A Case for Buying Yahoo Shares After the Microsoft Deal

“We believe Microsoft’s proposal substantially undervalues Yahoo.”–former Yahoo CEO Jerry Yang, in a letter to employees on Feb. 11, 2008 about Microsoft’s $41.6 billion unsolicited bid for Yahoo.

Yahoo will sell its search capabilities to Microsoft, “if there’s boatloads of money and the right technology involved.”–Carol Bartz, Yahoo chief executive, in an interview at the All Things Digital Conference on May 27.

“As far as we’re concerned, the boatload of cash is preserving our revenue…Having an upfront payment didn’t really help us from an operating standpoint.”–Bartz, in a conference call with analysts, announcing the deal on Wednesday.

yahoochartLet us be clear: Yahoo has squandered many chances to generate huge value for its shareholders in its three-year dance with Microsoft. First and foremost, it turned down Microsoft’s bid to buy the entire company for $41.6 billion last winter. Today, Yahoo has a market value of $24 billion.

But the past is the past. Looking ahead, there may be a good case for buying Yahoo now that it has outsourced much of its search business to Microsoft. It isn’t a blockbuster deal, but the move makes strategic sense for Yahoo.

Here is the play: Yahoo’s shares are taking a beating today, falling 11%, or $1.90 to $15.30 in midday trading. Investors are unhappy that the search deal didn’t include any “boatloads of cash” from Microsoft. Analysts had been expecting at least $1 billion. Investors also may be selling on the news that the on-again, off-again negotiations between the two companies are finally over.

The bears aren’t buying that the search deal will create value for Yahoo over the long term. But the bull case is worth considering. The deal enables Yahoo to tap into Microsoft’s Bing search technology, which has been rolled out with some success in recent months. Yahoo also will reap 88% of the combined search revenue, an increase from the 85% share that Microsoft offered when it first proposed a search deal last summer. Under that proposal, Yahoo’s take went down to 70% after three years.

For Yahoo, this adds up to $275 million in additional earnings before interest, taxes, depreciation and amortization annually, largely from cost savings on research and development and infrastructure costs associated with the search business. That translates into approximately $1 a share more of enterprise value, says Christa Quarles, of Thomas Weisel Partners, referring to a measure of the total value of a business, with debt and cash factored in. Yahoo’s 2008 Ebitda was $1.8 billion.

If you add in the roughly $200 million a year it won’t be shelling out now for large capital expenditures on the search business, the rise in enterprise value approach $2 a share, Quarles says. According to Yahoo Finance, Yahoo has an enterprise value of $20.56 billion.

Quarles has a “hold” rating on Yahoo, but she admits that today’s sell-off makes the stock look attractive. “People have gotten emotional around the selling and any time that happens, there can be buying opportunity around that,” she said.

To be sure, there are a lot of pitfalls to the search deal and few guarantees for Yahoo. Unlike a similar Google-AOL search deal that gave AOL guarantees on search pricing over the life of the pact, Yahoo is entitled to only 18 months of pricing guarantees in its 10-year deal with Microsoft. After that, Yahoo will be at the mercy of Microsoft’s technology to maximize searches.

It is worth noting that Google invested $1 billion in AOL, giving it more skin in the game than Microsoft, which has paid nothing upfront. But AOL’s parent, Time Warner, recently bought out Google’s investment for $283 million. Microsoft avoids such a risk in its deal with Yahoo.

The bears may be too angry about Yahoo’s long history of lost opportunity to focus on the positives of the search deal. “But I think Yahoo gets to have its cake and eat it too,” says Sandeep Aggarwal, an analyst at Collins Stewart. “Wall Street may have been expected too much, but Yahoo is a net gainer here.”

Beige Book: Job Seekers, Consumers Continue to Face Pressure

The tone of the beige book was more upbeat this month, unless, of course, you’re looking for a job, a raise or a loan.

The economy may be improving, but difficulties remain, especially in the job market. (Getty Images)

“All Districts indicated that labor markets remain slack, with most sectors either reducing jobs or holding them steady and aggregate employment continuing to decline,” the Federal Reserve’s summary of regional economic activity said. The Dallas district noted that hiring freezes continued, while the Atlanta region some auto and energy companies noted that they were planning additional job cuts in the coming months.

There were indications from staffing firms that companies were looking for temporary workers rather than full-time workers. If firms are increasing the number of temporary workers hired, that can be a sign that full-time hiring may be near a turning point. But the beige book only said employers were showing a preference for part-time workers, it didn’t give an indication whether more part-timers are being hired.

There were some pockets of strength. New York showed increases in employment in the legal sector. Most districts showed demand for workers in health care. Information technology workers, especially in the clean technology and defense-driven aerospace markets, saw increased hiring activity.

The slack labor market means that wages are flat or dropping. “Boston, Cleveland, Richmond, Chicago, Dallas, and San Francisco cited a range of methods firms are using to limit compensation, including cutting or freezing wages or benefit contributions, deferral of future salary increases, trimming bonuses and travel allowances, reducing hours, temporary shutdowns, periodic furloughs, and unpaid vacations,” the report said.

Meanwhile, credit condition remained extremely tight. “Bankers report a downturn in loan demand — particularly from the household sector — as well as ongoing tightening in credit standards and steady to higher delinquency rates,” the New York district reported.

A combination of falling wages and limited credit access underlines the difficulties facing the consumer. Recovery from extremely low levels of activity is looking more likely, but with the consumer facing such strong headwinds any form of the word “robust” won’t be in making headlines any time soon.

