Thursday, April 30, 2009

Cessna: The Other Shoe Has Dropped

On April 24th, the Wichita Eagle's Molly McMillin reported a rumor of another possible 2,800 layoffs at Cessna.

Today, she writes,
"Cessna Aircraft announced more production cuts and another 2,300 layoffs Wednesday as business jet cancellations continue to pile up during the down economy.

"Cessna issued 60-day layoff notices to 1,600 workers at every level of the company on Wednesday, including 1,300 in Wichita.

"Cessna also will issue layoff notices to 700 salaried employees by mid-June, the majority of them in Wichita."

The great general aviation bubble of 2007 has burst with a nasty splash. Earlier McMillin had written that business jet usage is down dramatically quoting UBS Securities analyst David Strauss, "Domestic and international business jet usage was down 30 percent in March and 30 percent for the first quarter of 2009."

Thus the accelerator's vengeance is visiting the industry. Moreover, cancellations are eating into the general aviation industry's backlog as the corporate jet has become the leprosy bell of gray flannel America.

Why is Textron so keen on cutting jobs at Cessna?

First, as I have written previously, 2007 is looking like it was a bubble year for the aircraft industry and specifically for the general aviation industry. The industry seems to have over expanded in 2008. Boeing, Spirit's biggest customer, in contrast, expanded production more cautiously in 2008. Spirit has used various strategies to preserve its talented workforce with considerable success.

Textron, Cessna's owner, says it has no plans to sell Cessna. McMillin quotes CEO Lewis Campbell: "Given the success we have had with the Textron Financial liquidation so far, and given the recent sale of two high-value assets and other cash-production opportunities, I feel now that it's highly, highly improbable and unlikely that we'll ever have to divest of any more assets."

Yet Textron itself is in play. Cutting jobs and costs is one way to try and boost profits in a lousy market and try to get the stock price high enough to keep the wolves at bay. I suspect Textron management may more worried about keeping their jobs than the state of their shareholders' wealth.

If the parent is sold, Cessna will be cut off from the defense end of Textron's portfolio.

On April 9 2009, the Financial Times' Justin Baer and Julie MacIntosh reported that, "Shares of Textron soared by 49 per cent amid speculation the industrial conglomerate could be broken up and sold to a consortium of Middle East and US investors.

"Al-Watan, a Kuwaiti newspaper, reported on Thursday that a United Arab Emirates group was close to a deal to acquire Textron, whose businesses range from Cessna aircraft and Bell helicopters to E-Z-Go golf carts, for $21 a share, or more than $5bn. The buyers would then find a US company to take over Textron’s defence division

Before the price jump, the market was valuing Textron's shares at $2 billion. After the price rise, they were worth $3 billion. Textron has about $10 billion in debt.

Baer and Julie MacIntosh reported, "Industrial bankers have long held the view that there is no single buyer for Textron because of its incongruous mix of aerospace and defence assets, the struggling financial division and an industrial business that builds products including golf carts and tools."

Bob Tita in the Wall Street Journal notes, "Industry observers predicted that any purchase of Textron's civilian aircraft business by a foreign consortium would have to be accompanied by the acquisition of Textron's military business by a U.S. company at the same time."

Might Boeing wind up owning the military piece of Textron? Tata wrote, "Loren Thompson, a defense analyst for the Virginia-based Lexington Institute, said Boeing Co. would likely be the frontrunner for the military business. The aerospace giant is already a partner in the production of the Osprey. 'The military operations would be a good fit with Boeing.'"

And what about the Wichita economy?

Wichita State's forecast of higher employment in 2009 than 2008 looks wildly optimistic. WSU's Center for Economic Development and Business Research (CEDBR) in its Barton School wrote "Employment in 2009 is expected to remain relatively flat with a gain of 0.3 percent, adding 3,829 jobs."

Cessna is no longer our number one employer: Spirit now is.

And yes, management makes a difference.

Wednesday, April 29, 2009

GDP Dropped at a 6.1% Annual Rate; Final Sales Down c.3.3%

The GDP numbers are out for the first quarter. The Commerce Department's Bureau of Economic Analysis announced GDP declined at a 6.1 percent seasonally annual rate. The acceleration of the decline in inventories knocked 2.8 percentage points off of that annualized growth rate. Final Sales declined at a 3.3 percent seasonally annual rate.

