sheet. It was very clear that the firm needed a big equity infusion or sell itself. A Chinese partnership could fill that need. My Cayne scurried to Asia over Labor Day weekend to ink a deal with CITIC and shortly afterward it was announced with many cheers. There were two problems with this deal. The first was that the details were never worked out and it was never signed. The second problem was that as proposed, the structure didn't result in Bear receiving additional cash to lower its leverage. The Chinese Bank/Securities Firm was going to invest $1 billion in Bear (hardly enough) and Bear was going to invest a like amount in the Chinese firm. Hence, no new cash and one of the dumbest deals of all time. Jimmy Cayne must have thought the investment community would perceive this new partnership as Bear's savior when in fact it was all smoke and mirrors. At the time, we assumed some other deal must be in the works.

The firm needed equity desperately but Jimmy Cayne, who owned about $1 billion of Bear stock, always thought the stock was worth more than it was. Apparently, some private equity firms saw value in Bear but no deal was good enough for Bear under Jimmy Cayne's watch. He is a master bridge player and the sale of Bear and some inflated price was always going to be his last trick. He was smarter than the rest of the world until he wasn't.

The questioning yesterday also addressed the difference in mortgage assets at other investment banks. Jimmy Cayne said the firm couldn't know others risk and there was no way for Bear to have seen the crisis coming. He said 99% of the financial community missed it. That may be so but 99% of the investment world didn't have a leading and dominant position in the mortgage market. As the leader of the firm, Jimmy Cayne should have asked more questions and Sam Molinaro should have been on top of the intricacies of the increasing defaults of the underlying mortgages as was Daved Viniar at Goldman Sachs. Since 2006, the unknown Hedge Fund manager named John Paulson, was scurrying to raise money specifically to short the mortgage market. John Paulson was not unknown to Bear Stearns as he was a former employee, a prime brokerage client, and a trading customer. The arrogance of Bear and of Jimmy Cayne cost employees and former employees billions of net worth. Good due diligence and strong risk management may have pushed Bear to understand why John Paulson had a different opinion than they did. The firm didn't have a leader in the mold of Ace Greenberg but instead this self-centered CEO ran the firm his way.

Leverage was high and the equity was always too cheap to sell. So when the perfect storm hit, this beloved firm evaporated over night. Better management could have changed history.

What Congress Doesn't Know About Wall Street

Congress is appropriately grilling Goldman Sachs executives on the mortgage debacle which helped to create the financial crisis. The practice of Wall Street has been and is to create products in the mortgage market, the equity market, the bond market, the loan market and many other markets. We have had many years of experience with the workings of Wall Street. The interesting facts that are not being discussed in these hearings is how the business actually works. Institutional investors expected investment banks to perform due diligence on New Issue Product. In this capacity, the underwriter is expected to analyze the deals to make sure no fraud is involved.

In aggregate, institutional investors looking at a deal will come to a consensus as to whether they like a deal or not. On the other hand, there is a wide range of buyers along the risk spectrum. Some investors are very conservative in the way they manage money and will only buy high quality securities in an extremely diverse portfolio. Others take a high risk, high reward approach. Such investors might only buy the riskiest securities that might produce out sized returns.

The approach Wall Street takes is to find the group of investors that is most appropriate for the risk of each specific transaction. In this light, the role of the institutional salesperson has been to provide his/her client with product that fits its strategy. As Congress pointedly asks the Goldman employees if their job is to look out for the interests of their clients, the Goldman response has been blank stares while not answering the question. The true answer is their responsibility is to provide product that meets the risk posture of each client as long as they knowingly are not selling them financial instruments that were created with fraudulent intent.

Congress wants Goldman and all other Wall Street firms to have their institutional traders and salesmen to act in a similar manner as they do with retail mom and pop clients. Many times institutional investors have differing opinions from Wall Street firms. As such, they are happy to buy securities being shorted by Wall Street. In the heyday of the mortgage market as well as in the heyday of the LBO frenzy, many institutional investors were aggressively trying to invest hordes of cash in their portfolios. In these situations, investors may have increased their risk tolerance and bought many securities that ultimately decreased in value or became worthless. Does such behavior and desires of sophisticated investors mean that Wall Street misled their clients?

The Misguided Financial Reform Bill

We have written before about our concerns and dislikes for the Financial Reform Bill proposed by Senator Chris Dodd. We continue to believe that the focus should be on reducing leverage of Wall Street firms to limit Too Big To Fail dramas of the future. Derivatives are clearly a focus of the bill and the current Goldman Sachs Mortgage investigation has elevated this issue to not only Congress but Main Street's average Joe. We would argue that there may be some moral and ethical issues to address but a synthetic security by definition needs a buyer and a seller. The seller needs to be someone shorting the securities. As such, the government argument about ACA and the German Bank not being aware of Paulson's involvement is irrelevant. For 25 years on Wall Street, we strictly adhered to the unwritten rule that nobody disclose the name of the buyer or seller of a financial transaction. This was sacrosanct to keeping the trust of customers. As for Mr. Paulson, he was an unknown hedge fund manager in 2006 when he was loudly saying the mortgage market was going to crumble. Nobody cared what he was preaching and in fact, it wouldn't be surprising if many buyers of mortgages were happy to be on the other side of one of his trades. Congress needs to rewind the clock and realize Mr. Paulson is famous today as he was absolutely correct with his analysis of the mortgage market and made billions in the process. However, in 2006 and 2007, he was just a name and he preached the future that most investors, Wall Street experts, and congressman didn't want to believe.

We are quite troubled with the provisions in the Bill which relate to Angel investing. For 20 years we have been active Angel investors in start-up companies. Some of those enterprises failed but many have grown and flourished. Our small universe of investments have resulted in thousands of new jobs as well as some new technologies that have driven commerce in the United States. Each of the thirty or so companies we have financed started as business plans and ideas for a business of the future. These fledgling businesses have no sales and certainly no earnings. As such, banks do not give loans to such enterprises. The entrepreneurs only hope is to find wealthy individuals (using the Obama definition) to supply venture money to fund the initial stages of their businesses. Typically an entrepreneur writes a business plan and sets out to find some individuals to give him/her some money to get this business off the ground. It could take a year or two in some cases until capital is raised to buy computers, rent space, and hire a few emplyees to test the new business idea. The good news is that small businesses under five years of age generated all new job growth between 1980 and 2005.

Given these facts, how could the Dodd Bill create new restrictions on Angel Investing? The Wall Street Journal recently had an Opinion similar to ours on this topic. Amazon, Facebook, Twitter, and Google were products of Angel investors. Does anyone believe these companies have created problems during the Financial Crisis? Start-up businesses beg to find any capital and take the money when an investor offers it to them. The new restrictions in the Bill would require an SEC review of these angel investments and delay the start of the funding for 120 days. This is ludicrous and will likely cause many of those companies to fail before they get off the ground. The ignorant policy makers need to understand that the U.S. economy is driven by small business and employment depends on the success of entrepreneurs' dreams. The Bill also wants start-ups to be regulated by all 50 states and for the angel investors' financial means to be increased. Congress should stick to the real problems facing the stability of the financial system. Whoever gave Senator Dodd the idea to restrict Angel investing needs to understand the facts of entrepreneurialism. Hopefully, Mr Dodd and Congress will come to their senses and allow fresh ideas to become the technologies and business ideas of the future.