Future of Investment Banks & Bonuses

On December 17th, 2010, the Financial Times asks: As regulators and politicians seek to tighten their grip on bonuses and leverage, what does the future hold for investment banks after the financial crisis? and how do food and clothing companies, as well as governments, react to rocketing input prices? 

In the chair, analysis editor Frederick Studemann debates the issues with FT colleagues Megan Murphy, investment banking correspondent, Martin Sandbu from the leader writing team and consumer industries editor Louise Lucas.

The video runs 16 minutes and 28 seconds.

Kraft: 3.6% Yield + Plus Emerging Market Synergy

Kraft will be absorbing its acquisition of Cadbury. Should you buy the stock?

It yields 3.64% and sells about 13 times 2011 estimated earnings according to
Barron's Dimitra DeFotis. Is the stock undervalued or is the market discounting lousy prospects? Cadbury certainly offers opportunities for synergy. Kraft is strong in countries Cabury is not and vice versa. With the emerging market econnomies providing the world's economic growth, this is important. Hanging over that rosy scenario is the question of whether Kraft can digest iCadbury's sweets. Managements in more than one industry have gotten indigestion from such major mergers.


Still DeFotis explains that mixing Kraft cheese with Cadbury chocolate should sweeten investor returns in this video.

The "Scarbus" 380: Rolls Royce Engine Explodes Forcing a Quantas Jet to Land In Singapore

Quantas Grounds its A380s

Airbus touts the A380 as the plane of the future. In this News Corp. video you can see the first Qantas airbus A380 touch down in Sydney, October 2008:

Quantas is quite proud of its safety record. What other major airline can brag of never having lost a jetplane? Keen on keeping that reputation, Quantas grounded its A380s after the emergency landing of its "scrabus" flight QF32.

According to News.Com.Au "Qantas made it clear it will keep its six superjumbos grounded indefinitely and has rearranged flight schedules using substitute aircraft.

"'The specific checks mandated by the directive were already being carried out by Qantas in conjunction with Rolls-Royce,' it said.

"'Qantas's A380 aircraft will not return to service until there is complete certainty that the fleet can operate safely.'"

Thus the planes of the future is having problems in the present.

News on Airbus's big one, the A380, first. Singapore Airlines found oil leaking from its Rolls Royce engines (courtesy of News Australia):

And yet more on SKYNews:

The Fallout for RollsRoyce:

In the Financial Times, Pilita Clark, its Aerospace Correspondent, reports "Rolls-Royce is preparing to cannibalise several half-built A380 superjumbos on production lines to obtain more than a dozen new engines to help its stricken airline customers such as Qantas.

"The engine maker has taken the rare step of negotiating with Airbus, the A380’s manufacturer, about raiding engines from three or four superjumbos due to be delivered next year from its Toulouse and Hamburg assembly plants, according to people familiar with the situation."

In an FT video, Pilita Clark, explains how the spotlight will now fall on Rolls-Royce, the maker of the engine.

The Future of Natural Gas

Oil prices make headlines; Solar and wind power are sexy, yet natural gas is the real news.

While U.S. oil production has been declining since the 1970s and the peak of world oil production is continually predicted, natural gas looks like the rabbit we are pulling out of the hat.  And the future is paved with shale.

It took companies like Mitchell Energy twenty years to figure out how to extract natural gas from the Barnett shale formation in Texas.  The technology having been mastered, we now realize that there is an abundance of gas in shale formations around the country and the globe.

Interestingly enough the home of the Whiskey Rebellion and the first U.S. oil rig, Pennsylvania, is home to one of the biggest.  The Marcellus shale formation in western Pennsylvania, west Virginia and western New York has been estimated as having natural gas equivalent to the nation's energy needs for twenty years.

Chevron's 4.3 billion Shale Bet

As iStockAnalyst put it, [C]onsider this number: 4.3 billion.That is what Chevron offered to pay for Atlas Energy.  As Bill Wince of Chesapeake Energy points out the big integrated oil companies are used to dealing with huge fields and negotiating with governments. Unlike America, in many countries the state not the landowner owns the mineral rights.   The independents can field an army of land men who track down tittles and negotiate drilling rights.  The Chevrons of the world have decided if they do not have a distinctive competence, they can always buy it. 


