Wednesday, August 31, 2005

Network (2005)

Today I had three separate conversations – one with a talk radio program in Cheyenne, WY, a second with a reporter from Newark, NJ, and a third with a business owner in St. Louis, MO. While these people undoubtedly differ in their political views, it seems that the price of gasoline has re-united the USA. To borrow a line from Howard Beale, played memorably by Peter Finch in Network (1976), We’re mad as hell about high gas prices and we’re not gonna take it any more!

Here are some of the questions on peoples’ minds: How high will the price of gas go? Will it cause a recession? What should the government do about it? What can families do about it? What stocks will be hurt by it? Which will be helped? And what are the alternative sources of energy that we should be developing to eliminate our dependence on oil?

Quick answers to the questions: I don’t know, maybe $4 a gallon by year end. It will cause a significant economic slowdown. The government should require automobile companies to increase cars’ miles per gallon – and the automobile companies should have the market sense to follow the demand. After all there are six month waiting lines for the hybrid Prius and GM and Ford are cutting prices to clear their lots of gas guzzling SUVs and trucks. Families that can afford to should switch to hybrid cars. If possible, they should car pool more often, and take public transportation.

Stocks that will be helped include the big oil companies, refineries, natural gas explorers, coal companies, and oil services companies. Stocks that will suffer include the automobile companies, the airlines, low-end and middle-tier retailers, and possibly Starbucks and other vendors of discretionary items that might get squeezed as commuters give up life’s little luxuries so they can afford the gas they need to get to work.

There are many sources of alternative energy none of which have gained much market share over the last 20 to 30 years. These include solar, wind, geothermal, hydrogen cells, coal shale, ethanol and probably others. I am not familiar with the economic advantages and disadvantages of each of these. However, I believe that a change in the price of oil from $30 to $70 per barrel inevitably changes the economic calculus of these alternatives.

When I hear the good people of Cheyenne, WY calling for politicians to take action on these alternative fuels or prepare to be voted out of office, I realize that $3 a gallon gasoline is pulling America together in a way that would have made Howard Beale proud.

Tuesday, August 23, 2005

Squawking about the three rings

Reports about Squawk Box indictments bring to mind the three rings of market information introduced in e-Stocks. As long as the inner ring holds onto its information advantage, investors can’t rely on the fairness of the securities markets. One remedy: disclose market-moving trade information simultaneously to all market participants.

With today’s Wall Street Journal page one story, the Squawk Box saga is emerging from the shadows. What happened? A rogue day trading executive, John Amore, paid stock brokers at Merrill Lynch, Citigroup, and Lehman Brothers to leave their phones off the hook right next to a squawk box which broadcast big trades to the brokers before the trades were executed. Amore’s firm, A.B. Watley, allegedly made $600,000 by front running these trades.

Watley profited from the virtual certainty that a big trade would move the market in predictable ways. It made $19,000 in a few minutes in one such trade. Here’s how: according to the SEC, a Citigroup broker, Ralph Casbarro in Bayside, NY left his phone off the hook for Watley. At 9:52 a.m. on July 24, 2002, Watley overheard a Citigroup trader announcing an order to sell Noble (NE) stock. Over the next three minutes, Watley day traders shorted 36,000 Noble shares -- selling borrowed NE shares with the almost certain promise of replacing them soon thereafter with less expensive ones and pocketing the difference -- at $28.63 a share. Over the next two minutes, Citigroup executed the NE sell order. As NE shares dropped, Watley traders covered their short positions – buying 36,000 shares at $28.10 each – and pocketing a $19,000 profit.

Watley’s scam brings to mind the three rings of market information which include:

  • The Inner Ring (e.g., traders at major investment banks, hedge funds, and mutual fund complexes);
  • The Middle Ring (e.g., intermediaries between the inner ring and individual investors such as stock analysts, brokers like Casbarro and NYSE specialists – 15 of whom were charged in April with making $19 million by front-running); and
  • The Outer Ring (e.g., individual investors).

Market regulation tries to enforce fairness by keeping big walls between the information in the three rings. But Watley profited illegally by tunelling through one of these walls. Casbarro and his peers had simultaneous access to the information in the middle ring. Through his illegal payments, Amore pretended to be in the outer ring while in reality gaining access to the middle one.

Regardless of whether Amore’s scam is isolated or more widespread, it raises a broader question of market fairness. The real profit action is in the interaction between the inner ring, where decisions to buy or sell big blocks of stock are made, and the middle ring where they are executed. Why were the sellers of NE who placed their big order with Citigroup on July 24, 2002 so eager to dump their shares? Is it fair to those in the outer ring not to know the information that drove those big NE sellers to sell that day?

