Friday, September 15, 2017

Have a Donut


Maturity YTM CY Mcap
XCO 2018 167% 23% $29
CIE 2019 85% 10% $50
REXX 2020 41% 20% $22
BONT 2021 38% 20% $11
HOS 2021 32% 12% $115

Tuesday, September 12, 2017

Review of The Art of Profitability by Adrian Slywotzky (Chapter 2)

See our reviews of Chapters One and Four of The Art of Profitability. The model in Chapter Two is "Pyramid Profit":

"Here's how it works at Mattel. You sell a Barbie doll for twenty to thirty dollars. But imitators can come in below you. So you build a firewall. You develop a ten-dollar Batbie to seal off that space. It's barely profitable, but it prevents other companies from establishing a connection with your customers. [...] But in order to achieve a real breakthrough, Mattel had to look in the other direction. Looking hard, they saw the opportunity for a $100 or $200 Barbie. [...] Suddenly, Barbie wasn't a product any longer, but a system... a firewall of defensive product at the bottom of the pyramid and powerful profit-generators at the top."
A company sells a set of products with escalating prices and margins but narrowing audiences; hence the pyramid. The firewall item brings customers into the system, some of which flow through the sales funnel over time and buy the much more profitable products at the top of the pyramid.

The best historical example of this strategy is when Alfred Sloan ran General Motors and segmented the car market into five brands: Chevrolet, Pontiac, Buick, Oldsmobile, and Cadillac. This was called the "ladder of success". It's been copied successfully throughout the car industry - all of the Japanese auto manufacturers have a pyramid model.

At first it seems like pyramid profit is a business to consumer model, where the profit is coming from aspirational, high margin, status symbol goods at the tops of pyramids. Certainly there are many more such examples: Tiffany's sells cheap lockets and such for teenage girls, clothing makers like Ralph Lauren sell clothes under several different labels with different levels of exclusivity.

Can a business to business product be sold under a pyramid profit model? Here is one venture capitalist who thinks so.
"Many SaaS businesses follow this profit model: there's a free/cheap tier, a medium priced tier that is appropriate to most customers, and an enterprise tier for customers with deep pockets who want the most features and services."
Pyramid profit models seem much more common than switchboard profit models, that's for sure. However if you are selling enterprise SaaS software to customers with deep pockets, odds are you are probably doing a little customization and therefore customer solution profit as well.

Seadrill Announces Comprehensive Restructuring Plan

Interesting, their opening proposal is to violate absolute priority and throw equity a little bone.

Seadrill Limited ("Seadrill" or the "Company") has entered into a restructuring agreement with more than 97 percent of its secured bank lenders, approximately 40 percent of its bondholders and a consortium of investors led by its largest shareholder, Hemen Holding Ltd.

The agreement delivers $1.06 billion of new capital comprised of $860 million of secured notes and $200 million of equity. The Company's secured lending banks have agreed to defer maturities of all secured credit facilities, totaling $5.7 billion, by approximately five years with no amortization payments until 2020 and significant covenant relief. Additionally, assuming unsecured creditors support the plan, the Company's $2.3 billion of unsecured bonds and other unsecured claims will be converted into approximately 15% of the post-restructured equity with participation rights in both the new secured notes and equity, and holders of Seadrill common stock will receive approximately 2% of the post-restructured equity. The agreed plan comprehensively addresses Seadrill's liabilities, including funded debt and other obligations. For additional information please refer to the Company's Form 6K filed along with this announcement.
The unsecured debt appears to be trading at ~30 cents on the dollar. So that values $2.3 billion of unsecured debt at $690 million. (Which seems unrealistically high; I'm not sure that people really think there be a 30 cent recovery.) If that is going to become 15% of the reorg equity, then the reorg equity is worth $4.6 billion. (Seems crazy.) If that's true, and the current equity is getting 2% of reorg equity, then the current equity is worth $92 million.

Current market cap is $115 million.

Monday, September 11, 2017

Review of The Art of Profitability by Adrian Slywotzky (Chapter Four) and Power to Burn: Michael Ovitz and the New Business of Show Business by Stephen Singular

Two years ago we reviewed chapter one of The Art of Profitability by Adrian Slywotzky, and the reviews of further chapters have been long overdue.

You may recall that the first chapter and profit model is called "Customer Solution Profit". Skipping ahead a little in the book, the fourth profit model is called Switchboard Profit.

The example of switchboard profit is the Creative Artists Agency as Michael Ovitz moved it into putting together movie deals in the late 1980s. CAA represented so many of the best writers, actors, and directors (who they would package together into deals) that negotiating leverage shifted from the movie studios to the talent. This drove pay (and moviemaking costs) significantly higher, which resulted in much more profit for the talent agency as well since it got a percentage of what the talent was paid. A positive feedback spiral also developed because talent risked missing good opportunities for work if they weren't represented by CAA.