Platts tells us, "Chevron's first deal in a US gas shale play dovetails nicely with the
company's plans to increase its proportion of gas production from 31% of total
output currently to 41% in the next seven years," according to Atlas' Indian joint venture partner, Reliance Industries, CEO John Watson who spoke at a Bank of America
Merrill Lynch's Global Energy Conference.

This is Not the Last Big Buy

Platts further reported, "Watson said he expects Chevron's Marcellus Shale production to grow from Atlas' 63,300 Mcf/d to more than 500,000 Mcf/d in the next decade and that, combined with the play's proximity to premium markets in the northeastern US made it fit into Chevron's plans.


"The cost per well in the Marcellus Shale are about half that in other
major shale plays such as the Louisiana's Haynesville and Texas' Eagle Ford
because vertical drilling distances in Appalachia are about half those in
rival plays.


"Atlas wasn't the first shale producer Chevron looked at and it probably
won't be the last, Watson said."

Heard on the Street: IEA's Energy Outlook Forecast 11/9/2010 5:42:06 PM
Forecasting the next quarter is perilous.  Forecasting the next 26 years is both easier and riskier.  Few will remember your forecast after the twenty six years pass and the fundamentals assert themselves over the long run.  Still, you have no idea where in the crazy commodity cycle you will be nor what the value of a dollar will be.

The International Energy Agency's 26-year forecast for the energy industry

The Wall Street Journal's Heard on the Street columnist, Liam Denning, talks to the Journal's Lee Hawkins:




Lee Hawkins and Liam Denning also discuss Chevron's "We Agree" Campaign.

Business Jets and Elections

Molly Mullins reports on a talk by Michael Scheeringa of Signature Flight Support, which operates 103 fixed base operations around the world. At the today’s Wichita Aero Club meeting, Scheeringa reassured her that “It’s a very resilient industry.”  She blogs, "The good news is that the market has begun to recover, although recovery has been muted.


"But Fortune 200 companies are flying as much today as they did in 2008, he said. It’s the small business owners who are not using business aviation as much."

That sounds like good news, but we need to see the orders before we know the rebound is truely here. Wichita needs a business jet revival.

Furthermore, she relates his judgement that "The political climate has caused uncertainty in the tax structure of smaller businesses. And that leads to uncertainty about income and generates a lack of confidence." Moreover, "That lack of confidence impacts the business aviation industry in Wichita and elsewhere."

Which brings us to the mid-term elections. The pundits are predicting big Republican gains, perhaps recapturing the House, picking up a half dozen Senate seats, and assorted governorships and state ledgislative seats. The latter is especially important given the redistricting that follows the decinimal census.

The economy hit bottom in June, 2009, but the unemployment rate is actually above where it was at the trough. Economic growth ahs resumed, but Americans are still mired in misery.

Comes November 2nd, the President will be blamed.

But is it just?

President Obama campaigned on the need to fix the economy. That created expectations among the voters. Not surprisingly, the voters wanted those expectations to be met.

What happened?

The nation's economic problems were essentially long term in nature (huge and chronic trade imbalances, lack of domestic saving, misallocated resources from the credit boom.) Yet the President focused on short term solutions: fiscal stimulus. Worse, he delegated the job of designing the solution to Congress.

Then, with the economy being far from fixed, the President switched his priority to changing the health care system and its financing. Reallocating resources for a sector equivalent to 17% of the whole economy (four times the size of the auto industry) predictably set off a debilitating dog fight between the winners and the losers. To make matters worse, the President delegated the design to Congress.  Will Rodgers once predicted that "no one's wallet is safe when congress is in session."

If voters are angry with the President's economic policies, their anger is understandable.

After they express that anger on November 2nd, the President should address the source of that anger and ask the American people for a second chance. He should warn them that our problems are long term and there are no quick fixes. We must realistically face America's secular economic decline before it is too late and put forth the painful policies that will reverse our strategic decline. The tea party activists who are focusing on the size of the federal deficits have unwittingly brought to fore a very real problem. The U.S. can only use deficits to attack weakness of demand if the dollar remains the world's reserve currency. And the more it uses the deficits to stimulate the economy the closer we are to losing the dollar's reserve status. When foreigners stop taking our dollars, our options close and we start looking more like Greece and Spain.