No Short Sleeves or Yellow Pantsuits: Life as a Woman at Lehman Japan

“I was sent home for wearing a short-sleeve dress, even though I was wearing a jacket.”

The quote fairly jumped out when Deal Journal was reading today’s page-one Wall Street Journal article on snags in Normura Holdings’ integration of the Lehman Brothers Holdings operations it acquired in September. As did the employee’s conclusion, that she would be leaving as soon as she receives her final guaranteed bonus payment.

The article details the number of ways in which Nomura’s integration efforts have stumbled over the cultural differences between the Japanese bank and its U.S. counterpart. “There has been tension over executive compensation, how quickly decisions are made and treatment of women in the workplace,” the article says.

The first two issues, of course, can crop up when any two businesses combine, and that pay practices in the U.S. are resented elsewhere in the world is old news. That makes the gender issues stick out: Women joining from Lehman were told by managers to remove highlights from their hair, to wear sleeves no shorter than midbicep and to avoid brightly colored clothing, the article says, citing several people who joined from Lehman.

Here are more details:

Asked about the training sessions for new hires, a Nomura spokeswoman said that both sexes were taught business etiquette, and the men and women were trained separately for logistical reasons.

Nomura’s human-resources department changed some women’s email addresses to their married names, from their maiden names, without asking which names they used professionally, according to the people who joined from Lehman.

The Nomura spokeswoman says the dress code is displayed on the company’s Intranet and is intended to ensure that clients and colleagues don’t feel uncomfortable. The email addresses were changed because of a problem during the transition process, she says, adding that she doesn’t know whether the complaints about them have been addressed.

“Nomura is more international-minded than its Japanese banking peers, but there is still a gulf between it and Western investment banks,” says Hiroyuki Ozaki, a professor of finance at the Tokyo University of Technology and a former Nomura banker, in the article. You think?

To keep Lehman bankers from leaving, Nomura agreed to guarantee their bonuses at top-of-the-market levels for two years. The article ends by pointing out that the last installments will be paid on Oct. 1 or, for a select few, on March 1, 2010. It will be interesting to see how many former Lehmanites that might walk out the door after that will be wearing skirts or pantsuits.

Fedspeak: Dudley on Lackluster Recovery, Expanding Balance Sheet

New York Fed President William Dudley said in remarks at the Association for a Better New York Breakfast Meeting that while growth may return this year, the recovery is likely to be lackluster. Given that outlook, he suggested it’s still too early to talk about the Fed winding down its balance sheet and changing monetary policy. In fact, he said that the Fed’s balance sheet is likely to expand by another $500 billion despite the fact that emergency lending has decreased in recent months. The following are some highlights of his speech:

The economic contraction appears to be waning and it seems likely that we will see moderate growth in the second half of the year. The economy should be boosted by three factors: 1) a modest recovery in housing activity and motor vehicle sales; 2) the impact of the fiscal stimulus on domestic demand; and 3) a sharp swing in the pace of inventory investment. In fact, if the inventory swing were concentrated in a particular quarter, we could see fairly rapid growth for a brief period.

Regardless of the precise timing, there are a number of factors which suggest that the pace of recovery will be considerably slower than usual.


Perhaps most important, the normal cyclical dynamic in which housing, consumer durable goods purchases and investment spending rebound in response to monetary easing is unlikely to be as powerful in this episode as during a typical economic recovery. The financial system is still in the middle of a prolonged adjustment process. Banks and other financial institutions are working their way through large credit losses and the securitization markets are recovering only slowly. This means that credit availability will be constrained for some time to come and this will serve to limit the pace of recovery.

If the recovery does, in fact, turn out to be lackluster, the unemployment rate is likely to remain elevated and capacity utilization rates unusually low for some time to come. This suggests that inflation will be quiescent. For all these reasons, concern about “when” the Fed will exit from its current accommodative monetary policy stance is, in my view, very premature.


Despite the recent dip in the size of the balance sheet, the size of the purchase programs underway makes it likely that balance-sheet growth will resume as assets acquired in conjunction with these programs overwhelm any further declines in the funds advanced via the shorter-term liquidity facilities. The size of the Federal Reserve’s balance sheet seems likely to grow to roughly $2.5 trillion, somewhat above the peak reached last December.

The Microsoft-Yahoo Search Deal: ‘Where’s the Boatload of Cash?’

The three-year courtship of Microsoft and Yahoo is finally over. But with today’s search agreement, the on-again, off-again romance ended with a whimper, not a bang.

yahoologo_D_20090729104823.jpgBloomberg News
Flowers grow under a Yahoo sign outside the company’s offices in Santa Clara, California.

Remember, this all began with Microsoft’s $44.6 billion offer for all of Yahoo, which Deal Journal once termed a “brute-force bid” that offered a 60% premium. And at one point, the Redmond, Wash., software giant was prepared to go as high as $47.5 billion. Then, M&A denouement. When the two sides started talking again, the new target was a search deal. And of the deal announced today, perhaps the reaction of analysts is best seen in the question posed by Christa Quarles, of Thomas Weisel Partners: “Where’s the boatload of cash?” (Prior proposed deals had promised upfront payments to Yahoo.)