One of the keys to getting this virtuous cycle started was for Ovitz to lock up a good source of stories to make into movies. There was a top literary agent in New York, Morton Janklow, who Ovitz identified as having a good story pipeline. Janklow initially did not want to talk to Ovitz, so Ovitz called him every week for a year until Janklow agreed to a deal!

Introverts and northern Europeans can't imagine doing something like that. But another example of a connector with incredible telephonic persistence was a literary agent named Irving Paul Lazar, profiled in this New Yorker article:

In the late forties, after the war, Lazar decided to move to L.A. permanently, and he quickly established himself as the connection between New York and Hollywood. Not a reader himself (he is notorious for not bothering to read the books he is selling), he cultivated writers, publishers, and playwrights, and brought the studio heads projects they could never have found by themselves, for prices they would never have dreamed of paying to anyone else. In New York, Lazar became known as the man who could get you bagfuls of money from Hollywood; in Hollywood, he was known as the man who could bring you the hottest properties before anybody else on the Coast had heard of them. In the days when a transcontinental telephone call was a big deal, Lazar was in touch constantly, perfecting his peculiar blend of gossip, news, and sales pitch, and a lot of people didn’t know whether Lazar was speaking to them from his poolside in Beverly Hills or from around the corner on Fifth Avenue. [...]

Early on, Lazar hit upon three rules that have stood him in good stead for over fifty years. The first was that he could always reach anyone, anywhere, any time. His secret weapon is the world’s largest address book, full of the private, unlisted numbers of people whom nobody else can reach. Who else can pick up the phone and call Mrs. Norton Simon, Jack Nicholson, Barry Diller, Larry McMurtry, Arthur Schlesinger, Richard Nixon, Cher, Gregory Peck, or Henry Kissinger, and get through immediately? The second rule was always to go directly to the top. Lazar doesn’t deal with underlings. The last rule was to insist on a quick answer. Even now, if I tell Irving that I want to think something over or discuss it with someone else he will snap, “Never mind, I can see you’re not interested, I’ll talk to Phyllis Grann.”
One funny thing that Lazar would do is call his circle of important connections every day. People would get a daily call!

The Art of Profitability source for the Ovitz information was a book called Power to Burn, which he recommends that students of profitability read. I give it a solid 3/5; I think the summary in AoP is sufficient.

Also, I can't really think of switchboard models beside this one. And it is also puzzling that, for all the monopoly power that CAA had in the film market, his young lieutenants were willing to consider leaving the firm if they weren't promoted and given equity.

But could you consider Google a switchboard? They obviously have some powerful profit model. Read about being A Serf on Google's Farm.

Speaking of making money by connecting people, I have had two books on this topic by Ronald Burt on my list to read: Structural Holes, and Brokerage and Closure.

Andrew Wylie On Amazon & Book Publishing (2013)

Really funny interview with literary agent Andrew Wylie.

LB: I once tried to interview [Amazon Publishing head] Larry Kirshbaum. Amazon did not seem eager to make that happen.

AW: [rolls eyes] Larry came to see me at the London Book Fair last year and asked when I was going to sell a book to Amazon. I said, “Never,” and he said, “Never say never,” and I said, “Larry, never. Goodbye.”

It’s not serious. They can’t get their books into any bookstores.

LB: But what if bookstores carried their books?

AW: It would be a different game. And if they hired a couple of civilized people. They don’t publish anything of any interest to anyone.

LB: They do better with genre fiction, at least.

AW: They can do all of that shit. Take over daytime television, too. They are deeply into refrigeration.

Thursday, September 7, 2017

Ruminations On Corporate Governance

Just noticed that FactSet sells a database about “takeover defenses”:

SharkRepellent.net is a corporate governance research tool focused on takeover defense, corporate activism, and proxy related issues. Defense profiles are available for U.S. public companies which we compile from a company’s articles of incorporation, bylaws, state takeover law and shareholder rights plan, illustrating how a company has chosen to defend itself from potential unsolicited takeovers and proxy contests.
This database looks like it would be worth exploring. Sad, however, that its marketing uses the word “shark” to describe company owners who have decided to attempt to work with fellow owners to convince managements (their employees!) to take actions that they feel would be beneficial.

Also, the term "takeover defense" is euphemistic and misleading. How about calling it “management entrenchment”? Or “principal-agent accountability disruption”?

Good corporate governance is, to a large degree, the inverse of the “takeover defense” and anti-“activist” devices that have been created over the past decades to entrench management agents at the expense of their owner principals.