Moreover, without significant policy changes there is a very real threat in the medium term. The perceived erosion of the rule of law (think of the treatment of GM's bondholders), the costs of the healthcare system reengineering, and the prospect of tax hikes if the Bush tax cuts expire have eerily recreated the conditions of 1936. These set the stage for the Roosevelt recession of 1937. We avoided the financial collapse that trasformed the recession of 1929 into the Great Depression. Now we have recreated the conditions for the 1937 recession, a recession whose severity was exceeded only by the contractions of 1929-33 and 1920.

President Obama should take advantage of his party's upcoming defeat to embark on a new program of economic leadership.

Economic Update: Wichita and the World

1) The world economy is eighteen months into an economic recovery. The U.S. economy lagged six months behind. Employment lagged another six months behind that and Wichita lagged yet further behind.  The most recent news is mixed.  the Commerce Department reported Housing starts were up.  Alan Rappeport writes in the Financial Times that "That was stronger than economists expected and marked the third month running that starts increased."  The Fed reported that September industrial production was down.  Rapeport tells us that "US industrial production fell for the first time in more than a year last month."

2) The U.S. unemployment rate is still at 9.5% reflecting the enormous dislocations caused during the bubble years of 2004-7. The administration's two top economists Larry Summers have retreated to academia.  CNN interviewed Peter Diamond the new Nobel Laureate who seems to see it differently.  He told CNN’s Fareed Zakaria GPS: "The central focus of the problems in the economy right now is not that the labor market is working badly but the demand for labor is way down. ... I view the US economy as extraordinarily adaptive . . . I expect the economy to adapt this time as well."

3) Wichita and Kansas are seeing signs of recovery. Wichita's August unemployment rate at 8.2% is down a percentage point from a year ago. (August is the worst month each year.) For four straight months we have seen an improvement over the year before. A new state study shows job openings up and up relative to the number out of work. The Kansas Department of Labor reported, "There are more job vacancies in Kansas this year than last year, according to the 2010 Job Vacancy Survey. The survey, completed by employers during the second quarter of 2010, found there were an estimated 32,091 job vacancies statewide. This represents a 24.5 percent increase in vacancies from 2009." World trade is vital for Kansas and the world economy is pulling up the Kansas economy.

4) As for the aviation industry, it is a three legged stool: commercial, military, and general aviation. Commercial aviation is reviving. The lessors are back. The other two legs are weak.  Most countries are cutting military spending around the world. General aviation (business jets and private planes) is still in a big slump.

5) The business aviation industry has its big show in Atlanta while we speak. In connection with that, Honeywell's new forecast shows a 10% increase over the next decade, but tough slogging over the next two years. For 2010, Honeywell Aerospace estimates deliveries of 675-700 new business jets, down 16-17 percent from 849 in 2009 mainly due to continued global economic weakness as well as overarching concerns about government debt, austerity programs, export growth, financing costs, and general availability. Rob Wilson, President, Business and General Aviation, Honeywell Aerospace said "The industry should begin another period of expansion by 2012"  Molly Mullins reports on Hawker's new business jet, the 200 and on Cessna's new version of the Citation, the Citation X.

6) Hawker-Beechcraft's two lines of business are military and business jets: not a pretty picture. Kansas has put together a package to keep it from moving to Louisiana, but the union has now rejected the firm's proposed labor contract. This cloud remains over our economic horizon.

Wichita's Unemployment Rate Rises Seasonally to 8.4 Percent; GDP Grows at 2.4 Percent; and Europe's Mercedes Reves Up

The Stock Market Falls Again

Here it is Friday afternoon and the U.S. Stock Market is down some more after a 144 point plunge yesterday. The Fed of Philadelphia's activity index took a dive and new claims for unemployment jumped over a half million. That latter is one statistic economists do not want to see rise and it is one of the Conference-Board's leading indicators. Yesterday's plunge turned a nicely developing  global rally into a global route.