Here are the early takes of other analysts on the deal:

Mark May of Needham & Co. says the deal is a clear negative for Yahoo because:
1) There’s no upfront payment;
2) The minimum guarantee is only for 18 month of the 120 month deal;
3) The deal requires regulatory approval and management expects closing in early 2010;
4) Management doesn’t expect to see the full benefits of the deal until 24 month after regulatory approval, which could mean not until 2012;
5) While the first sentence in the news release says Yahoo “will become the exclusive worldwide relationship sales force for both companies’ premium search advertisers,” we believe most of the value is and will be derived via the self-service channel – which Microsoft will now control;
6) At the deal’s expiration in 10 years, Yahoo may be at Microsoft mercy given that there’s only one other supplier (Google) and regulatory wouldn’t allow a Google/Yahoo partnership last year.

Quarles, of Thomas Weisel Partners, says the upside to Yahoo’s shares is muted because of the last of upfront payments. Also, Yahoo isn’t likely to save much money in expenses, but will have to spend time and energy integrating the operations at the two companies devoted to search and advertising. “Combining search indexes and reorganizing a global sales force is not a trivial matter and a distraction that Google can take advantage of,” she says.

Collin Gillis of Brigantine Advisors: “Any agreement where MSFT powers search – and shares the search data to Yahoo is open to scrutiny from US and EU Justice Departments. The agreement could be the trigger that leads to federal regulation where behavioral targeting data collection of user Internet activity is moved to an opt-in basis. This could be a major disruption to companies such as Yahoo that collect vast amounts of data on its user base. While Yahoo offers the ability to opt-out of the data collection - less than 1% of its users do so.”

Secondary Sources: Fed Politics, Excess Reserves, Economists and the Queen

A roundup of economic news from around the Web.

  • Fed Politics: On his Maverecon blog, Willem Buiter isn’t impressed with Ben Bernanke’s charm offensive. “Chairman Ben Bernanke is running for re-appointment. The open way in which he does this is, at least to me, toe-curlingly embarrassing… Is it really necessary to defend the institution of the Fed, and what remains of its independence (independence from Congress that is; independence from the Executive went out of the window long ago), by making statements like the following:”The best way to have a strong dollar is to have a strong economy”, ”I don’t think the American people want Congress running monetary policy”; ”I was not going to be the Federal Reserve Chairman who presided over the second Great Depression” or ”When the elephant falls down, all the grass gets crushed as well”? The first of these statements is utter nonsense, although US politicians use it all the time. As regards the second statement, I wish it were true but I am not so sure. As regards the third statement, I will take chairman Bernanke’s word for it. He has, however, apparently decided to go down in history as the Federal Reserve chairman who presided over the creation of the biggest moral hazard machine ever. As regards the fourth, this is obviously incorrect if you make sure the elephant is in a place where there is no grass. This “Town Hall Event with Chairman Bernanke” politicises the Fed even more. It does not serve the institution, but demeans it. It may serve chairman Bernanke’s re-appointment.”
  • Excess Reserves: Todd Keister and James McAndrews at the New York Fed offer a great explanation for why there are more excess reserves at the Fed. “The quantity of reserves in the U.S. banking system has risen dramatically since September 2008. Some commentators have expressed concern that this pattern indicates that the Federal Reserve’s liquidity facilities have been ineffective in promoting the flow of credit to firms and households. Others have argued that the high level of reserves will be inflationary. We explain, through a series of examples, why banks are currently holding so many reserves. The examples show how the quantity of bank reserves is determined by the size of the Federal Reserve’s policy initiatives and in no way reflects the initiatives’ effects on bank lending. We also argue that a large increase in bank reserves need not be inflationary, because the payment of interest on reserves allows the Federal Reserve to adjust short-term interest rates independently of the level of reserves.”
  • Economists and the Queen: The Guardian reports on the U.K. economists responding to a letter from Queen. “A group of eminent economists has written to the Queen explaining why no one foresaw the timing, extent and severity of the recession. The three-page missive, which blames “a failure of the collective imagination of many bright people”, was sent after the Queen asked, during a visit to the London School of Economics, why no one had predicted the credit crunch. Signed by LSE professor Tim Besley, a member of the Bank of England monetary policy committee, and the eminent historian of government Peter Hennessy, the letter, a copy of which has been obtained by the Observer, tells of the “psychology of denial” that gripped the financial and political world in the run-up to the crisis.”

Compiled by Phil Izzo

The Morning Leverage: KKR’s Many Hats In Dollar General IPO

In this morning’s media roundup:

News: KKR is readying an IPO for Dollar General, the rare portfolio company that has actually done well in the economic downturn. KKR is also making good of its new capital markets team by signing on as an underwriter for the IPO, according to our colleagues at the Wall Street Journal. The paper theorizes that a Dollar General IPO has a two-fold benefit for KKR: possibly netting the firm a 33% return on its $2.8 billion equity investment, and giving it the opportunity to showcase itself as a broader investment bank ahead of its own public debut. Read on here.

Platinum Equity may have lost out to Delphi Corp.’s creditors in a bankruptcy auction, but the firm isn’t quite ready to throw in the towel. It said it looks “forward to working on the next phase of this process with Delphi, its lenders and General Motors.” Perhaps we’ll see another TV Guide-type happy ending?

CVC may be the last firm standing. Re: the sale of AB InBev - TPG out, KKR out, CVC in, according to Bloomberg.

After months of dodging the bankruptcy bullet, Colony Capital’s Station Casinos has filed for Chapter 11. Station’s casinos will continue to operate as usual, but the parent company faces a long haul in bankruptcy as it continues to be at odds with bondholders. Read the Wall Street Journal story via LBO Wire.

Analysis: Proof that lending still hasn’t loosened: Companies in the U.K. paid off more bank loans than they were granted for the first time since 1997, writes the Financial Times. That same bottlenecked financing environment continues to heavily influence PE deal-making on this side of the pond, as is evidenced in this Private Equity Beat post about Apax’s all-equity purchase of Bankrate.

