Stores See Shoppers in Retreat (NYTimes, 11/09/07)

November 9, 2007
Stores See Shoppers in Retreat
By MICHAEL BARBARO
Consumers have rendered a verdict on the coming holiday season: grim.
From discounters like Wal-Mart to luxury emporiums like Nordstrom, the nation’s biggest chains reported the weakest October in 12 years yesterday.
The stores cited two main forces for the troubles: deepening economic jitters and unseasonably warm weather across the country, which left few consumers in the mood to buy.
The performance has set the stage for deep discounts in November and December as stores scramble to clear out unsold racks of clothing and electronics.
Sales at stores open at least a year, a crucial yardstick in retailing, rose just 1.6 percent last month, the slowest growth since October 1995, according to the International Council of Shopping Centers. The poor results — on the heels of a dismal September — have made this one of the worst fall shopping seasons in decades.
“Retailers are running from this fall like it was the plague,” said John D. Morris, a senior retail analyst at Wachovia Securities.
Wal-Mart Stores, the nation’s largest retailer and a bellwether for the industry, said sales rose a meager 0.7 percent last month, even after the company lowered prices on toys and electronics to drum up business.
Anticipating a consumer spending slowdown, the company has now introduced steep doorbuster discounts — like a $400 laptop — every weekend until Thanksgiving.
Even so, Wal-Mart predicted sales growth could be flat for November.
Midprice department stores did not fare much better last month. Sales fell 1.8 percent at J. C. Penney and 3.8 percent at Kohl’s, two chains that have produced strong performances all year.
In a sign of things to come, both Kohl’s and Penney’s held storewide sales last weekend, with discounts of up to 50 percent.
Even higher-end stores struggled in October. Sales fell 1.5 percent at Macy’s and 2.4 percent at Nordstrom and 7 percent at Dillard’s.
“There is big-time trading down going on,” said Bill Dreher of Deutsche Bank Securities, referring to the phenomenon of consumers’ turning to lower-priced stores because of financial insecurity.
“Nordstrom customers are trading down to Macy’s, and the Macy’s customer is trading down to Target,” he said.
That may account for strong sales at stores known for cheap chic — fashionable clothing and home décor at steep discounts. For example, sales rose 4.1 percent at Target and 3 percent at TJX, the parent company of TJMaxx and Marshall’s.
Luxury chains remained largely immune to the slowdown, with sales at Saks rising 10.6 percent.
The warm weather throughout October appears to have tamped down demand for clothing at the mall. Sales fell 3 percent at American Eagle Outfitters, 6 percent at Limited, 8 percent at Gap and 10.6 percent at Chico’s FAS, the adult women’s clothing chain.
Mr. Morris, who covers mall-based clothing chains, said several had begun cutting back on orders for the holidays, lest they become stuck with racks of unsold sweaters and coats.
The chains said that as the weather grew cooler, business was likely to improve, perhaps sharply this month. But an industry trade group, the National Retail Federation, is still predicting holiday season sales will rise 4 percent, the slowest in five years.
With oil prices soaring, the housing market slumping and the stock market in flux, there is little optimism that this will be a stellar season.
“Our customers are clearly facing headwinds that are impacting both sentiment and discretionary spending levels,” said the chief executive of J. C. Penney, Myron E. Ullman III.
And he does not expect the conditions to improve anytime soon. “We expect the challenging retail environment to continue for the foreseeable future,” Mr. Ullman said.

Rising Demand for Oil Provokes New Energy Crisis (NYTimes, 11/09/07)

November 9, 2007
Rising Demand for Oil Provokes New Energy Crisis
By JAD MOUAWAD
With oil prices approaching the symbolic threshold of $100 a barrel, the world is headed toward its third energy shock in a generation. But today’s surge is fundamentally different from the previous oil crises, with broad and longer-lasting global implications.
Just as in the energy crises of the 1970s and ’80s, today’s high prices are causing anxiety and pain for consumers, and igniting wider fears about the impact on the economy.
Unlike past oil shocks, which were caused by sudden interruptions in exports from the Middle East, this time prices have been rising steadily as demand for gasoline grows in developed countries, as hundreds of millions of Chinese and Indians climb out of poverty and as other developing economies grow at a sizzling pace.
“This is the world’s first demand-led energy shock,” said Lawrence Goldstein, an economist at the Energy Policy Research Foundation of Washington.
Forecasts of future oil prices range widely. Some analysts see them falling next year to $75, or even lower, while a few project $120 oil. Virtually no one foresees a return to the $20 oil of a decade ago, meaning consumers should brace for an era of significantly higher fuel costs.
At the root of the stunning rise in the price of oil, up 56 percent this year and 365 percent in a decade, is a positive development: an unprecedented boom in the world economy.
Demand from China and India alone is expected to double in the next two decades as their economies continue to expand, with people there buying more cars and moving to cities to seek a way of life long taken for granted in the West.
But as prices rise, the global economy is entering uncharted territory. The increase so far does not appear to be hurting economic growth, but many economists wonder how long that will last. “These prices are too high and will end up hurting everybody, producers and consumers alike,” said Fatih Birol, chief economist at the International Energy Agency.
Oil futures closed at $95.46 on the New York Mercantile Exchange yesterday, down nearly 1 percent from the day before. But the price has become volatile, and many analysts expect the psychologically important $100-a-barrel threshold to be breached sometime in the next few weeks.
“Today’s markets feel like the crowds standing up in the final minutes of a football game shouting: ‘Go! Go! Go!,’” said Daniel Yergin, an oil historian and the chairman of Cambridge Energy Research Associates, a consulting firm. “People seem almost more relaxed about $100 than they were about $60 or $70 oil.”
Oil is not far from its historic inflation-adjusted high, reached in April 1980 in the aftermath of the Iranian revolution. At the time, oil jumped to the equivalent of $101.70 a barrel in today’s money.
For most of the 20th century, as it transformed the modern world, oil was cheap and abundant. Throughout the 1990s, for example, oil prices averaged $20 a barrel. Even at today’s highs, oil is cheaper than imported bottled water, which would cost $180 a barrel, or milk, at $150 a barrel.
“The concern today is over how will the energy sector meet the anticipated growth in demand over the longer term,” said Linda Z. Cook, a board member of Royal Dutch Shell, the big oil company. “Energy demand is increasing at a rate we’ve not seen before. On the supply side, we’re seeing it is struggling to keep up. That’s the energy challenge.”
More than any other country, China represents the scope of that challenge. As it turned into a global economic behemoth over the last decade, China also became a major energy user. Its economy has grown at a furious pace of about 10 percent a year since the 1990s, lifting nearly 300 million people out of poverty. But rapid industrialization has come at a price: oil demand has more than tripled since 1980, turning a country that was once self-sufficient into a net oil importer.
India and China are home to about a third of humanity. People there are demanding access to electricity, cars, and consumer goods and can increasingly afford to compete with the West for access to resources. In doing so, the two Asian giants are profoundly transforming the world’s energy balance.
Today, China consumes only a third as much oil as the United States, which burns a quarter of the world’s oil each day. By 2030, India and China together will import as much oil as the United States and Japan do today.
While demand is growing fastest abroad, Americans’ appetite for big cars and large houses has pushed up oil demand steadily in this country, too. Europe has managed to rein in oil consumption through a combination of high gasoline taxes, small cars and efficient public transportation, but Americans have not. Oil consumption in the United States, where gasoline is far cheaper than in Europe, has jumped to 21 million barrels a day this year, from about 17 million barrels in the early 1990s.
If the Chinese and Indians consumed as much oil for each person as Americans do, the world’s oil consumption would be more than 200 million barrels a day, instead of the 85 million barrels it is today. No expert regards that level of production as conceivable.
More realistically, global demand is expected to rise to about 115 million barrels a day by 2030, a level that is likely to tax the world’s ability to pump more oil out of the ground. Already, the world is running on a limited cushion of spare capacity; any interruption in supplies, whether from hurricanes or armed conflict, causes prices to spike.
“We don’t have any shock absorbers,” Mr. Goldstein said.
For oil companies, high prices have set off a frenzied search for new sources around the world. After a long lull in investments through most of the 1990s because of low prices, major oil companies have invested billions of dollars to bring in more supplies.
The trouble is that these big new developments take a long time, and companies have been hobbled by higher costs. The cost of drilling rigs, for example, the basic tool of the trade, has doubled in recent years. Analysts say it will take time, but new supplies will eventually work their way to market.
Supplies have also been hampered by political tension in the Persian Gulf, the war in Iraq, devastating hurricanes in the oil-producing Gulf of Mexico, production difficulties in Venezuela and violence in Nigeria’s oil-rich province. Many of these geopolitical factors have contributed to a political risk premium variously estimated at $25 to $50 a barrel. Recently, in just nine weeks, oil jumped from $75 to $95 a barrel for little apparent reason.
“Fifty-dollar-a-barrel oil seems so far away at this point,” said Thomas Bentz, a senior energy analyst at BNP Paribas in New York, citing a figure that seemed an impossibly high price for oil only a few years ago. “Oil will stop rising when we see demand destruction. We haven’t seen that yet.”
When will it happen? Veterans of the oil business, having lived through booms and busts, say no one should count on oil rising forever. Economic slowdowns in China or the United States — or especially, in both — would probably send prices tumbling.
It happened a mere decade ago, after the Asian financial crisis sent economies there into a tailspin. Global oil prices fell by half, from $20 a barrel to $10, in months.
“It would be a big mistake to think the laws of supply and demand have been abolished,” Mr. Yergin said.