Declines in investment spending accounted for more than the total decline in GDP.

Prices, as measured by the GDP price deflator, rose 2.9 percent (2.0 percent without food and energy.) Inflation is not dead.

On the bright side, such a massive inventory fall should be self correcting to some degree. Import declines more than offset the small fall in exports. Net exports on net contributed back almost two percentage points to the negative growth rate in GDP.

The decline in GDP was worse than the 5.0 percent consensus expectation.

Yes, I am sticking with my prediction thet the U.S. economy hit its trough in March. The magnitude of the inventory correction is in line with my scenario.

How Business Schools Have Failed Business

How Business Schools Have Failed Business

Why not more education on the responsibility of boards?

Wall Street Journal: April 24, 2009

By Michael Jacobs
As we try to understand why our economy is so troubled, fingers are increasingly being pointed at the academic institutions that educated those who got us into this mess. What have business schools failed to teach our business leaders and policy makers? There are three profound failures of sound business practices at the root of the economic crisis, and none of them have been adequately addressed by our business schools.

Just about everyone agrees that misaligned incentive programs are at the core of what brought our financial system to its knees. Countless individuals became multimillionaires by gambling away shareholders' money. Incentive systems that rewarded short-term gain took precedence over those designed for long-term value creation.

We could chalk this all up to greed, as many pundits have. But first we should ask how many of the business schools attended by America's CEOs and directors educate their students about the best way to design management compensation systems. Amazingly, this subject is not systematically addressed at most business schools, and not even discussed at others.

Secondly, as Washington scrambles to restructure the financial regulatory system, those who still believe in the private sector are asking why corporate boards were AWOL as institution after institution crumbled. Why did it take rumors of nationalization and a drop in Citicorp stock to below $2 a share to inspire Citigroup to nominate directors with experience in financial markets?

American icon General Electric was stripped of its coveted AAA-rating because of problems emanating from its financial services unit. Yet its board has only one director with experience in a financial institution. If it is the board's job to oversee a corporation, it seems logical that there would be a segment in the core curriculum of every business school devoted to board structure, composition and processes. But most programs don't cover the topic.

The third breakdown came in the investment community. Nearly 20 years ago I wrote a book titled "Short-Term America" that warned about the growing chasm between those who provide capital and the companies who use it. The concept is simple: When money provided to homeowners or businesses comes from an anonymous source, possibly half way around the world, there are serious challenges to operating a functioning system of accountability.

Nationally, finance departments at business schools offer hundreds of courses in asset securitization and portfolio diversification. They have taught a generation of financial leaders that risk can be diversified away. But in their B-school days, few investment bankers examined the notion of "agency costs." That concept explains that as the gulf between the provider and the user of capital widens, the risks involved with selecting and monitoring the participants in the portfolio increase. It should come as no surprise that financial institutions amassed securities that consist of a diversified portfolio of deadbeats.

About 70% of the shares of American corporations are held by institutional investors such as pension and mutual funds. These organizations are brimming with MBAs. But how many of these MBAs took a class devoted to how shareholders should exercise their rights and obligations as the owners of America's corporations? Few, if any. When shareholders are uneducated about their obligations, how can a corporate accountability system function properly?

Recently, when I delivered a guest lecture at another school, a distraught-looking student pulled me aside after class. She explained that my talk was very disturbing to her. After investing two years and $100,000, she was only weeks away from receiving her MBA. But prior to our class, she had never heard a discussion about board responsibilities or the rights of shareholders. She said she felt cheated.

By failing to teach the principles of corporate governance, our business schools have failed our students. And by not internalizing sound principles of governance and accountability, B-school graduates have matured into executives and investment bankers who have failed American workers and retirees who have witnessed their jobs and savings vanish.

Most B-schools paper over the topic by requiring first-year students to take a compulsory ethics class, which is necessary, but not sufficient. Would Bernie Madoff have acted differently if he had aced his ethics final?

Could we have avoided most of the economic problems we now face if we had a generation of business leaders who were trained in designing compensation systems that promote long-term value? And who were educated in the proper make-up and responsibilities of boards? And who were enlightened as to how shareholders can use their proxies to affect accountability? I think we could have.