Just for fun: Alright, maybe not fun, but “just for interesting,” is Wired magazine’s piece on pirate economics. As Free Exchange points out, modern piracy is not as swashbuckling as you might think.

Deals of the Day: MicroHoo–Not an M&A Deal, but a Deal Nonetheless

Deals of the Day gathers all the biggest news of the morning related to mergers and acquisitions, bankruptcies, financing and private equity. Deal Journal’s homepage is http://blogs.wsj.com/deals. You can see real-time updates of our posts and our favorite deal-related articles on other Web sites through our Twitter feed at http://twitter.com/wsjdealjournal.

Today in MicroHoo

Just When You Thought You Were Out…: Yahoo and Microsoft agreed to a 10-year search partnership, a deal that ends a protracted dance and unites the pair against Google. [WSJ]

KKR and Dollar General

A Diamond in the Rough: Kohlberg Kravis Roberts is in advanced preparations for an IPO for Dollar General. It will also be a lead underwriter on the deal. [WSJ]

Mergers & Acquisitions

This Bud’s for You and You and…: CVC Capital submitted a $2.3 billion bid to buy part of Anheuser-Busch’s operations in Europe. Other suitors remain interested and the auction continues. [WSJ]
Related: TPG dropped its plan to bid for those A-B InBev operations in Europe. [Bloomberg]

Sumitomo Trust & Banking: The Japanese firm has agreed to buy Citigroup’s Japanese asset manager, Nikko Asset Management, for about $1.1 billion. [Reuters]

The cost of M&A: Petro-Canada and Suncor Energy began notifying executives on Tuesday that they will be laid off following completion of the companies’ $20.6 billion merger next month. [Reuters]

Financial Institutions

Lazard: The investment bank’s second-quarter earnings fell 18%, but results were much better than analysts expected and Bruce Wasserstein sees brightening prospects in the financial industry. [WSJ]

Wells Fargo: The bank’s purchase of Wachovia Corp., meant to bolster deposits and mortgage operations, has deepened the company’s commitment to investment banking as corporate stock and bond sales surge. [Bloomberg]

Numora-Lehman: The Japanese firm has been laboring to integrate the Lehman Brothers international operations, particularly its investment banking. [WSJ]

BofA: A seven-month review by Bank of America of customer usage patterns shows less and less dependence on traditional outlets. [WSJ]

Bankruptcy & Restructuring

Station Casinos: The casino operator sought bankruptcy court protection after months of talks on a prepackaged filing foundered. [WSJ]

Rescue plan: Some CIT investors are complaining that their offer of alternative financing was “largely ignored” by the company, even though it could have provided the lender with up to $6 billion in funds. [WSJ]


TCI: The hedge fund’s three-year battle with J-Power shows the obstacles that overseas investors face in trying to gain a voice in Japanese companies. [Bloomberg]

Capital Markets

IPO Market: After a slow July in the U.S., bankers and investors are preparing for a handful of new-stock issues in August. [WSJ]

Fidelity Investments: The firm will offer its retail investors access to initial public offerings and follow-on deals underwritten by Deutsche Bank in a move to offer clients more opportunities. [WSJ]

Banco Santander: The Spanish bank has appointed advisers to spin off its Brazilian business in an initial public offering that could raise at least $3 billion. [FT.com]

Economists React: Bad News, Good News in Euro-Zone Lending Report

Banks in the 16-country euro zone further tightened their credit standards in the second quarter, and companies and households may even face slightly tougher requirements in the current quarter, the European Central Bank said in a report on bank lending released Wednesday.

The … survey reports that lenders have continued to tighten credit standards across mortgages, consumer credit, and corporate loans. While the net balance of lenders reporting tightening again reduced in comparison to the prior quarter, the survey continues to report a balance that indicates significant net tightening. — Robert Self, Credit Suisse

While the survey keeps showing a net tightening in the banks’ credit standards, the good news is that such figure is lower than in the first quarter, especially for enterprises, where the net tightening broadly halved. Still, the [survey] confirms that both demand and supply factors will result in a restrained lending throughout the remainder of the year and possibly beyond. – Davide Stroppa, UniCredit Research

The key driver behind the tightening in credit conditions in Q2 remained concerns about the economic outlook. The net percentage of banks reporting that access to market financing and their capital position were contributing to rising lending standards also remained in positive territory. But both series are now at or below their pre-credit-crunch levels, suggesting that these factors are not restricting lending as much as they were. – Ben May, Capital Economics

Euro area banks signaled that their access to funding in the money market and the debt securities market was less impaired than in the first quarter, suggesting that governments’ and ECB measures are gradually bearing fruit. Following decent money and credit flows for June, the [lending survey] outcome is likely to comfort the ECB in its “wait and see” mode ahead of its 6 August policy meeting. – Frederik Ducrozet, Crédit Agricole SA

The survey showed a broad based improvement, even though banks continued to tighten their lending criteria in the three months to July. … Tightening is now less widespread: the net percentage of banks that tightened fell to around 20% for both corporate and household loans, less than half as much as at the turn of the year. … Loan demand remained depressed from corporates, but banks reported the first increase in demand for household mortgages in three years. … According to the forward-looking questions, banks intend to tighten their lending standards even less in the coming months and they expect a significant improvement in loan demand, especially from corporates. Finally, the survey suggests that problems with bank capital and funding are receding as a direct constraint on bank lending. – Greg X Fuzesi, J.P. Morgan


Placement Agents Form Lobbying Group

A group of about 25 placement agents has started a lobbying group to address various proposals, including one from the Securities and Exchange Commission, that would effectively ban placement agents from seeking capital from public pension funds.