Markets have been particularly spooked since the Commerce Department issued its GDP report a week a go.  The economy grew at a 2.4 percent rate in the second quarter.  This was seen as lack luster growth.  However the deceleration was not due to a lack of demand but to an over appetite for imports.  Real, domestic final demand grew at a 4 percent annual rate.  More economic stimulus would further aggravate our current account balance.

Its Bureau of Economic Analysis revised the last two and a half years of national income accounts estimates showing, as I expected, that the recession was deeper and the recovery stronger than previously reported.

Good News From Germany

The global rally had been fueled by news that the Bundesbank had increased its forcast of German economic growth. Germany is the Eurozone's engine. Moreover the strength in the world economy is reflected in the new resource M&A boom according to Javier Blas and William MacNamara in the Financial Times. They report, "The rise of China and India has sparked a renewed surge in aggressive dealmaking in the resources sector, with more than $50bn in proposed take­overs this week alone wagering on continued strong commodities demand."

The American stock market is focused on the possibillity of a "double-dip recession."  As I said yesterday, "I don't see a double-dip recession, either here or nationally...It's too late for one to start. They need to happen within 12 months."  We had a  double dip recession in 1973-75.  The economy fell in response to the oil shock of the arab oil embargo.  The economy recovered in the first half of 1974, but as inflation artificially inflated manufacturing order books, firms soon found their perceived demand to be ephemeral.  Industrial activity plunged after June in the "second dip."  The recession of 1982 followed closely (fourteen months) on the heels of the 1980 reession leading some economists to argue it was really one double dip recession not two separate recessions.

There real recession threat for the U.S. is more medium term.  When tax hikes and the supply side effects of the new health care legislation hit in 2011 and 2012, we could see something like the "Roosevelt Recession" of 1937-38.

Wichita's Good Bad News.

Dan Voorhis of the Wichita Eagle reported, "The July unemployment rate in the Wichita area hit 8.4 percent — worse than June, but much better than the 10.3 percent in July 2009."   That compares with 8 percent in June.

The rise is seasonal.  As Voorhis points out, "The unemployment rate typically rises in July as thousands of students and school staff enter the work force looking for jobs."   Chris Moon in the Wichita Business Journal notes that "metro [Wichita] had 26,669 people who were out of work, up from 25,184 a month ago."

To look past the seasonal effects, compare July's unemployment rate to the same month in 2009 (10.3%.)  That is a big drop.   This is the third straight month that the unemployment rate improved compared to a year ago and that provides grounds for optimism.   The Eagle quotes this Friends University professor as seeing "encouraging economic trends that will soon translate into better employment.  'I can see the unemployment rate in the fall closer to 7 percent than where it is now.'
[and the] strength in commercial aircraft construction and a general demand for Wichita-made products in other parts of the globe.."

Kansas

Seasonal factors drove the state unemployment rate up for July to 6.9 percent.   Kansas Department of Labor economist Tyler Tenbrink said "Kansas continued to see steady but slow job growth in July. An increase in goods producing jobs, like construction, are very important. We are still seeing a decline in some service providing jobs, like information services and financial activities. A bright spot this month within those declining industries was administrative and support services, which includes job placement services for temporary workers. We are particularly interested in job gains in this area because employers tend to use these services before hiring permanent workers. This industry saw its first over-the-year job gain since June 2008, a positive indicator that we may continue to see growth in other industries in the coming months."

Sheila Bair, Financial Reform, and Fannie and Freddie: Of Sound and Fury

President Obama has signed into law the Dodd Frank financial reform law. 

The most needed provision of the new law is its authority to resolve failing non-banks procedures along the lines of the FDIC's bank failure resolution process when the non-bank poses systemic risk The FT's Tom Braithwaite interviews Sheila Bair, Chairman of the FDIC, in this video (10m 19sec) "about how she is going to implement the new powers that were given to her by the new legislation on financial reform."

In an unrelated(?) story, Congressman Issa has dug up some very interesting facts about two non-banks not covered by Dodd-Frank.  The Financial Times' Suzanne Kapner reports "Countrywide Financial made 153 “VIP” loans to Fannie Mae executives, in an effort to win goodwill from the giant mortgage finance company, according to a letter released on Tuesday by a US congressman.