Rising Demand for Oil Provokes New Energy Crisis (NYTimes, 11/09/07)

November 9, 2007
Rising Demand for Oil Provokes New Energy Crisis
By JAD MOUAWAD
With oil prices approaching the symbolic threshold of $100 a barrel, the world is headed toward its third energy shock in a generation. But today’s surge is fundamentally different from the previous oil crises, with broad and longer-lasting global implications.
Just as in the energy crises of the 1970s and ’80s, today’s high prices are causing anxiety and pain for consumers, and igniting wider fears about the impact on the economy.
Unlike past oil shocks, which were caused by sudden interruptions in exports from the Middle East, this time prices have been rising steadily as demand for gasoline grows in developed countries, as hundreds of millions of Chinese and Indians climb out of poverty and as other developing economies grow at a sizzling pace.
“This is the world’s first demand-led energy shock,” said Lawrence Goldstein, an economist at the Energy Policy Research Foundation of Washington.
Forecasts of future oil prices range widely. Some analysts see them falling next year to $75, or even lower, while a few project $120 oil. Virtually no one foresees a return to the $20 oil of a decade ago, meaning consumers should brace for an era of significantly higher fuel costs.
At the root of the stunning rise in the price of oil, up 56 percent this year and 365 percent in a decade, is a positive development: an unprecedented boom in the world economy.
Demand from China and India alone is expected to double in the next two decades as their economies continue to expand, with people there buying more cars and moving to cities to seek a way of life long taken for granted in the West.
But as prices rise, the global economy is entering uncharted territory. The increase so far does not appear to be hurting economic growth, but many economists wonder how long that will last. “These prices are too high and will end up hurting everybody, producers and consumers alike,” said Fatih Birol, chief economist at the International Energy Agency.
Oil futures closed at $95.46 on the New York Mercantile Exchange yesterday, down nearly 1 percent from the day before. But the price has become volatile, and many analysts expect the psychologically important $100-a-barrel threshold to be breached sometime in the next few weeks.
“Today’s markets feel like the crowds standing up in the final minutes of a football game shouting: ‘Go! Go! Go!,’” said Daniel Yergin, an oil historian and the chairman of Cambridge Energy Research Associates, a consulting firm. “People seem almost more relaxed about $100 than they were about $60 or $70 oil.”
Oil is not far from its historic inflation-adjusted high, reached in April 1980 in the aftermath of the Iranian revolution. At the time, oil jumped to the equivalent of $101.70 a barrel in today’s money.
For most of the 20th century, as it transformed the modern world, oil was cheap and abundant. Throughout the 1990s, for example, oil prices averaged $20 a barrel. Even at today’s highs, oil is cheaper than imported bottled water, which would cost $180 a barrel, or milk, at $150 a barrel.
“The concern today is over how will the energy sector meet the anticipated growth in demand over the longer term,” said Linda Z. Cook, a board member of Royal Dutch Shell, the big oil company. “Energy demand is increasing at a rate we’ve not seen before. On the supply side, we’re seeing it is struggling to keep up. That’s the energy challenge.”
More than any other country, China represents the scope of that challenge. As it turned into a global economic behemoth over the last decade, China also became a major energy user. Its economy has grown at a furious pace of about 10 percent a year since the 1990s, lifting nearly 300 million people out of poverty. But rapid industrialization has come at a price: oil demand has more than tripled since 1980, turning a country that was once self-sufficient into a net oil importer.
India and China are home to about a third of humanity. People there are demanding access to electricity, cars, and consumer goods and can increasingly afford to compete with the West for access to resources. In doing so, the two Asian giants are profoundly transforming the world’s energy balance.
Today, China consumes only a third as much oil as the United States, which burns a quarter of the world’s oil each day. By 2030, India and China together will import as much oil as the United States and Japan do today.
While demand is growing fastest abroad, Americans’ appetite for big cars and large houses has pushed up oil demand steadily in this country, too. Europe has managed to rein in oil consumption through a combination of high gasoline taxes, small cars and efficient public transportation, but Americans have not. Oil consumption in the United States, where gasoline is far cheaper than in Europe, has jumped to 21 million barrels a day this year, from about 17 million barrels in the early 1990s.
If the Chinese and Indians consumed as much oil for each person as Americans do, the world’s oil consumption would be more than 200 million barrels a day, instead of the 85 million barrels it is today. No expert regards that level of production as conceivable.
More realistically, global demand is expected to rise to about 115 million barrels a day by 2030, a level that is likely to tax the world’s ability to pump more oil out of the ground. Already, the world is running on a limited cushion of spare capacity; any interruption in supplies, whether from hurricanes or armed conflict, causes prices to spike.
“We don’t have any shock absorbers,” Mr. Goldstein said.
For oil companies, high prices have set off a frenzied search for new sources around the world. After a long lull in investments through most of the 1990s because of low prices, major oil companies have invested billions of dollars to bring in more supplies.
The trouble is that these big new developments take a long time, and companies have been hobbled by higher costs. The cost of drilling rigs, for example, the basic tool of the trade, has doubled in recent years. Analysts say it will take time, but new supplies will eventually work their way to market.
Supplies have also been hampered by political tension in the Persian Gulf, the war in Iraq, devastating hurricanes in the oil-producing Gulf of Mexico, production difficulties in Venezuela and violence in Nigeria’s oil-rich province. Many of these geopolitical factors have contributed to a political risk premium variously estimated at $25 to $50 a barrel. Recently, in just nine weeks, oil jumped from $75 to $95 a barrel for little apparent reason.
“Fifty-dollar-a-barrel oil seems so far away at this point,” said Thomas Bentz, a senior energy analyst at BNP Paribas in New York, citing a figure that seemed an impossibly high price for oil only a few years ago. “Oil will stop rising when we see demand destruction. We haven’t seen that yet.”
When will it happen? Veterans of the oil business, having lived through booms and busts, say no one should count on oil rising forever. Economic slowdowns in China or the United States — or especially, in both — would probably send prices tumbling.
It happened a mere decade ago, after the Asian financial crisis sent economies there into a tailspin. Global oil prices fell by half, from $20 a barrel to $10, in months.
“It would be a big mistake to think the laws of supply and demand have been abolished,” Mr. Yergin said.