Several placement agents started talking about an advocacy group two months ago, after bans on their services were put in place at New York State Common Retirement Fund and New Mexico State Investment Council, both of which are dealing with pay-to-play scandals. Now, the SEC proposal has intensified the urgency.

“If this ban does get passed, we not only could lose a lot of business but we could lose our entire livelihood,” said Charles Eaton, founder of placement agent C.P. Eaton Partners LLC, a member of the group. “If we are banned from doing business with all public funds we would be unable to replace the lost business opportunities, since public funds are a large part of the alternative investment industry.”

The group, whose other members Eaton wouldn’t name, sees a need to educate lawmakers and government agencies on the difference between placement agents and “finders,” and to inform them that registered, reputable placement agents don’t approach politicians or participate in political contributions as part of their business model.

The group, which has hired lobbying firm MultiState Associates Inc., has come up with a code of conduct that includes being fully registered with required authorities such as the Financial Industry Regulatory Authority, the SEC, and certain states; full disclosure of the placement firm’s involvement with a particular fund and the specific incentives that the agent will receive; absolutely no contributions or other payments to any politicians or any others in a position to influence the decisions at the institutions; and full compliance with the private-placement rules governing the sale of securities such as limited partnerships.

“Frankly, we already adhere to these codes of conduct,” Eaton said. “It’s what we do every day.”

MultiState has focused on talking with lawmakers in New York state up to now. The ban by the Common Retirement Fund is seen as especially crucial as it might spur other state retirement systems to take similar actions.

“Obviously, the proposed [SEC] action is of great concern, but the language isn’t clear,” said Steve Markowitz, chairman of MultiState, which plans to issue a public statement once the SEC’s 60-day public comment period on the proposed rules commences.

The group is also trying to get general partners, limited partners and investment consultants to come to their defense.

“I think the SEC wants to know what people think and it needs to hear from as many people as possible before a decision is made that will adversely affect not only the placement industry but the entire institutional investment industry,” Eaton said.

For more, read the LBO Wire story.

Point/Counterpoint: Does the U.S. Need More Government Stimulus?

Most economists say that the U.S. economy will return to growth in the current quarter. But the job market is expected to continue to remain under pressure. Some have argued that another round of stimulus is necessary to prop up the job market. Here Laurence Seidman, Chaplin Tyler Professor of Economics at the University of Delaware, makes the point that the costs of a high jobless rate are greater than the price of more stimulus. John Silvia, chief economist at Wells Fargo, responds that more stimulus would be counterproductive as the economy sits on the cusp of recovery.

Laurence Seidman says:

There’s no excuse for letting the unemployment rate stay above 8% all next year when it can be prevented for only an additional 2 percentage points in federal debt as a percentage of GDP.

Yet, according to the respected macro-econometric model of Ray Fair of Yale, that’s just what we’re doing unless we immediately multiply the magnitude of the fiscal stimulus package.  Congress set the magnitude last February when the unemployment rate was 7.6%.  Now the unemployment rate is 9.5%.

There’s no need to renegotiate the components of the stimulus package.  Congress just has to vote to multiply all components of last February’s package by M for the last two quarters of 2009.  I recommend M=4, an injection of $800 billion instead of $200 billion; the Fair model’s forecast for M=4 is shown under “Stronger Stimulus.”

According to the model, M=4 will cause federal debt as a percent of GDP to be only 2 percentage points higher than if there had been no fiscal stimulus due to positive feedback effects on tax revenue and GDP from the fiscal stimulus.

Unemployment Rate
Quarter No Stimulus Current Stimulus Reduction Stronger Stimulus Reduction
2009.2 9.1% 8.9% 0.2% 8.9% 0.2%
2009.3 9.8% 9.3% 0.5% 8.7% 1.1%
2009.4 10.4% 9.4% 1.0% 7.8% 2.6%
2010.1 10.7% 9.3% 1.4% 7.1% 3.6%
2010.2 10.8% 9.1% 1.7% 6.7% 4.1%
2010.3 10.8% 8.8% 2.0% 6.7% 4.1%

John Silvia says:

We have heard repeated calls for another stimulus to jumpstart the economy; however, these proposals are poorly positioned to set the economy on a sustainable, noninflationary growth path.

First, the context of another stimulus would be different, as the economy has begun to stabilize.  Another fiscal stimulus would only amplify the cycle, creating risks for interest rates and inflation, with significant global monetary easing already in place.  Recent trends in the dollar and federal deficit have raised concerns from foreign investors on the sustainability of U.S. policy.  The impact of another stimulus in a changed economy runs the risk of steroid induced, short-run growth at the cost of significant long-run losses of economic muscle.

Second, Washington policymakers have failed to recognize structural change in the economy and continue to push pro-cyclical policies.  The first stimulus emphasized short-run job gains with temporary funding that are unsustainable.  The push to restart consumer spending, despite risks of renewed leverage, will only delay the necessary increase in national saving required to meet future federal deficits.

Third, the initial Obama Administration stimulus needs more time to work.  Politicians are quick to overpromise to American voters were eager for solutions, but in a society of microwave meals, the economy is a slow cooker.  Despite estimates from the nonpartisan Congressional Budget Office (CBO) that most of the stimulus impact would not begin before late 2009, politicians promised returns far sooner.