Here’s a piece called “Structural Defenses to Shareholder Activism” [pdf] that contains quite a few of these devices. We would posit, then, that good governance would consist of the absence of these devices from the company’s bylaws and practices. Notice this horrifying statistic from the piece:
“In 2014, there have been only two hostile takeover bids for U.S. companies to date and there were only five hostile takeover bids in 2013. This is compared to 160 in 1988, when every board lived in fear of a hostile takeover fight."
How can it be beneficial to shareholders to have such a drastic curtailment of interest from third parties who can imagine a more productive use for their property?

From a press release put out by Marcato Capital that contains their letter to Buffalo Wild Wings, Inc.:
It has now been more than seven weeks since Marcato—a 5.2% stakeholder in BWW—requested a limited amount of information for the purpose of communicating with fellow shareholders. As I’m sure you know, Marcato has an unassailable right under Minn. Stat. § 302A.461 to receive this information. Other public companies routinely provide such information to shareholders without question or delay when presented with similar requests. This is in fact the very same information that BWW is already using itself—we are merely seeking to have a “level playing field” with the Company. It should not take nearly two months to produce.

The Company initially refused to acknowledge that Marcato owned any BWW shares. Specifically, Company counsel stated that the Schedule 13D which we filed with the U.S. Securities and Exchange Commission on August 17, 2016, a copy of which was enclosed with our request, was “insufficient to demonstrate that any particular entity was a shareholder of BWW as of [August 22, 2016].” 

Company counsel insisted that we provide a brokerage account statement evidencing Marcato’s ownership. When asked to explain, our attorneys were told by your counsel that Marcato “could have sold all of its shares” since the 13D filing. To put it another way: management appears to have envisioned a scenario in which Marcato submitted a shareholder list request after it sold all of its BWW holdings, without disclosing the sale in a subsequent 13D amendment.
The Minnesota statute governing shareholder information requests is here.

This is an excerpt from a book about Exxon, mentioned on Phil Greenspun’s blog:
Clinton introduced Diane Sawyer. She summoned to the stage members of a panel to talk about women’s issues; the panel included Tillerson and Lloyd Blankfein, the chief executive of Goldman Sachs, the investment bank with a public reputation as much in need of repair as ExxonMobil’s. The ballroom atmosphere suggested the laying on of liberal, globalized hands to cleanse sinful multinational corporations. “These are some of the power hitters,” Sawyer said of Tillerson and Blankfein. Tillerson talked about ExxonMobil’s charitable initiatives to support girls and women in some of the poor countries where the corporation extracted oil. “Technology comes very natural to ExxonMobil,” he said. “What are the technologies that will provide them [girls and women] capabilities to undertake their daily activities in a more effective and efficient way?” Sawyer later asked him: What is the responsibility of a multinational corporation to make the world better through charitable activity? Is it a tithe of 10 percent? How much? “Ultimately,” Tillerson said, “this is our shareholders’ money we’re spending. It’s not my money to tithe. It’s not the corporation’s. It’s our shareholders’.”
A New York Times piece pointing out that index fund managers may be violating current antitrust laws.
Such ownership patterns are already illegal. Section 7 of the Clayton Antitrust Act makes firms that buy stock in other firms liable if “the effect of such an acquisition may be substantially to lessen competition, or to tend to create a monopoly.” In 1957 the Supreme Court noted that such prohibitions hold “even when the purchase is solely for investment.” Unfortunately, because the antitrust implications of institutional investment were not recognized until recently, legal action has not yet been taken.

However, indiscriminate application of these laws would disrupt an industry that many Americans rely on for (often) low-fee, diversified savings. To avoid such disruption, the government should enforce the Clayton Act against institutional investors while recognizing a safe harbor for those that either take a small stake in an oligopolistic industry (less than 1 percent of each company) or invest in no more than one company per industry. BlackRock could own a large stake in United or Delta or American or Southwest, but not all of them.
Horizon Kinetics has done very good work on unintended consequences of the index investing boom. We note that the regulations that govern mutual funds may have adverse effects on corporate governance. For example, the Investment Company Act of 1940 requires that investments made by a diversified fund be “limited in respect of any one issuer to an amount not greater in value than 5% of the value of the total assets of the fund and to not more than 10% of the outstanding voting securities of the issuer”. This is probably the real reason why these institutions have invested in multiple companies per industry. And the result is actually that the big fund managers have invested an amount in each company that is too small to care about and too small to exert much influence.

"EXCO Resources, Inc. Borrows Remaining Undrawn Amount of Its Amended and Restated Credit Agreement" $XCO

"The Company, at the direction of the Audit Committee, has retained PJT Partners LP as financial advisors and Alvarez & Marsal North America, LLC as restructuring advisors."