High-Priced Oil Adds Volatility to Power Scramble (NYTimes, 11/07/07)

November 7, 2007
High-Priced Oil Adds Volatility to Power Scramble
By MARK LANDLER
As the price of oil surges toward a symbolic milestone of $100 a barrel — hitting $96.70 yesterday — it is creating new winners and losers across the globe.

In southern China, high oil prices forced Wang Pui, a trucker, to wait in line 90 minutes the other day to fill up, just to be told he could pump only 25 gallons, as China faced spot shortages of gasoline and diesel fuel.

When Vladimir V. Putin was making Russia’s bid to be host of the 2014 Winter Olympics last July, he reached into the country’s deep pockets, bulging with oil profits, and pledged $12 billion to turn a Black Sea summer resort into a winter-sports paradise. Russia, which was nearly bankrupt a decade ago, won the Games.

The prospect of triple-digit oil prices has redrawn the economic and political map of the world, challenging some old notions of power. Oil-rich nations are enjoying historic gains and opportunities, while major importers — including China and India, home to a third of the world’s population — confront rising economic and social costs.

Managing this new order is fast becoming a central problem of global politics. Countries that need oil are clawing at each other to lock up scarce supplies, and are willing to deal with any government, no matter how unsavory, to do it.

In many poor nations with oil, the proceeds are being lost to corruption, depriving these countries of their best hope for development. And oil is fueling gargantuan investment funds run by foreign governments, which some in the West see as a new threat.

“Five months ago, readers would not have recognized S.W.F. as meaning sovereign wealth fund,” said Daniel Yergin, chairman of Cambridge Energy Research Associates, referring to the funds set up by Russia, Norway and others to invest their oil profits. “And yet now,” he said, “they’re recognized as one of the fundamental forces of the global economy.”

The basic calculus of expensive oil still holds: exporters enjoy a windfall and importers bear a heavier burden. But some unexpected countries are reaping benefits, as well as costs, from higher prices.

Consider Germany. Although it imports virtually all its oil, it has prospered from extensive trade with a booming Russia and the Middle East. German exports to Russia grew 128 percent from 2001 to 2006; exports to the United States grew just 15 percent.

Throughout Europe, the rise of the euro has acted as a hedge against fluctuations in the dollar-denominated oil market, while the heavy taxation of fuel has made rising oil prices less jarring to motorists.

“For Europeans,” said David Fyfe, a senior oil market analyst at the International Energy Agency in Paris, “$100 oil is mostly symbolic.”

Elsewhere, it is much more. For developing countries, oil can be a tool of national transformation — whether the goal is a middle-class standard of living or a utopian society.

In Venezuela, President Hugo Chávez is pouring oil proceeds into a socialist revolution, creating free health care, free education and cheap food; enabling heavy public spending that has helped fuel four years of economic growth.

The trouble, said Theresa Paiz, a Latin American director for the Fitch ratings agency, is that “it’s not really clear how the money is invested.” Mr. Chávez’s government is steering large chunks of money to development funds and state-owned companies not subject to audits.

Transparency International, an organization that tracks corruption, ranks countries from least to most corrupt, and in its 2007 index Venezuela was at 162 out of 179 countries.

Concerns about corruption are even more pronounced in Nigeria and Angola.

Oil-rich Angola is taking in two and a half times the cash it did three years ago. Hotels in the capital, Luanda, are booked months in advance, largely by foreign oil companies. Sales of luxury cars are booming, and the International Monetary Fund projects the economy will grow 24 percent this year, one of the world’s fastest rates. Yet analysts for the Catholic University of Angola’s research center say two in three Angolans live on $2 or less a day, the same ratio as in 2002, when the country’s decades-long civil war ended.

The government is eager to show that oil wealth is benefiting ordinary citizens. It has rebuilt 2,400 miles of roads, refurbished 4 airports, and laid 430 miles of new railroad track.

But many Angolans take it as a given that oil has enriched public officials most of all. In 2003, a newspaper in Luanda identified the 20 richest people in Angola: 12 were government officials; 5 were former officials. Angola’s growing muscle — it is now the biggest oil supplier to China and the sixth biggest to the United States — is leading it to rethink its global position. It recently joined the Organization of the Petroleum Exporting Countries and is limiting its cooperation with the I.M.F.

In perhaps the most far-reaching change, China has become Angola’s financier, lending Luanda as much as $12 billion for the country’s reconstruction, in return for guaranteed oil supplies.

The contest among importers to secure access to oil supplies has become fierce.

China, a one-time oil exporter that now must import half its oil to lubricate its booming economy, is facing politically troublesome shortages of fuel from Shenzhen to Beijing, as Chinese refining companies refuse to supply diesel at unprofitable state-regulated prices. To head off a crisis, China raised retail prices for fuel nearly 10 percent on Nov. 1.