Finally, policy-makers are acting at cross purposes.  Feared costs of proposed policy on healthcare, energy and taxes outweigh uncertain future benefits, freezing both hiring and investment decisions.  While some policy initiatives may benefit society in the long run, the costs of uncertainty today are astronomical.  Moreover, earmarks, the cost of passage for the last stimulus, use taxpayer funds inefficiently.  Another stimulus would require further political grease.

Cowing Potential Targets With The Threat Of A Traditional LBO

Bankrate Inc. has filed a load of documents with the Securities and Exchange Commission relating to Apax Partners’ pending purchase of the personal finance Web site. Most interesting amidst all the shareholder lawsuits, valuation calculations and tender offer documentation is some background on the transaction that shows starkly the impact that a lack of debt financing is having on the M&A world.


The documents show that Bankrate has been toying with the idea of a sale off and on since June 2007 - or, roughly when the credit crunch was just kicking in - in response to “inbound inquiries.”

Talks with Apax Partners were proceeding somewhat seriously in the summer of 2008, but the bankruptcy of Lehman Brothers Holdings Inc. brought the process to a screeching halt for a few months. Discussions picked up again in April of this year, as Bankrate, worried about how to bulk up given a perceived lack of access to capital, went back to Apax and one other private equity firm referred to as “Party A” in the filings.

Apax made an all-equity offer of $30 a share on June 16, which would have worked out to roughly $601 million total, according to some back-of-the-envelope calculations. The company tried to push for an increase to $33 a share - or in the ballpark of $661 million, an increase of just $60 million - but Apax balked.

According to the filings, it said that in order to “even consider such a significant increase in price, Apax would need to change the proposed transaction structure to a more traditional leveraged buyout transaction.”

Throwing the word “leverage” around like that caused some trauma to Bankrate, which appears to have concluded quite rapidly that “introducing leverage into the potential transaction would create a high and undesirable level of uncertainty as the cost of possibly obtaining a higher price.”

It might seem that Apax - which did bump up its price by 50 cents, to $30.50 - was playing hardball here, but then again, why shouldn’t it? Consider that the mysterious Party A never made an offer, and in fact indicated to Bankrate that it would not be able to do so “at a price level that would be competitive with that of Apax’s proposal.” Consider also the pressure that Bankrate was under to do the deal, since it already knew its second quarter and year results were going to miss the mark, a factor that ultimately caused Apax to revise its offer down to that final $28.50-a-share level.

Bankrate ultimately acquiesced to that price level after insisting on a few conditions that would give it more rights if anything went wrong. Its language in the following paragraph gives some insight into Bankrate’s thinking:

After discussing “the market and competitive environment, including among other things recent and projected future financial results, the timing of Bankrate’s upcoming announcement of second quarter results, the likely market reaction to that announcement, the likely impact on Bankrate’s stock price and the likely duration of that effect given market conditions, and Bankrate’s ability to pursue its plan and make strategic acquisitions as an independent company, especially if Bankrate’s stock price were to decline following the announcement of weak second quarter results…the Bankrate board of directors determined that given that the likelihood of Apax raising its offer price was low, Bankrate would be willing to proceed with a transaction at Apax’s offer of $28.50 per share.”

Geithner: China Needs to Be Less Dependent on U.S. Consumer

Treasury Secretary Timothy Geithner said China will have to adjust its economy to be less dependent on the U.S. consumer as Americans go back to “living within their own means.”

Mr. Geithner, speaking at a dinner marking the end of two days of discussions between the U.S. and China, said the Asian giant is embarking on “a remarkably ambitious set of reforms” that will see China grow more from consumer demand than exports.

He added that both countries have taken big steps towards repairing the global economic crisis through a series of stimulus packages and reconstruction efforts that will put the U.S. and China “on a path to a more balanced and sustainable recovery in the future.”

Meanwhile, China’s state counselor, Dai Bingguo, took aim at the elephant in the room, saying that China is not planning to use its military or economic might to challenge the U.S.
Mr. Dai said China was not “biding its time” and did not have “some hidden agenda.” Americans, he said, “should not lose any sleep over China.”

The U.S.-China Strategic and Economic Dialogue is a forum designed to foster closer cooperation between the two global powers. At its close, both vowed to maintain efforts to pull the global economy out of recession and shore up financial markets. They also agreed on a plan to create more balanced global growth in the future.

Much of the discussion was dominated by continuing Chinese concerns about the U.S.’s growing pile of debt. Chinese Vice Premier Wang Qishan, in talks with Mr. Geithner and other officials, urged the U.S. to protect the value of the dollar. Mr. Geithner played down the topic, saying the two countries were on the same page when it came to the need for emergency measures to help bring the world out of recession.

The Little Known Banks Advising Sprint-Virgin Mobile

Who are these guys anyway?

With a few exceptions, Sprint Nextel’s acquisition of Virgin Mobile USA involved a cast of advisers that aren’t household names in the M&A world.

Sprint Nextel was advised by Wells Fargo Securities, which didn’t crack the top 30 on Dealogic’s rankings of investment banks by announced U.S. deal volume through July 21. Most of Wells Fargo Securities’s investment bankers come from Wachovia, which Wells acquired last year.

Two little known firms, Foros Advisors LLC and Colonnade Advisors LLC, provided a fairness opinion for Virgin Mobile.

Dealogic has no record of Foros advising on any deals over the past five years. (Deal Journal couldn’t even find a listed phone number for the firm). It turns out that Foros is a tiny operation that was recently started by Jean Manas, Deutsche Bank’s former head of mergers and acquisitions for the Americas.