"An additional 20 VIP loans were made to Freddie Mac employees, the other large government-sponsored buyer of home loans, according to the details released by Darrell Issa, a California Republican."

Senator Dodd was a recipient of two of Angelo's VIP loans.

Which brings us to the most interesting question about the financial reform package.  The President assures us this will end future bailouts.  Unfortunately, the President left the job of constructing a bill to Congress.  Congress gave us a 2,300 page rewrite of financial regulation and it contains is no solution to the Freddie Mac and Fannie Mae problem.  Here is the biggest sinkhole in the federal bailout and not a word!  I guess Congress did not want to mess with the Financial Industrial Complex.  Incidentally (?), Senator Dodd and President Obama were the two biggest recipients of campaign contributions from Fannie and Freddie sources.   Dr. Blair prudently sidestepped a question on this amazing omission.  Neil Murphy, an eminent banking authority, loved to ask "Other than that, Mrs. Lincoln, how was the play?"  I can hear him ask it again.

But do not worry!   Suzanne Kapner  writes, "Barney Frank, a Massachusetts Democrat, has said that he plans to start work on new legislation when Congress returns from its August recess. The White House is expected to submit plans for fixing the system by early next year."

"To-morrow, and to-morrow, and to-morrow,
Creeps in this petty pace from day to day,
To the last syllable of recorded time;
And all our yesterdays have lighted fools
The way to dusty death."

Farnborough, Jobs, and Wichita

Wichita's unemployment rate is 8.0 percent.

The national recovery is starting to come to us. Wichita's unemployment rate was 8.0 percent June, down from 9.0 percent in June, 2009. Dan Voorhis reported in this morning's Eagle.   "'Given that it's for June, that's a positive sign for Wichita,'" quoting Mammon Among Friends' own Malcolm Harris, Professor of Finance at Friends University.

Note the data is not seasonally adjusted. The national unemployment rate, which is, fell to 9.5 percent (from 9.7 percent.) The national rate fell as fewer folks were in the June labor force. That was in part because of the seasonal adjustment and in part because those census workers who took the work for a few extra dollars but were not looking for permanent work left the labor force. He also quoted "Jeremy Hill, director of the center for Economic Development and Business Research at Wichita State University, [who] said the bulk of the new jobs has come in the medical sector and professional and business services."

As I told Dan Voorhis, "We're 12 months into a national recovery and some of that is spilling into the local economy." One big area of improvement is the aircraft industry.  New aircraft orders are up for the five months through May according to Commerce Department data.   Although well below the boom years of 2007 and 2008, there is a distinct recovery showing up.  Both Boeing and Airbus have been conservative in their production planning.  Boeing is now slowly stepping up its 737 production, a sign it is growing confident.  Increased production also protects Boeing from potential cannibalization of the 737 market by its and Airbus's new planes.   Spirit Aerospace largely avoided layoffs by using a shortened workweek during the worst of it.  By thus spreading the work around, it conserved its younger workers who are the manufacturer's future.

Which brings us to Farnborough:

The Farnborough International Airshow is this week: 19-25 July 2010. The biennial show was last held at the peak of the boom in aircraft orders.  The 2008 show (pictured on the right) set a record of US$88.7 billion worth of orders announced during the show.  Note planes are priced in dollars not Euros.

Boeing's Dreamliner made a splash. The 787 flew into Farnborough Monday and returned home yesterday.  Gulliver, the Economist's Business Travel commentator blogged, "The Dreamliner is much more than just another incremental upgrade to Boeing’s fleet: its revolutionary lightweight carbon-composite wings and fuselage mean much-improved fuel efficiency (20% better than comparable planes made from aluminium, according to Boeing). This could well persuade airlines to open some direct routes around the globe that they previously deemed uneconomic."

Today's Eagle carries an AP report by Jane Wardell and Emma VanDore that orders have totaled $25 billion.

There is life among the aircraft lessors. Halleluja!

I knew the aircraft industry was in trouble when I learned AIG was Boeing's and Airbus's biggest customer.   AIG required a federal bailout, CIT entered bankruptcy and GE Financial was in trouble (the piggy bank that Jack Walsh built was broken.)  Lessors' share of aircraft orders dropped from 40 percent to 2 percent.