India is potentially even more vulnerable than China, some analysts say. Although it consumes a third as much oil as China, it imports 70 percent of its oil. It also has no strategic reserves, and demand is growing faster than in any other economy except China’s. Like China, India subsidizes fuel, particularly the kerosene used by lower- and middle-class families for cooking — a policy that costs it some $12 billion a year. If oil reaches $100 a barrel and stays there, analysts say, India will be forced to roll back those subsidies.

“Sooner or later, prices are going to bite,” said Subir Gokarn, Standard & Poor’s chief economist in Asia. “Clearly household budgets will be significantly affected.”

Without an increase in retail prices, officials at the Ministry of Petroleum and Natural Gas warned recently, they might no longer be able to buy adequate supplies of crude for India’s refineries. “Unless consumers are paying for what they consume,” said M. S. Srinivasan, the petroleum secretary, the ministry “is going to be left with a big hole in its pocket.”

But raising fuel prices could ignite even greater civil unrest in India than in China, where a man was killed recently after jumping a line to buy gas in the city of Xinyang, in Henan Province.

Even in developed countries like Canada, rising oil prices can cause dislocation. The region around the oil sands in northern Alberta is the closest thing the developed world has to a 19th-century boom town. The influx of workers has created a shortage of skilled labor in neighboring British Columbia, where construction is under way for the 2010 Winter Olympics.

In comparison, the problems faced by other oil producers seem almost benign. For them, the most burning question is what to do with all the money. Norway, the world’s 10th-largest oil producer, wants to guarantee every child a subsidized kindergarten spot by the end of 2008.

It has increased spending on kindergarten to $3.3 billion this year, from $2.75 billion, partly using money transferred from its $350 billion State Pension Fund, once known as the Petroleum Fund. Most of the fund is earmarked to pay the future pensions of Norway’s 4.6 million people.

“The discipline is structural,” said Johan Nic Vold, a consultant and former executive at Royal Dutch Shell. “Without it, the demands on politicians to use the oil revenue would be almost insatiable.”

Perched on the Persian Gulf, Dubai has taken a similarly long view. Treating its oil reserves as temporary, it used the proceeds to expand pell-mell into tourism, trade, real estate and construction. The oil sector now accounts for only 5 percent of Dubai’s gross domestic product.

But perhaps no country has reveled in its oil wealth like Russia. NetJets Europe, the private-jet company, plans to open an office in Russia because the traffic between Moscow and London has become so dense.

This month, Christie’s will stage what it expects to be a record-setting auction week dedicated to Russian art, including the auction of a Fabergé egg made for the Russian royal family.

Russians have kept London’s high-end real estate market buzzing. “There are a lot of Russian buyers around who are prepared to pay a vast amount of money,” said Michael Chetwode of the Home Search Bureau.

Back home, Russia’s oil wealth is trickling down. Mr. Putin is using it to finance “priority national projects,” like improved health care and education, and access to affordable housing.

Oil may also help Mr. Putin cling to power after he leaves the presidency, perhaps as prime minister. As he noted recently, “We all remember what state the country was in seven, eight years ago.”

Eight years ago, oil was trading at $16 a barrel.

Reporting was contributed by Ian Austen in Ottawa; Keith Bradsher in Shenzhen, China; Thanassis Cambanis in Dubai; Walter Gibbs in Oslo; Jens Erik Gould in Caracas, Venezuela; Sophia Kishkovsky in Moscow; Sharon LaFraniere in Angola; Heather Timmons in New Delhi; and Julia Werdigier in London.

Real Losses Have Nothing to Do With Money (NYTimes, 10/21/07)

October 21, 2007
Dealbook
Real Losses Have Nothing to Do With Money
By ANDREW ROSS SORKIN
SEVEN years ago, I received a call on a Sunday afternoon from Donald Meltzer, then the co-head of mergers and acquisitions at what was then Credit Suisse First Boston. I was hoping that he was calling with news about a deal. Instead, his voice cracked as he told me that Gordon A. Rich, a 43-year-old star at the firm, had died in a car accident the night before.
A lump rose in my throat. I had known Mr. Rich well — to friends he was known as Gordo. At his funeral, an overflowing room of hardened Masters of the Universe — the biggest names in the business — turned to mush; they didn’t just cry, they bawled. I sobbed, too.
Two weeks ago, I got a similar call. This time, Douglas Braunstein, the head of investment banking at JPMorgan Chase, called to tell me about another death, of someone else I knew well: Shane Wallace, a 38-year-old telecommunications banker at JPMorgan Chase. Mr. Wallace had been fighting brain cancer for more than a year.
Over the next 24 hours, I received more than a dozen other Kleenex-filled calls from Wall Street titans to commiserate about Mr. Wallace. Each time I choked up. Nobody talked about deal making or stock prices; they talked about his life, his family and his love of fishing.
And on Friday, I got an early-morning call that James M. Allwin, a 54-year-old former Morgan Stanley banker who was president of Aetos Capital, had died. Another good person, struck down too early.
I tell these stories not to be sappy, but because most Sundays this column examines the ups and downs of Wall Street. Usually, it is inspired by the news of the week, and that means the human beings behind the headlines can sometimes become lost.
So I thought it was worth taking the time to point out that the “titans of finance” don’t wear their suspenders 24 hours a day (except when they pull all-nighters). The mythical table-pounding banker for whom dollars and deals trump all else is, more often than not, exactly that: mythical. And the suspender-wearing thing is mythical, too — or at least probably out of fashion.
On Thursday night, I was reminded of those myths when I attended an annual memorial dinner for Mr. Rich, an event that always brings out some of the biggest names on Wall Street. Mr. Rich was the antithesis of the Gordon Gekko archetype and, even seven years after his death, he still commands a special loyalty.
In attendance was Joseph R. Perella, who founded First Boston’s mergers and acquisitions group in the 1970s; Charles G. Ward III, the president of Lazard; Raymond McGuire, co-head of Citigroup’s investment bank; Mr. Braunstein; and dozens of Credit Suisse colleagues.
The group, of about 175 people, has been getting together for the last five years to celebrate the life of Mr. Rich and to raise money for a scholarship fund they started in his name. It has become like a family reunion for the close-knit fraternity of merger specialists. Virtually everybody either once worked with or across the negotiating table from Mr. Rich.
And everyone was his friend. That’s a rarity on Wall Street; Mr. Rich had a Clintonesque ability to make anyone feel like the most important person in the room.
Mr. Rich commands this almost Pied Piper-like loyalty because he was the last person you would expect to find on Wall Street. Sure, he made millions of dollars. He made a cameo appearance in “Barbarians at the Gate,” the book that chronicled the battle for RJR Nabisco.
But he was a blue-collar investment banker. He was in on the joke; he regularly used to laugh about how he was overpaid. He was a prankster who lived for his family, cooking and the Yankees — an irreverent man shot through with personality who might actually have a tough time getting a job in finance today.
HIS former colleagues started the Gordon A. Rich Memorial Fund to help pay college tuition for needy students who are the sons or daughters of secretaries, janitors and other working-class members of the financial services industry. It reflects Mr. Rich’s own priorities — he often enjoyed gossiping with his staff more than his clients.
The memorial group has raised about $4 million since it started the scholarships. It helps send four new needy students to college annually, providing each of them with a $12,500 stipend. (Surprisingly, the foundation has too few applicants, so if you are reading this and you know someone who qualifies, tell them to apply.)
It may be sad that what humanizes bankers and brings Wall Street together the most is death, especially of people still young and in their prime. At Mr. Wallace’s funeral, it wasn’t just his colleagues in attendance. All his competitors were there, too.
Mr. Wallace received a diagnosis of brain cancer a year ago. It was amazing to watch an institution like JPMorgan, and all of his clients — he worked for MCI on its sale to Verizon — rally around one of its rising stars when he was falling. He drifted in and out of the office for the last year, working on the $27 billion buyout of Alltel until nearly the very end.
Shane Wallace may have been a deal devotee, but like some others on Wall Street, he was hardly in it just for the deal.
DealBook also has a newsletter and a Web site, nytimes.com/dealbook, that is updated continually when markets are open.