Colonnade, which is based in Chicago, has advised on 17 small deals — mostly under $50 million — in the past decade, according to Dealogic. Colonnade was started by former J.P. Morgan banker Stuart Miller.

Deutsche Bank also advised Virgin Mobile. As of July 21, Deutsche Bank ranked 11th in announced U.S. deal volume, according to Dealogic.

Evening Reading: Why Did GM Spin Off Delphi?

“I can’t live if living means without you”: It’s been a long slog through bankruptcy for Delphi. Today the auto-parts maker’s lenders prevailed in a bankruptcy auction and are poised to take control of the bankrupt auto-parts supplier. But as Matthew DeBord writes over at the big picture: “Through all the gyrations and the endless bankruptcy, nothing much has changed: GM still can’t afford to lose Delphi, and Delphi still can’t afford to be liquidated. So did it really make sense to spin Delphi off in 1999? Of course not. But that’s what Wall Street wanted, and that’s what Wall Street got. One can never underestimate the finance business’s hatred for old-line vertically integrated companies.”

I don’t want to play in this game any more: Wilbur Ross was once a big proponent of investing in banks. These days? Not so much. Well, at least not under the rules the FDIC has proposed for private-equity firms to invest in banks. “I assure you that my firm will never again bid if the proposed policy statement is adopted in its present form,” he wrote in a letter to the FDIC as part of the regulator’s public- comment process for the rules issued July 2. That’s quite an about face for a man who attended Sheila Bair’s roundtable discussion in early June and walked away calling the meeting “highly productive,” writes Erin Griffith.

Cha-Ching: Zappos.com Inc. CEO Tony Hsieh was reportedly opposed to his firm’s deal with Amazon. But whether he was or not, he certainly stands to have a pretty good pay day — $214 million, Dealscape reports.

Goldman Bashing: There’s little doubt that Goldman Sachs would prefer nothing more than to have its name out of headlines. That, however, does not seem likely to happen. The latest piece comes courtesy of Michael Lewis, who offers up a tongue-in-cheek examination of the many rumors about Goldman. And Lewis had to address the most vicious rumor floating around about Goldman: That it’s “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

Writes Lewis: “For starters, the vampire squid doesn’t feed on human flesh. Ergo, no vampire squid would ever wrap itself around the face of humanity, except by accident. And nothing that happens at Goldman Sachs — nothing that Goldman Sachs thinks, nothing that Goldman Sachs feels, nothing that Goldman Sachs does –ever happens by accident.”

Current Recession Offers Redemption to Tech Industry

Information and communications technology companies, whose bust dragged down the world economy in 2001-2002, are much less of a problem and much more of the solution in the current recession, a report by the Organization for Economic Cooperation and Development suggests.

The ICT industry — which includes anything from manufacturers (think Intel Corp.) to software firms (Microsoft Corp.) to Internet companies (Google Inc.) — took a hit from slumping global demand, but it is showing signs of a rebound, the OECD found. After a “tough start to 2009” with nearly all performance indicators plunging in the first quarter, sometimes as much as 40% from year-ago levels in Japan, Korea, China and other Asian economies, the industry has seen “positive month-on-month growth for most countries, and inventories running down sharply” in May and June.

Asian firms, particularly in Japan, Korea, Taiwan and China, are leading the sector’s recovery. Though production drops were generally sharper in this downturn than in 2001-2002, so was the rebound in the first quarter of 2009. Even Europe and the U.S., where analysts haven’t yet spotted strong signs of recovery, appear to have at least bottomed out, the OECD noted.

And the upturn looks likely to hold up. Unlike financial-sector firms, which were at the center of the economic cyclone this time, most ICT companies have learned the lesson from the dot-com bust and were “in a much stronger position to survive” and continue to invest in innovation thanks to large cash-to-debt ratios on their balance sheets, the study wrote. One notable exception was Microsoft, which had $23 billion in net cash in the first quarter of 2009, down from $39 billion in 2002. In July the software giant posted a 29% decrease in quarterly profit, marking its “first full year of declining sales since it went public more than two decades ago,” the Wall Street Journal reported.

But the industry didn’t just weather the economic storm better than it did a decade ago. This time it will also be a key component of the global economic recovery. The ICT sector, in fact is poised to play a large role in long-term investment projects funded with stimulus money, the OECD noted. From Australia to the U.S., OECD countries, which include the largest industrialized economies, and major non-OECD nations, like China, are betting on expanded broadband access and new, high-speed communication networks to spur lasting national economic growth and development. The U.S. alone plans to spend $7.2 billion to put broadband into rural households, schools, libraries and health-care providers. Some OECD countries, even have a separate “broadband stimulus plan” running parallel to a recovery package; in Italy, for example, that’s valued at around 1.25 billion euros ($1.77 billion).

Deal Journal Video: An SEC Trial of the Heart

How did a love affair lead to convictions in an insider-trading case?

In his column today, Deal Journal’s Dennis K. Berman tackles the story of an Ernst & Young partner, who went in search of an affair and ended up in with six counts of securities fraud. The ordeal comes at a time when the number of insider-trading cases are on the rise — they reached an all-time high in 2008. It also opens up a rare, intimate portal into how life really happens, and how it gradually, almost unexpectedly, can veer out of control.

Evan Newmark and Berman discusses the case.

Home Prices, Jobs Will Come Back Sooner in Some States Than Others

Today’s home-price data offered some hope that the worst of the economic storm has passed, but they are also a stark reminder that not all regions of the U.S. are equal.