America's business schools need to rethink what we are teaching -- and not teaching -- the next generation of leaders.

Mr. Jacobs, a professor at the University of North Carolina's Kenan-Flagler Business School, was director of corporate finance policy at the U.S. Treasury from 1989 to 1991.

Tuesday, April 14, 2009

PPI and Retail Sales Down

The Bureau of Labor Statistics reported that the Producer Price Index (PPI) for finished goods fell 1.2 percent in March (0.0 excluding energy and food): that is 3.5 percent below a year ago. PPI for intermediate goods fell 1.3 percent and for crude goods .3 percent.

The Commerce Department announced Retail and Food Sales fell 1.1 percent in nominal terms. Autos and auto parts lead the decline with a 2.3 percent decline. Note this is in nominal terms. If consumer prices also fell this would reduce the decline in real terms.

Since the number of cars sold in March rose, there must have been a substantial fall in some combination of the prices or the richness of the mix of cars to produce the decline in dollars spent on cars and parts. Retail Sales of automobiles and light trucks and automotive parts were down 2.3 percent based on an 8.5 percent increase in vehicle sales offset by a 9.7 percent fall in dollars spent per vehicle sold.

This could provide a nice bottom for the recession trough.

Sunday, April 12, 2009

Who's Boeing's and Airbus's Biggest Customer? Would You Believe AIG?

Our local economy here in Wichita is heavily dependent on the aircraft industry. Spirit's main customer (80% of its business) is Boeing. Airbus has a team of fifty engineers downtown.

Guess my surprise when I read that their biggest customer is AIG. I learned this reading an article by Justin Baer, Francesco Guerrera and Julie MacIntosh in London's Financial Times. I had known that International Lease Finance Corporation (ILFC) was the largest customer for the two companies' commercial aircraft. When they went to the Federal Reserve to ask for a line of credit, I discovered ILFC is a subsidiary of AIG, the insurance giant whose punting in credit default swaps led to its rescue last fall by the Federal Reserve.

The Financial Times writers tell us, "ILFC has ordered 168 new aircraft worth $16.7bn from Boeing and Airbus.
"The aeroplanes are scheduled to be bought during the next 10 years, with 49 of them - worth about $3bn - set to be delivered this year."

Understand that many airlines have credit ratings that are too fragile to allow their borrowing funds to buy planes on their own and consequently they lease them. Given airlines' propensity to lose money, a lessor can be more likely to benefit from the tax shields of depreciation and interest payments than they are. The biggest player in this market is ILFC.

AIG is trying to sell ILFC, presumably to raise capital. No one will buy it without a secure form of short term finance. According to AIG's 10K, the bulk of ILFC's debt is long term. As of the end of 2008, however, $1.7 billion of its $50 billion in assets were financed with commercial paper. In 2008, ILFC had to raise $4.7 billion to pay off maturing debt and repayments.

J. Lynn Lunsford and Daniel Michaels report in the Wall Street Journal, "ILFC's fleet is valued at roughly $50 billion. The company had outstanding debt of $32.5 billion and listed shareholder equity at $7.63 billion at the end of last year."

A particularly scary prospect is if ILFC were forced to dump some of its 955 planes onto the market. We certainly do not need discounted used planes competing with Boeing's and Spirit's backlog.

The Financial Times article:

AIG aircraft unit seeks $5bn Fed credit line

By Justin Baer, Francesco Guerrera and Julie MacIntosh in,New York
Published: April 8 2009 03:00 | Last updated: April 8 2009 03:00

