Monday, January 26, 2009

Short-Term Capital Mismanagement

It almost strikes me that Ken Lewis is trying to make it appear as if he's taking aggressive action, to make his own botched deals look better – first Countrywide Financial, now Merrill Lynch. I particularly love this line: “Recent reports that Mr. Thain had spent $1.2 million to redecorate his office caused Mr. Lewis to further question Mr. Thain's judgment, according to a person close to Mr. Lewis.”

Do you think that Warren Buffett does his questioning about managers after the fact? Wouldn't you want to be sure of a person's judgment before closing a larger-than-life deal?

The fact with John Thain, like Stan O'Neal before him, is that he's a product of the past era on Wall Street, of egregiously-high, wage labor. They've built their lives around receiving flagrant "bonus" checks, so even in a time of total crisis, it almost appears bizarre how desperate they are to get them.

The alignment of interests is all-important. John Thain has a gold-standard résumé – Harvard MBA, Goldman Sachs executive, CEO of the NYSE – and it would be very easy to talk up his abilities. In fact, he is probably an extremely smart, excellent manager. The only problem is that John Thain's interests are aligned with John Thain, and not shareholders.

Even more, he probably has no sense of attachment that comes from building anything, aside from his résumé or loose loyalties to Goldman Sachs. This makes a huge difference in terms of how someone manages a business.

This type of manager will make decisions to do acquisitions at high prices, or sell assets (like the CDO portfolio) at rock-bottom prices to appease Wall Street or manage the share price and work to build a corporate empire at the expense of shareholder value. And, of course, they will pay themselves outrageous compensation packages, also at the expense of shareholders.

I believe that the BAC-Merrill deal supports my theory of management determinism. I would bet that Ken Lewis' prime reason for this deal was the “Merrill Lynch franchise” – one of the most storied Wall Street names, and “the thundering herd” (no pun intended, that's really what they call their brokers).

But Ken Lewis flat-out admits to placing no emphasis on management, as if it didn't matter at all and he fully expected Thain to be gone within a short period of time. It appears that he made a $50 billion purchase with the same standards that other people would use for a $50 purchase.

Lo and behold, it is already looking like another trainwreck deal. It's looking like AOL-Time Warner, which was announced in January of 2000 – at the apex of the tech bubble – and then merged a year later. This was one of the most value-destroying transactions ever undertaken. My favorite line from the deal was: “One of the creative breakthroughs was in the valuation.”

The experience with an owner-operated business, where the CEO has huge economic and emotional interests – Steve Jobs at Apple, Buffett at Berkshire – will almost always be a superior investment, relative to some bureaucratic behemoth run by hired MBA operators. It is the difference between night and day.

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This work by Nicholas E. Radice is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.