Home prices often are discussed on a national basis. Easy credit earlier this decade was a trend that spanned the country, boosting home prices nearly everywhere. But some markets were more bubbly than others. For example, the huge runup in places like Las Vegas and Miami weren’t mirrored in Cleveland or Dallas, which saw more modest rises, or Detroit, which is facing a housing bust without ever having a boom. Meanwhile, as the financial crisis hit the entire country and credit started to dry up, everyone was affected, but the pain isn’t equal all over.

If the banking system has indeed stabilized, and the national story for home prices fades, the markets’ regional faces will begin to take over. Metro area unemployment (which will see new data released tomorrow) and regional inventories of unsold homes will be more important than national lending standards.

The recession, like the housing market, has had a national reach, but IHS Global Insight points to disparities across regions. “The District of Columbia and Texas have been somewhat insulated from the worst of this recession, thanks to heavy concentrations in federal government and energy, along with their lack of a major housing bubble. Those two will lead the recovery and gain back their lost jobs the quickest,” IHS economists wrote in a research note. Meanwhile, “Numerous states in the Northeast and Midwest … have suffered severely and will not regain those jobs anytime soon. By the end of its recession next year, Michigan will have lost nearly 13% of its job base since 2005; it will need more than a decade to replace them.”

The following chart provides IHS estimates for when each state will return to pre-recession levels for jobs:

State Return to prerecession job level
Alabama 2013
Alaska 2011
Arizona 2014
Arkansas 2012
California 2013
Colorado 2012
Connecticut after 2015
Delaware 2013
District of Col 2010
Florida 2014
Georgia 2013
Hawaii 2012
Idaho 2012
Illinois 2015
Indiana after 2015
Iowa 2013
Kansas 2012
Kentucky 2013
Louisiana 2012
Maine 2014
Maryland 2012
Massachusetts 2013
Michigan after 2015
Minnesota 2013
Mississippi 2013
Missouri 2012
Montana 2011
Nebraska 2012
Nevada 2013
New Hampshire 2012
New Jersey 2013
New Mexico 2011
New York 2012
North Carolina 2013
North Dakota 2011
Ohio after 2015
Oklahoma 2012
Oregon 2014
Pennsylvania 2012
Rhode Island after 2015
South Carolina 2012
South Dakota 2012
Tennessee 2013
Texas 2011
Utah 2011
Vermont 2015
Virginia 2011
Washington 2012
West Virginia 2014
Wisconsin 2014
Wyoming 2014

Source: IHS Global Insight

Bernanke’s Wealth Drops Amid 2008 Market Plunge

The bloodbath on Wall Street last year appears to have claimed one more high-profile victim: U.S. Federal Reserve Chairman Ben Bernanke.

[Ben Bernanke]

His wealth took a hit last year, according to financial disclosure forms released by the Fed Tuesday. As of the end of 2008, Bernanke’s asset holdings were between $850,000 and $1.9 million. That compares to a $1.2 million-$2.5 million range the year before.

A good deal of Bernanke’s hit came from a large-cap stock variable annuity he holds, whose value dropped from between $500,000 and $1 million at the end of 2007 to $250,000-$500,000. Bernanke’s Vanguard international growth fund also lost value.

Bernanke sold Canadian government bond holdings in two transactions last July and November.

Warburg’s David Coulter On Webster Financial And The FDIC

Warburg Pincus announced a deal Monday to invest $115 million in Connecticut bank Webster Financial Corp. This is the firm’s first major bank deal in years. Unlike many other private equity investors that have put money into banks lately, Warburg chose to purchase common stock in Webster that will give it a minority stake, without any backing from the Federal Deposit Insurance Corp. We caught up with David Coulter, co-head of Warburg’s financial services investment team, for his take on the investment and on bank investing in general.

David Coulter

Why did you invest in Webster?
In the long term, we are optimistic about the banking sector. We know there is more regulation and more transparency. But a very good and solid regional banking franchise is still an attractive long-term investment. Webster is a well-run regional bank that’s close to its customer base. Also, this is still an attractive time in terms of valuation. We looked at a lot of banks. The issue was where is the economy and where is the bank in the economic downturn. It took us a while to find a regional bank that we have good understanding about. Webster’s management is also open to having a partner like us.

Why is the investment structured as a common equity injection?
Half of the deals Warburg does are for minority positions. The reason this deal is structured as common stock is because that’s what the company wanted. People nowadays focus on different capital ratios including tangible common equity ratio, and the company wanted to solidify that.

What kind of exit strategy do you have in mind for Webster?
We definitely think long term here. If we like an investment, we can like it for a long time. For example, we have owned a stake in [insurance company] Arch Capital Group since 2001, and over time, we distributed shares of Arch to our limited partners. We might do that with Webster as well. That’s an elegant way to exit.

Why did you take this route, rather than investing in a failed bank or a healthy community banks, as many other private equity firms are choosing to do?
Webster is not a government-assisted deal. We are definitely much more focused on healthy institutions. We do not invest in community banks because their market capitalization is too low to allow us to put sufficient capital to work.

What do you think of the Federal Deposit Insurance Corp.’s proposed guidelines for failed bank acquisitions?
In an assisted deal, the government is playing a big role. In return for that role, [it’s natural for the government] to have restrictions on the investors. Everybody will come out with comments based on their own position. We are watching closely how those guidelines will play out. We participated in a roundtable discussion hosted by FDIC earlier this month, and we are definitely part of the conversation.