The Financial Times' Pilita Clark reported that "Steven Udvar-Hazy made a notable re-entry into the field.  He is one of the biggest names in aircraft financing who founded and ran ILFC, AIG’s aircraft leasing arm, until his departure earlier this year. He announced a $4bn order for 51 Airbus A320 family aircraft for his new leasing company, Air Lease Corporation."

"That news was swiftly followed by Boeing’s announcement that GE Capital Aviation Services, the aircraft leasing arm of General Electric, was ordering 40 of its best-selling 737 jets valued at around $3bn, according to the manufacturer’s published prices."

The A320s and the 737s are the workhorses of much of commercial aviation and seem to be commodity most easily leased.  Udvar-Hazy largely created the air leasing business with International Lease Finance Corporation (ILFC), now owned by AIG.  When AIG lost its AAA bond rating, ILFC got shut out of the commercial paper market and was hard pressed to buy new planes.  Udvar-Hazy's solution?  He left ILFC and started a new company and now he has ordered 40 Boeing 737-800s.  That should be good news for Spirit Aerospace here in Wichita which makes fuselages for 737s.

Is the market developing according to Boeing's view of the world or Airbus's?

The first step to understanding an industry and a company's business model is asking who the customers are. On the commercial side, Airbus and Boeing (and Bombardier and Embraer) sell to commercial airlines and air freight companies. The customers' business models will drive the demand for their planes. As the busiest airports get more and more congested, the airlines will either have to fly bigger planes with more seats into those hubs or fly longer point-to-point routes to relieve pressure on the hubs. Airbus in the A380 bet on the former, while Boeing in the 787 bet on the latter.

Pilita Clark reported from Farnborough Monday that "Emirates, the Dubai-based airline, on Monday announced a $9bn order for 30 Boeing 777 passenger jets, making it the biggest deal so far at the show."

This follows the the Berlin airshow where she reported on June 8th that "the Dubai-based airline, placed one of the largest civil aircraft orders in history on Tuesday when it said it would buy 32 A380 superjumbo passenger jets from Airbus in a deal worth $11.5bn."  That Airbus claimed was the biggest commercial aircraft order by dollar value ever.

At the time the FT's Clark further reported, "Emirates already had 58 A380s on order, with Tuesday’s announcement taking that number to 90, firmly cementing its position as the largest operator of the superjumbo.


"The deal is a big boost for Airbus, which now has 234 orders from 17 buyers. The programme is far from making a profit, however, after it was affected by numerous delays and cost overruns.
In addition to its A380 orders, Emirates has 70 Airbus 350s, 18 Boeing 777-300s and seven Boeing air freighters on order, totalling 143 wide-body aircraft worth more than $48bn.

"The world’s largest passenger jet, which typically has 525 seats, costs $346.5m at list prices, although large customers receive sizeable discounts."

While the luxury airlines can offer has been much commented on in the press, Airbus is stressing that the A380 is a money maker for airlines:  "The big news for operators is that the A380 is earning hard dollars at the same time. Introducing this next-generation jetliner is saving customers millions in operating costs annually while creating thousands of extra seats on long-haul routes. With the lowest cost per seat and the lowest emissions per passenger of any large aircraft, the A380 provides a competitive edge."


Molly McMillan reports in Air Capitol Insider, Hawker Beechcraft has found some business and Bombardier brags "it has captured 50 percent of net orders in the 100- to 149-seat marekt segment over the past two years. The program is on schedule for entry into service in 2013."

In a video report, Richard Milne reports from the Farnborough Airshow on the rise of emerging market manufacturers and the challenge posed to Airbus and Boeing from the Bombardier C-Series.  (3m 5sec) 

Separately,Molly McMillan reported in the Eagle, that "Hawker Beechcraft is looking at states that might be suitable for developing facilities to build parts for the company and has narrowed the field to two — Mississippi and Louisiana" according to its CEO, Bill Boistur. Molly McMillin reports that he said, "'The market for our products has decreased dramatically over the last 18 months...Our view is that this is not a momentary decrease, and we believe strongly it's necessary to adjust the cost structure of the company to be able to be profitable in a small market.'"