Those in the inner ring have huge information – and therefore trading – advantages over those in the outer ring. Regulation Fair Disclosure (FD) requires public company management to disclose market moving information simultaneously to all investors. As the Watley case demonstrates, big trades move markets, so why are those in the inner ring afforded a special privilege of not disclosing their trading intentions?

As long as these information advantages persist, the stock market will remain a weighing machine whose scales slope steeply towards those privileged members of the inner ring.

Friday, August 19, 2005

Spending Google's (pi - 3) million shares

Google plans to raise about $4 billion by selling some shares -- 14,159,265 to be exact -- the figure is the first eight digits that follow the decimal in the value of pi – the ratio between a circle’s circumference and its diameter.

I can’t help but be amused by Google’s proud nerdiness which has certainly helped it recruit a phenomenally talented work force. Although Google’s too clever by half attitude towards Wall Street certainly cost it proceeds in last year’s Dutch auction style IPO, its ability to blow through earnings targets each quarter has contributed to the tripling in its stock price since then.

Google has realized that it can now capture some of the proceeds that it left on the table when its shares were initially sold at $80 a share last year.

And here’s an idea for how to spend some of that money: link property valuation statistics with
Google Earth.

If you have not experienced Google Earth, I suggest downloading the free version and taking it for a test drive. Starting with a three-dimensional image of the earth, it zooms in to as close as a few hundred feet from any address on earth. Using satellite images of varying quality, it flies you around the globe where you can see images such as the swimming pools and tennis courts of seaside Southhampton, NY estates.

Google could build a cash gusher by linking Google Earth to property valuation statistics. It could produce color coded maps of regions and neighborhoods whose colors vary with market value. If you clicked on a particular property, it would show the current value of the property as well as a graph of its value, for the last 10 years. If you were looking to purchase a property, you could view it from different angles, tour the neighborhood, and figure out how a property’s price compared to others in the neighborhood. If you were looking to sell one, you could use the same information to help set a selling price.

Revenue would come from advertising and fees from realtors, mortgage companies and sellers of home-related products and services whose sites linked to it. No doubt this idea would not spend all Google’s proceeds, but it could provide Google with a good return on its (pi - 3) million shares.

Friday, August 12, 2005

Blanche DuBush

Blanche DuBois, of Tennessee Williams’ A Street Car Named Desire, is famous for her plaint: “I have always depended on the kindness of strangers.”

DuBois comes to mind in assessing the state of our economy. Just as Blanche depended on strangers, so does the US economy. And like Blanche’s strangers, ours are not as kind as we might hope. Consider these US dependencies:

Clearly the US economy is hazardously dependent on the kindness of manifestly unkind strangers. So as his motorcade speeds past the mourning Cindy Sheehan to raise money from his Pioneers and Rangers, this president is putting on a bravura performance in the role of George DuBush.

Friday, August 05, 2005

Party like it's 1999

Today’s IPO of Chinese search engine, (BIDU), brings back fond memories of those wonderful days before the dot-com crash.

In case you hadn’t noticed amid today’s down market – fueled by fears of rising wages – BIDU’s 4.04 million share offering spiked 354% on its opening day. While this is a far cry from’s 600% first-day pop back in November 1998, at $122.54 for each of its 32.5 million shares, the stock market values BIDU at $3.98 billion.

Each dollar of BIDU’s $1.2 million in estimated 2005 profit is worth $3,319, a mere 38 times Google’s $87 price/earnings ratio. To put this in perspective, Google, with $4.5 billion in sales and $968 million in profit, has a stock market capitalization of $81 billion. If the stock market valued Google at BIDU’s P/E ratio, Google’s stock market capitalization would hit about $3.1 trillion – a not unimpressive figure.

BIDU is China’s most popular search engine with a 44.7% market share, according to Internet research firm iResearch. Google is in second place in China with 30.1% of the market. BIDU’s 2004 revenues totaled $13.4 million and $5.2 million in its most recent quarter (during which it earned $303,000). In 2004, BIDU generated 91% of its revenue from auction-based, pay-for-performance advertising.

Some major Silicon Valley players are toasting BIDU’s bubblelicious valuation. Draper Fisher Jurvetson’s 8.2 million shares are now worth over $1 billion. And Google’s 2.6% of BIDU is worth a cool $103 million.

Tonight they’re gonna party like it’s 1999!