The Gloomsayers Should Look Up (NYTimes, 10/21/07)

October 21, 2007
Everybody's Business
The Gloomsayers Should Look Up
By BEN STEIN
BEFORE I start on this little tour d’horizon, I just want to say that a good, fresh Taco Supreme from Taco Bell is more tasty than just about anything at any fancy-pants restaurant anywhere in the world. And they didn’t pay me, and they don’t even know me. Just for perspective.
And really, the whole story about the economy, credit, morality and rescues is about perspective. Start with the good news about perspective: The economy is basically in fine shape. Not perfect, but darned good. Almost all mortgages are not in default. Almost all workers in the labor force who care to work are not unemployed. The largest percentage ever of American household units, what were called “families” in the old days, own their own homes.
The stock market, in both absolute terms (the number on the Dow) and relative terms (the relationship of price to earnings), reflects optimism and an extraordinary, robust level of profits.
On a more sophisticated note of analysis, the spread between the interest rate paid on risk-free Treasury issues and on the Merrill Lynch master junk-bond index is far, far less than it was in the dark days of the tech meltdown from 2000 to 2002. (This data comes from Marty Fridson of FridsonVision, le dernier cri when it comes to junk.) This is a sign of less than horrific fear about high-risk debt.
Newspapers (which often sell on fear, not on fact) talk frequently about a mortgage freeze. However, for all but the least qualified buyers, mortgage money is plentiful, and in fact the potential borrower is bombarded with offers. Hotels and airplanes are full. Casinos in Las Vegas are jam-packed. There is still a long waiting list for Bentleys in Beverly Hills.
This country does not look like a country in economic trouble. Nevertheless, some extremely worrisome things have happened and are now being revealed, and worse are to come.
As everyone knows, we have a housing correction on a large scale. True, it’s a correction from a high level, but it’s still a big correction. There has been a spectacular upsurge in mortgage delinquencies among subprime borrowers. While the sums involved are tiny, compared with the dimensions of our lusciously huge economy, they are unfortunate in many ways, as we will see.
There has been a stupendous wave of fear washing over Wall Street and the large “money center” banks because of commitments to finance mergers and leveraged buyouts that now look questionable. The large banks and investment banks are committed to lend hundreds of billions of dollars for deals that looked sweet when deal guys were playing musical chairs but look dicey now that the music has stopped. Some people think that the game won’t start again for a while (although I happen to think it will restart very, very soon — the fees are just too good for this game to stop).
In recent weeks, there has been another tsunami of fear about money tied up in so-called conduits. These are basically incredibly risky and foolish instruments in which money is borrowed short to be lent long. Every finance student in the world is taught to be wary of this deal because when it goes bad, it goes really bad, but nevertheless, there are many big players in Europe and the United States who have done these deals.
There is deep worry that lenders caught up in bad loans to subprime borrowers, failed conduits and Wall Street deal makers will have to take big losses that will impair the capital of the lenders and shake the foundations of the nation, credit-wise.
Now comes the “and there is worse to come” part. It certainly looks to little me as if the top dogs on Wall Street made some staggering mistakes. They took on very risky loans. They tried to juice returns in a low-interest-rate world by maneuvers so dicey that the maneuvers would not survive scrutiny and had to be hidden on off-balance-sheet entities, sometimes outside the country.
All those titans of the Street at Merrill Lynch, Citigroup and elsewhere can fire their underlings and blame them for their losses. But the C.E.O.’s are paid big bucks to know what’s happening and to run their companies prudently (as Goldman Sachs and JPMorgan apparently did). Clearly, with immense losses in a wide variety of investments, prudence was not used in the last several years at some of our most esteemed money houses.
As I have said for 20 years, it’s basic when you are lending to subprime borrowers to take substantial reserves for likely defaults. Obviously, this was not done. When you borrow short and secure and lend long and risky, you take huge reserves for the day when the trade turns sour. This was apparently not done. If it had been done, there would be no problem.
Those at the top can blame anyone they like for their companies’ imprudence, but they are ultimately responsible. Why are they still in their jobs? Not one C.E.O. of a major commercial or investment bank has lost his job despite some staggering write-downs. Why? Is this the board of directors’ old buddy system at work? Sure looks like it.
Now, the ultimate Wall Street player and insider, Henry M. Paulson Jr., the Treasury secretary, has bestirred himself to take serious notice of the credit problems faced by some very big lenders. He wants to create a bailout fund in which banks that still appear sound buy some of the debt of the troubled players like Citigroup.
THE deal, as far as I can tell, is that they buy the most secure levels of debt that Citigroup and others own, get large fees and allow Citigroup and the others to keep the debts off their balance sheets. But there are at least two giant issues here.
One is that it’s a bit too predictable that Mr. Paulson would basically pooh-pooh the subprime problems until major Wall Street powers got in trouble and then — presto! — swing into action. It might have been inspiring had he stepped up to the plate when smaller players like home buyers were getting burned, but that’s not really his style.
The other is that it’s hard to see what good the maneuver would do. Suppose Citigroup or some other lender has a perfectly good loan to sell. Why does Citigroup need a big Treasury-sponsored organization to sell it? They can sell it to anyone right now. The problem is with the questionable loans. And they seemingly are not part of the plan from the Treasury.
The Treasury plan is either just plain foolish (an explanation not to be sneered at) or it’s the thin edge of the wedge: what may follow is to have a government fund to buy the slightly less fragrant parts of the portfolio. Indeed, that would seem inevitable to me, and I’ll tell you why.
The goal is to keep Citigroup and others from taking large losses on bad loans. If the loans are sold to supershrewd buyers of debt like Leon Black or David Tepper or our resident megagenius, Warren E. Buffett, those buyers will demand a big haircut on the deal. Losses will have to be taken. The only buyers who might step in to pay full price are — drumroll, please — you and I, the taxpaying suckers.
I could easily be wrong, but I suspect that at the end of the day, you and I will be bailing out the hundred-million-a-year finance titans who messed this up in the first place. This is what happened with the savings-and-loan disaster. The S.& L. chieftains — very often connected with Michael R. Milken and Drexel’s junk-bond world — became multimillionaires and billionaires by wheeling and dealing with government-insured money. When the loans went bad, you and I picked up the bill while the bankers went shopping for their Bentleys.
NOW, let me go back to my role as Little Benjy Sunshine. None of this will sink our glorious economy. The losses are nothing compared with the losses in the tech debacle. They will be nothing like the numbers bandied about in the fear-mongering media. If there is a questionable $200 billion pool of loans, that means a small percent will be lost, not all of it. This big, strong economy will sail on through.
But the vicious, cruel truth is that some very greedy, selfish and, yes, stupid men made fortunes on deals that were economically and/or ethically wrong. (Why else hide them off balance sheet or abroad?) They got immense fees, stunning paychecks and the inheritance of maharajahs. Their great-grandchildren will be rich from their deeds and misdeeds. As far as I can tell, they are not being called to account in any major way. The ones at the top aren’t fired or, if they are fired, are fired very rich. (Never mind that silly mouth music from Citigroup about “the year of no excuses.”) Despite what looks to me like a breathtaking lack of disclosure, I have not seen any lawsuits by the Securities and Exchange Commission against any of these big money-center princes or principalities — not to mention criminal investigations from other law enforcement authorities.
And we stockholders and taxpayers foot the bill, of course. But even this is not the worst part: there are still lots of people who can say with a straight face that the world of finance is overregulated, that we should trust the power players to do the right thing, that if we put finance under a microscope, or allow financial miscreants to be sued for misconduct, America will be harmed. There are still people, and I know many of them well, who believe that old myth that you can trust the markets to fix everything — that old magical thinking that some thieves will stop other thieves from robbing the sheep like us. That’s the really sad part. Some babies never learn.
But in the meantime, try that Taco Supreme. It’s awfully good. Wall Street hasn’t figured out how to ruin that one yet.