AIG's aircraft-leasing unit is in talks over a $5bn credit line from the Federal Reserve that could be used to facilitate its sale - an unusual move that would raise the stakes in the US government's bail-out of the stricken insurer.
People close to the situation said discussions between International Lease Finance Corp, AIG and the New York Fed were still ongoing and no decision on whether the facility would be provided, and how big it would be, had yet been taken.
ILFC, a profitable company and a top customer to both Boeing and Airbus, is in advanced talks with three private equity consortia but it needs extra liquidity because AIG's collapse has choked off many of its traditional sources of funds. A bitter downturn in demand for air travel has made the task of raising extra funding even more daunting.
People close to the situation said the credit line from the Fed would come from the billions of dollars worth of loans the monetary authorities have already extended to AIG.
But even if ILFC's credit facility comes from existing resources, the Fed's involvement in the sale of an AIG subsidiary could deepen criticism of the authorities' role in the insurer's rescue. The New York Fed declined to comment.
AIG, with the Fed's blessing, has pledged to support ILFC until its separation from the insurer. But the company's efforts to raise several billion dollars through a new credit facility have met with tepid demand from European banks and other traditional sources of aviation finance, people familiar with the matter said.
AIG said ILFC's fundraising efforts were "making normal progress given the tough market conditions", and declined to comment further.
ILFC is in advanced talks with several consortia of potential buyers that include Carlyle Group, Thomas H. Lee Partners and Greenbriar Equity Group. But without reassurances that ILFC's short-term financing needs could be met, it may be unlikely any of the bidders would be willing to take on such a capital-intensive business.
ILFC has ordered 168 new aircraft worth $16.7bn from Boeing and Airbus.
The aeroplanes are scheduled to be bought during the next 10 years, with 49 of them - worth about $3bn - set to be delivered this year.

Thursday, April 09, 2009

U.S. Exports Up, Current Account Down, And New Jobless Claims Fall!

Today brought some startlingly good news. Our trade deficit fell from over $36 billion a month in January to under $26 billion in February. "Initial claims for state jobless benefits decreased 20,000 to 654,000 in the week ended April 4."

To put that in perspective, we had been running a current account deficit equivalent to 5% of GDP going into the current financial storm. Indeed, our deficit, which was being financed by external borrowing from China among others, is a major contributor to the current financial crisis. Take the February deficit multiply it by twelve months in a year and divide it by fourth quarter GDP and it represents just 2.2% of GDP. Given the month to month fluctuation in exports and imports, it is far fetched to project one month's performance, but we have seen a steady improvement in the trade deficit.

The improvement in February came in part from increased exports. Is this a straw in the wind that the world inventory correction has run its course? Or is this a random monthly fluctuation?

Tuesday, April 07, 2009

Housing Bubbles & Depressions

Vernon Smith and Steven Gjerstad (Smith a professor at Chapman University and the latter visiting) analyze U.S. housing bubbles and what they wrought in a Wall Street Journal opinion piece. Economist Smith won his Nobel prize for work in behavioral economics. When he started out, economists were able to reproduce bubbles in laboratories. Bubbles seemed so transparent that the economists thought they would never occur in "the real world."

So much for economists being Pollyannas!

Airbus Is Ramping Down Production in Response to Lower Orders

Daniel Michaels reported in yesterday's Wall Street Journal,

"Airbus said Friday that it booked orders for just 16 planes in March, compared with 54 orders in March 2008 and 37 orders the previous year. The company has said it may capture only between 300 and 400 new orders this year, down from 777 orders minus cancellations last year."

How does one lower production in an outsourced world? The care and feeding of supply chains gets tricky. France created the Aerofund to help suppliers deal with the strong Euro and expand. It is now diverting funds from it to stay afloat in the crisis. Airbus's production chief, Tom Williams, told the Journal, "With a limited investment, we'll buy strategic components with very long lead times and carry them ourselves. It gives us more flexibility."

Here in Wichita, we have Sirit and its suppliers to worry about.

Friday, April 03, 2009

The Employment Report: Have We Hit Bottom?

Measured by the survey of U.S. establishments, jobs fell by approximately two thirds of a million in March (661,000) and the unemployment rate rose to 8.5 percent.

The financial services sector has lost a half million jobs since December, 2006.

And for the Wichita economy,what about the aircraft industry?

The Bureau of Labor Statistics publishes data on employment in transportation equipment other than motor vehicles which is predominantly the aircraft industry. In our sector, jobs fell by 8,400 in March with a total decline of over 75,000 since September.

And the future?

Two weeks ago I said my hunch was we were at the bottom. The employment report is grim, nevertheless, I am now convinced that we are at the recession trough. The vast worldwide inventory correction should have run its course. Many of the indicators (housing starts, factory orders, home sales) have hit bottom and have turned up, if only for a month. The stock market, the earliest of leading indicators is rallying. Unfortunately employment will lag well beyond the cyclical bottom.