Business: Investment Banking 2.0 – What’s Next? January 24, 2008Posted by John in Technology.
Tags: andy kessler, business, investment banking, investment banks, wall street
My good friend Andy Kessler wrote an OpEd piece today for the WSJ on What Happened to the Banks? It’s worth a read if you’re in tech and want to understand the dynamics of banking and Wall Street. Andy had a great perspective given he’s been in Wall Street and ran a successful hedge fund. His view is that the future of banking will be “firms that successfully combine banking and investment banking will walk away with the prize..”.
As the next cycle of tech innovation comes Internet 2.0 the banking business better get their act together so entrepreneurs (and investors) can secure capital, get liquid, and make some money.
Note: Andy Kessler is the author of many leading books about Wall Street: Wall Street Meat; Running Money, How We Got Here; and End of Medicine. Andy is a contributing writer to both the NY Times and Wall Street Journal.
Below is the reprint of his blog post in full (too good not to post) – Great insight. Thanks Andy. Andy’s blog is here.
Investment Banking 2.0 – By Andy Kessler
If you want to know what’s going to happen to the big banks and investment banks, you’ve got to go back to early 2003, when the seeds of destruction were planted.
It had been a year or so since a couple of trillion dollars of investor wealth had been wiped out. The Dow was 8000 and dropping, and the stocks of big institutions from Citi to Merrill Lynch to Morgan Stanley were at multiyear lows. Bank lending was down, but no one was really worried. The old “borrow short, lend long and pocket the difference” game had been around for millennia, and banks had weathered worse than this mild economic slowdown.
What was not at all clear was how investment banks were going to make money going forward. Wall Street had piles of capital and no place to go. Stock trading and large parts of bond trading had gone electronic. Decimalization of the stock market wiped out markups. IPOs were down, mergers were down and, gasp, bonuses were way down.
Stocks were out and investors wanted yield — safe, predictable returns — but there wasn’t much profit in that. Some, especially hedge funds and international investors, insisted on even higher yields than plain old government bonds.
So Wall Street, as it always does, gave investors what they wanted — excess yield in the form of derivatives, asset-backed, mortgage-backed, collateralized debt obligations (CDOs), basically funky amalgamations of lots of other pieces of paper. Done right, no one but you knew how to value these exotic instruments, so you could mark them up way more than a penny and generate huge fees, profits and bonuses. Win-win.
Low interest rates from the Federal Reserve and a rising housing market meant the subprime flavors of these CDOs took off like wildfire. Merrill Lynch and Bear Stearns and everyone else raced to package up these CDOs with pretty bows and sell them off as high rated goodness to those hungry for yield.
Banks loved it because they could sell off loans, generate fees and go make some more. It wasn’t enough. Billion-dollar hedge funds popped up overnight to buy these things, with leverage on leverage to generate even higher returns. Savings & Loan banks were long gone, so by 2006, armies of mortgage brokers, many just online, answered the call to feed the beast with loans.
Until it went on for too long. By 2006, it was a one-way trade. Banks, especially Citigroup and State Street, couldn’t resist the sweet siren’s call, especially with “borrow short, lend long” in their DNA. Off balance sheet, they set up conduits, so-called SIVs, to use leverage and buy up lots of these subprime CDOs — $100 billion worth for Citi — breaking Wall Street’s unwritten “sausage” rule that you sell this stuff to clients, but never own it yourself.
SIVs were mostly invisible yet huge money makers, which makes me question how much money the plain old bank was making. Not much, it turns out. And in the end, neither did these SIVs. Others like Merrill Lynch and UBS got caught with inventory of these CDOs, having packaged them but not able to sell them off fast enough. Goldman Sachs smelled spoiled meat and shorted enough of the market to minimize the hit to their capital structure.
When the inevitable blowup came, most holding the toxic sausage required new capital from a government bailout to survive. No not from the Fed, but from the governments of China, Singapore, Abu Dhabi, Kuwait and New Jersey. Without their cash, Citi and Merrill stocks would halve again.
But that’s old news. What about going forward? First, no one, and I mean no one, is going to buy a package of loans without knowing what each and every one of them is, what the risk of default is, etc. Rating agencies can no longer be trusted. The good news is that the same computer technology used to create CDOs can easily be extended to offer this needed transparency, loan by loan. But the bad news for investment banks: The packaging game just won’t be as profitable.
So who has the strong hand? As always, it’s a capital game, whoever accumulates the most will be best positioned for what’s next.
Banks? Sure, they’re slow and steady, but lending is dull, not that profitable, as we have seen, so growth is limited. While Citigroup fiddles, JP Morgan is the model, as one of the few big banks to not load up on CDOs to enhance earnings. Instead, it has been quietly accumulating billions in hedge fund assets.
Investment banks? Balance sheets are now mostly cleaned up, but outside of Goldman Sachs, management teams are under scrutiny to see who can come up with the right business model away from CDOs. It won’t be until that model becomes clear that their stocks can go up enough to raise serious capital to compete. Not all will.
How about hedge funds or private equity? Lots of money will be made buying distressed debt at the bottom of this cycle, but most of it by firms that are small partnerships on a relative basis, and I don’t see them gearing up huge sales forces to become big players. But that can be fixed.
My view is that firms that successfully combine banking and investment banking will walk away with the prize, by being able to offer a full range of services to clients — short-term loans against assets or receivables as well as bonds and equity for long-term projects, the kind of underwriting and trading that requires large amounts of capital. The inevitable consolidation that should have occurred after Glass-Steagall (the 1933 law that separated banks and investment banks) was repealed in 1999 had been on hold while everyone chased easy profits. But now the shakeout is here.