Banks May Pool Billions to Avert Securities Sell-Off (NYTimes, 10/14/07)

October 14, 2007
Banks May Pool Billions to Avert Securities Sell-Off
By ERIC DASH
Several of the world’s biggest banks are in talks to put up about $75 billion in a backup fund that could be used to buy risky mortgage securities and other assets, a move designed to ease pressure on a crucial part of the credit markets that threatens the broader economy.
Citigroup, Bank of America and JPMorgan Chase, along with several other financial institutions, have been meeting to come up with a plan to create a fund that could prevent a sharp sell-off in securities owned by bank-affiliated investment vehicles. The meetings, which began three weeks ago, have been orchestrated by senior officials at the Treasury Department, and the discussions have intensified in the last few days.
A broad framework for an agreement could be reached as early as tomorrow, according to people with knowledge of the discussions, but many important details still need to be hammered out. Another round of discussions is taking place this weekend, and it is still possible that the parties will not reach an agreement.
“Treasury is very serious about getting some solution in place to take away the fear hanging over the markets,” said Alex Roever, a credit analyst at JPMorgan Chase who has been following the discussions but is not involved in them. “It is a very challenging thing to do. There are so many parties involved and they all don’t agree.
The proposal echoes the 1998 bailout of the hedge fund Long Term Capital Management, when a group of big banks came together to prevent the fund from collapsing after it made a series of bad bets. And the current round of crisis-driven collaboration illustrates the heightened level of concern among both government and financial players.
While there are signs that the broader credit markets have begun to stabilize after the Federal Reserve lowered interest rates last month, a pocket of the commercial paper market remains under siege: structured investment vehicles, known as SIVs. The fear is that problems with these vehicles could infect the broader economy.
SIVs, which issue short-term notes to invest in longer-term securities with higher yields, are often organized by banks but are not actually owned or held by them. They are supposed to be financed through the issuance of commercial paper backed by pools of home loans and credit card debt, but the loss of confidence in the quality of subprime mortgage bonds has also tainted these securities.
Analysts say that investors have all but stopped buying SIV-affiliated commercial paper, and the worry is that the 30 or so SIVs will unload billions of dollars of mortgage-related assets all at once. That would put intense pressure on prices. As Wall Street firms and hedge funds mark value of similar investments they held to their new lower values, they face potentially huge hits to their profits.
Still, the impact on the biggest banks is even more severe. In times of crisis, they are committed — either legally or to maintain their reputations — to stepping in to buy those securities. Banks have already been buying significant amounts of commercial paper in recent weeks, even though they did not have to. But if they are forced to bring those assets onto their balance sheets, they might be less willing to lend to businesses and consumers. That could set off a credit crunch and thrust the economy into a recession.
The proposal being floated calls for the creation of a “Super-SIV,” or a SIV-like fund fully backed by several of the world’s biggest banks to provide emergency financing. The Super-SIV would issue short-term notes to finance the purchase of assets held by the SIVs affiliated with the banks, with the hope of reassuring investors.
But whether the banks would buy the assets directly or just buy the short-term debt is still unclear, according to people briefed on the situation. So are other aspects, like the amount of capital each bank would need to contribute, how it would be administrated, and the fee structures and cost burdens.
The effort to create a backup fund began about three weeks ago, when the Treasury secretary, Henry M. Paulson, called a meeting in Washington that included the chief executives of Citigroup, Bank of America, JPMorgan and other big banks. With Wall Street firms having almost no luck finding buyers for mortgage-backed securities and derivatives, Mr. Paulson wanted to see what could be done to relieve the bottleneck.
Several rounds of discussions followed — in Washington, New York and on conference calls — led by two senior Treasury Department officials: Robert Steel, the under secretary for domestic finance and a former Goldman Sachs executive who is a close adviser Mr. Paulson; and Anthony Ryan, a former investment banker who is now assistant Treasury secretary for financial markets.
Besides hearing from senior executives from each of the big banks, the group also sought ideas from others. Several big international banks, including Barclays and HSBC, have been asked about their interest in participating. The group also reached out to several of the major structured investment funds, as well as big institutional investors in the commercial paper markets.
Edmund L. Andrews contributed reporting.

The Man Who Won as Others Lost (NYTimes, 10/13/07)

October 13, 2007
The Man Who Won as Others Lost
By LANDON THOMAS Jr.
Paul Tudor Jones II leans back in his chair and grins. The stock market is going to crash, and he knows it. “There will be some type of a decline, without a question, in the next 10, 20 months,” he says in his rich Memphis drawl. “And it will be earth-shaking; it will be saber-rattling.”
Coming from a financial speculator as prominent as Mr. Jones, a man with about $19 billion of short-term trading capital at his disposal, the words might be enough to send ripples through a stock market that, apparently defying logic, has been hitting new highs each day.
Except that the crash to which Mr. Jones refers occurred Oct. 19, 1987. His prognostication — brazen, and as impudent as the man himself — was made in a documentary called “Trader,” which was filmed in the year preceding that day.
Now, 20 years after the 508-point decline, several strategists are anticipating that the earth will shake again. Valuations are stretched beyond historical comparisons. The market, ever more volatile, is reaching new highs, ignoring a buildup of bad news. Most crucially, the strategists say, the sentiment that the market’s rise is infinite seems to have taken permanent hold.
“The overvaluation of stocks is more extreme than the 1929 high,” said Robert R. Prechter Jr., an independent market forecaster in Gainesville, Ga., and a well-known follower of Elliott Wave theory, which examines the extent to which investor psychology creates stock market patterns. “Which tells me the next bear market will be the biggest in many years, probably since 1929-32.”
At the end of the day Oct. 19, 1987, stocks were down 22 percent — precisely the “Acapulco cliff dive” predicted by Mr. Jones in the video. The day ruined the careers of many, but it made the reputations of Mr. Jones and Mr. Prechter, whose professional relationship dates to the mid-1980s.
In the video, Mr. Jones can be seen huddled over a graph, comparing the market’s peak in 1987 with a previous high in 1929.
As Elliott Wave theory would have it, the two market tops may have been 60 years apart but the herdlike exuberance of investors pushing stocks ever upward was the same. On Oct. 5, 1987, Mr. Prechter, then and now the best-known proponent of the theory, told his subscribers to sell.
While the rest of Wall Street counted its losses, Mr. Jones, at age 32, returned 200 percent for his investors that year and drew a payday of an estimated $100 million for the year, an almost unheard-of sum at the time.
No one, including Mr. Prechter himself, claims that Mr. Jones relied solely on Mr. Prechter’s call. Indeed, in the video Mr. Jones can be seen as early as 1986 making a case that the market would fall. But the crash did not last long. Prices rebounded the next day, and within two years, the market had regained all that it had lost that day.
Now, Mr. Prechter is suggesting that the country is facing not just a market crash, but also a depression. On every measure, he says, the market is more overvalued than it was in 1987 before the reversal. The price-to-book ratio of the S.&. P 500-stock index today is 4.04, compared with 1.73 in 1987. And measures of the bullishness of Wall Street traders confirm Mr. Prechter’s assessment of the overvaluation.
To be sure, the one feature of every long-running bull market is the small clutch of market pessimists whose clamor that the end is nigh seems to rise in pitch with each successive peak.
But Mr. Prechter’s gloominess may resonate, especially in light of Mr. Jones’s high regard for him. “Prechter is the best because he is the ultimate market opportunist,” Mr. Jones said in the book “Market Wizards,” a collection of interviews with successful traders compiled by Jack D. Schwager.
That is not to say that Mr. Prechter has any undue sway over Mr. Jones, who since he started Tudor Investment in 1986 has generated a return of 26 percent a year and has seen his assets grow from $125 million to $19 billion. Indeed, Mr. Prechter’s relentless bearishness has not made him a favorite of bullish hedge fund managers.
At a time when hedge fund trading is dominated by computer trading programs and traders with Ph.D.’s, Mr. Jones, who got his start trading bales of cotton on the New York Cotton Exchange, is of the older style, relying on intuition, market smarts and the force of his personality. A macro trader, he is known for making big sweeping bets on the direction of stock exchange indexes, commodities and currencies.
As for his view on the market, Mr. Jones declined to comment for this article. Over the last 17 years, he has rarely publicly expressed an opinion about stocks, bonds or currencies — a reflection of his influence as a trader.
This summer, his funds were hit by the credit crisis and lost 5 percent in August. Through September, Mr. Jones is barely ahead, up 2.5 percent, and he could end up having his worst year in more than a decade.
“He has had a tough time lately,” said Byron R. Wien, a friend of Mr. Jones and a strategist at Pequot Capital Management, a rival hedge fund. “But he is a talent. You go through cold periods, but you don’t lose it.”
It happens to every fund manager, the spell when the magic touch disappears. And although all the top traders preach the discipline of not letting your losses get to you, the video suggests that even the best feel the almost physical pain of trading defeats.
In one scene, Mr. Jones, his knee jiggling with such violence that his tie sways, is shown losing $6 million in one day, in December 1986. It was a big loss, given that he had only $125 million under management at the time. “This is what is known as the agony,” he says, slumping in his chair. “This is devastating. An intellectual blow.” He stops talking. He looks distant and distracted. “I hate it.”
Mr. Prechter, who keeps in touch with Mr. Jones through e-mail and the occasional phone call, says that Mr. Jones, his recent rough stretch notwithstanding, is best placed to survive a crash.
“He does not go cold and clammy,” Mr. Prechter said. He does not know if Mr. Jones shares his dark view of the market, though he allows that “Paul is certainly aware of the risk of an extensive bear market” and “is well aware that stocks are vulnerable.”
But don’t expect Mr. Jones to relive his 1987 glory. One investor who has spoken with him in the last week, who asked not to be identified because he is not authorized to speak publicly about Mr. Jones’s investment strategies, said that the recent rate cut had made Mr. Jones increasingly bullish. Indeed, as opposed to 1987, Mr. Jones is said to be reminded of 1998, when cuts by the Federal Reserve led to the stock market boom of the late 1990s. “I have not heard him mention Prechter in a long time,” this investor said.
The 1987 video offers an intriguing window into the everyday life of big-league traders, and it has the feel of a time capsule. Full of swagger and braggadocio, Mr. Jones can be seen skiing in Gstaad, Switzerland, or riding a horse on his estate overlooking the Chesapeake Bay — when he is not screaming out orders to his traders. He comes across as a young Gordon Gekko. Greed was not only good; it was fun.
Although the video was shown on public television in November 1987, very few copies exist. Those that do are hoarded by traders who watch the hourlong movie in the hope of gleaning possible trading tips from Mr. Jones. On the Internet, bids for the video start at $295. According to Michael Glyn, the video’s director, Mr. Jones requested in the 1990s that the documentary be removed from circulation.
It is no surprise that Mr. Jones wants some distance from that version of himself. He was a bit of a cowboy, out to prove he was the best. Now, 20 years later, he sits atop the new hedge fund rich. He is married to a former model from Australia, has a mansion in Greenwich, Conn., and owns a big-game reserve in Tanzania. Forbes estimates his net worth to be $3.3 billion.
On Wall Street, the roles are reversed. Mr. Prechter foresees a return to the Depression; Mr. Jones, who himself said a depression would follow the 1987 crash, may well be fully invested.
“People will be gasping,” Mr. Jones says with glee in the video, referring to the 1987 crash that he was sure would come. “It will be total rock ’n’ roll.”