Goldman Sachs will own a bank, maybe even Citigroup (Goldman’s $85 billion market capitalization might be able to swallow Citi’s $125 billion value) and strip it down to what it needs. JP Morgan should reunite the House of Morgan by merging with Morgan Stanley, and become a full-service powerhouse. But JP Morgan could buy Merrill or Lehman or Bear Stearns instead. Bank of America will merge with who’s left. But don’t count out others who have done well with capital. Fortress Investment Group, despite a rocky IPO a year ago, has a powerful real estate arm that could own loan origination and servicing and enough assets to buy its way into the banking or investment banking business. Same for the Blackstone Group.
Capital flows a lot more fluidly around the globe these days. Expect consolidation to start now. The real winners on Wall Street will be the ones with huge stockpiles of capital who listen to the market, and who are fleet of foot enough to smell out and deploy their capital creating instruments that global growth companies need, rather than false profits from eating their own sausage.
The Big Five?: Goldman CitiSachs, House of Morgan, Bear of America, Fortress Lehman Lynch and Blackstone Suisse.
Tech Stocks STX: CEO Bill Watkins – He Gets No Respect January 23, 2008Posted by John in Technology.
Tags: bill watkins, business, earnings video, john furrier, on demand technology, seagate, stx, technology business
Bill Watkins has Seagate pumping but he gets no respect from Wall Street. Cnet’s Charles Cooper has a very good interview and story with and about Bill Wakins, the CEO of Seagate.
I’ve been doing an earnings podcast with Bill for most of the last 6 qtrs and have watched how he’s managed to keep Seagate focused. He’s navigated Seagate through price wars, product changes, big acquisitions, and now a sagging Dow. He’s like Rodney Dangerfield of tech stocks – “he gets no respect”.
Here are some of the earnings podcasts that I’ve done with Bill Watkins. The best part of web 2.0 media is the historical record or archive. Lets take a listen to Bill over the past two years.
Here is the CEO Bill Watkins – story since 2006. On the record with me on his company and his performance. With Seagate generating over $700 million in cash, over $500 million in free cash, no inventories, and double-digit growth, what will it take for Wall Street to wake up. Bill keep on podcasting.
Storage Business: Record Everything for Seagate – Is it Breakout Time for the Stock? October 16, 2007Posted by John in Technology.
Tags: business, earnings video, john furrier, seagate, seagate q1, technology business
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The storage business is red hot. Why? We all need more storage. Seagate puts out their earnings and yesterday I sat down with Seagates Chief Sales and Marketing executive, Brian Dexheimer, to preview today’s Q1 earnings result. Sales are soaring. Here is Seagate’s press release.
The results were awesome for Seagate. Record everything…shipments, revenue, net income, industry shipments, new products,..etc. The stock has been hovering and seeing a resistance at and around $28 per share for two years. Will it break through and go higher and higher? We shall see. The disk drive business is changing and so is Seagate.
Highlights from my video podcast with Brian Dexheimer:
- 132 million units a record for the industry
- shipments represent 36% of the entire industry shipments
- margin expansion 25 points
- $3.3 billion in revenue
- 60 cents EPS (non gaap); started at 44 cents at the beginning of the qtr
- pricing dynamics – best conditions in all of the past 4 quarters
- demand was strong
- strongest trend in the overall growth is in the high capacity area
- hottest area is the digital home
Seagate is seeing the results of the Maxtor acquistion in terms of leverage and scale in the gross margin expansion – operational efficiency. Solid state disk drives will be upcoming on the horizion. Branded products up and the upcoming qtr looks strong. New security solutions are doing well with the demand for secure data. Average sale for the consumer side is over 350 GB.
Seagate has a strong presence in the consumer, enterprise, and the emerging web 2.0 service provider area. The web 2.0 service provider area includes Google, Facebook, Myspace, and many new niche applications such as surveilllance among others.
Seagate has a secret weapon. Green Disk Drives. Green drives are a major growth area. On the clients side the hybrid is looking good – combing flash and rotating storage to reduce the power budget of the PC which frees up battery life and screen life.. On the enterprise side there is a tremendous shift toward small form factor devices. These devices are consuming 35% less power and 40% of all their shipments came in the area of the new form factor.
The industry is still cyclical, but the cycle has dampened – lower lows and higher highs. This is due to the consolidation in competition and in the supply chain components available (motor, heads, media, etc). This leads to efficiencies and scale that gives Seagate more margin room. Also it gives Seagate stabilized component prices, fewer competitors, and allows them to gain more scale and more efficient business models from the stability in competition and critical component prices. The storage business is turning into a major growth sector.
Price wars? There is a change in behavior in pricing from competitors.
What’s different? Seagate has multiple business growth areas. Single biggest trend is in the digital home – 70-80% growth and it’s early. Storage deployment in the home is a nice growth area to compliment their traditional enterprise area. Add the consumer electronic market and Seagate is now twice as big. Seagate will approach $13 billion this year.
Seagate is breaking out and breaking records.
Here is the video of my exclusive interview with Brian DexHeimer
On the strength of 47 million disk drive shipments, the Scotts Valley, Calif., company reported revenue of $3.29 billion, vs. $2.79 billion in the year-ago period. Analysts polled by Thomson Financial expected revenue of $3.22 billion.
Seagate reported GAAP net income of $355 million, or 64 cents per diluted share. Excluding charges associated with the company’s acquisitions of Maxtor and EVault, Seagate earned $385 million, or 69 cents a share. Analysts predicted earnings of 64 cents a share.
“The first fiscal quarter has historically been a strong one for Seagate, and this year, we benefited from unit demand greater than expected,” CEO Bill Watkins said in a company statement. “We believe we are well positioned to continue driving year-over-year revenue growth, and these record quarterly results demonstrate the effectiveness of Seagate’s business model.”