Is Private Equity Giving Hertz a Boost? (NYTimes, 09/23/07)

September 23, 2007
Is Private Equity Giving Hertz a Boost?
By ANDREW ROSS SORKIN
LAST fall, Mark P. Frissora, the newly hired chief executive of Hertz, kept running into the same question from potential investors.
Hertz, which Ford had sold just 11 months earlier to a consortium of private equity firms for $14 billion, was trying to sell shares to the public in an offering that valued it at $17 billion. As Mr. Frissora tried to drum up interest in the offering, skeptical investors kept asking him the same question: Why was Hertz worth $3 billion more in less than a year?
“I had to spend the first 15 minutes of every road-show meeting trying to explain this,” Mr. Frissora said in a recent interview, still sounding somewhat exasperated by the experience.
His job was not made any easier by the fact that the private equity investors — the Carlyle Group, Clayton, Dubilier & Rice and an investment arm of Merrill Lynch — had piled $12 billion in debt on the company, and then paid themselves a $1 billion dividend, which amounted to nearly half of the $2.3 billion in cash they had invested.
“Very smart investors thought there couldn’t possibly be any value left,” Mr. Frissora said.
Judging by the company’s share price, many investors have changed their minds. Since the initial public offering in November, Hertz’s shares have risen 43 percent from their $15 offering price, to $21.51.
Indeed, Hertz now looks as if it was not necessarily the model of the big, bad buyout that its fiercest critics had suggested. Its private equity owners looked at the business with fresh eyes and made a number of changes that improved operating performance. By streamlining how the company cleaned and refueled vehicles, they doubled the number of cars that could be processed every hour and re-rented. Hertz was able to do so without huge reductions in the work force: it cut less than 5 percent of 32,000 jobs.
Even so, the private equity guys also saddled Hertz with billions of dollars in debt, which is taking its toll on the company. Interest expenses of $901 million pushed Hertz’s net income down to $116 million in 2006, from $350 million the year before. That gives the company less maneuvering room should the economy — or its own revenue — slacken. Still, analysts say they remain uniformly optimistic because Hertz’s pre-debt performance has been improving sharply this year. And while it carries a big pile of debt, it has less than other recently privatized companies and just slightly more than Avis Budget.
Still, it is unclear whether Hertz is the exception or the rule of the recent buyout boom. Tightening credit markets pose a threat to all companies carrying big debt loads. For example, Freescale Semiconductor, which was taken private last year, saw its debt trade at 91 cents on the dollar last week amid concerns about the company’s financial prospects. But default rates on corporate debt currently remain near record lows of about 0.7 percent. If interest rates rise and debt payments skyrocket, some private equity darlings could stumble. In the 2001 recession, the default rate rose to 8.3 percent.
“Hertz is an example of a success story, but you have to be unbelievably courageous to believe history won’t repeat itself with some other companies,” said Steven Rattner, co-founder of the Quadrangle Group, the private investment firm, who has been sounding the alarm about the dangers of cheap debt. “We’re not magicians or alchemists.”
Nonetheless, a close look at the industry over its three-decade history shows that, on average, the firms have actually managed to improve, at least marginally, the businesses they own. “The empirical evidence is actually quite good,” said Steven N. Kaplan, a professor at the University of Chicago Graduate School of Business, who conducted the seminal study on the subject in the 1980s. “There is no evidence in any large sample study that they harm operating performance.”
No one has completed studies of the most recent boom, which has its own set of new wrinkles: bigger targets, higher premiums and much bigger upfront fees, all of which strain comparisons with private equity’s performance in earlier decades. Few academics appear to be studying the operational performance of recent buyout targets, but Edith Hotchkiss, a finance professor at Boston College, has been running the numbers. She is scrutinizing 176 companies taken over from 1990 to 2006, and her conclusion so far is positive.
“We continue to see operating gains,” she says, but she cautions that profit margins among the current takeover targets don’t match the operational returns of earlier decades. “The magnitudes are not as high,” she says.
SO how, exactly, did Hertz justify the $3 billion in new value before its I.P.O.? Easily, Mr. Frissora said, as he leaned back in a chair in a conference room at Spencer Stuart, the recruiting firm that brought him to Hertz. But his candid answer was not a complete ode to Hertz’s private equity owners.
He said a third of the value was simply a result of “market-related timing”: because of increased air travel, shares of other travel-related companies had jumped sharply since Hertz was acquired.
“It had nothing to do with private equity,” he said nonchalantly, though he gave his bosses at the private equity firms credit for making a good bet on the market. Mr. Frissora ascribed another third of the increase in value to the performance of Hertz’s equipment rental business — not its traditional car rental business, but equipment used in construction — which took off as a result of the housing boom and better internal processes. Again, it is not an improvement that can be attributed entirely to the private equity owners.
And finally, he said, “They bought it at a discount.”
Ford, he explained, was in distress and needed cash quickly when it sold Hertz. Rather than pursue an I.P.O. and take in the risks associated with an offering, Ford chose to sell. It was a heated auction, but “Ford could have gotten more money for it if they had done what private equity did,” he said.
It is a refrain heard again and again by shareholders across the country who feel that they have been shortchanged by corporations too quick to sell when private equity comes calling. Laura B. Resnikoff, an associate professor and the director of the private equity program at the Columbia Business School, who is doing a case study on Hertz, said she grapples with the issue constantly. “A good management team at a public company could do all of this, of course. And yet, we don’t see management teams doing it.”
Why?
“The rate of change that private equity forces on portfolio companies is something most public companies are not comfortable with,” she said. Nor are public shareholders always willing to shoulder the burden of high debt loads. Perhaps most crucially, management often does not have the same incentives as a private equity owner to pursue such drastic change.
At public companies, which seek to deliver steady returns to shareholders, executives are often rewarded for playing it safe. At a private-equity-owned business, the system favors risk-taking: Management can earn huge pay packages if turnarounds succeed — and face quick dismissal if the status quo continues.
At Hertz, inertia seemed to rein. In the 25 years before Mr. Frissora’s arrival, the company was run by only two chief executives. Neither reported to Ford’s chief executive; each reported to a manager three layers below the chief financial officer. And its managers were paid some of their bonuses in Ford’s poorly performing stock, hardly an incentive to increase performance.
George W. Tamke, a partner at Clayton, Dubilier & Rice and Hertz’s chairman, says the company was “a corporate orphan.” For the most part, Ford had left it alone as long as it hit its quarterly forecasts. That bred an insular culture that helped create a great brand, but not great business practices. For example, Hertz had its own printing facilities for marketing materials; it had never considered using an outside printer. The unit also had more than 600 computer programmers to manage its system, and even had its own security department. Forget about outsourcing. “They insourced everything,” Mr. Frissora said.
Some think Hertz still isn’t lean enough. Christina Woo, an analyst at Morgan Stanley, who has been particularly bearish on the industry, in part because of too much price competition, suggests that Hertz still has ample expenses to slash.
Nonetheless, it appears that private equity has brought a new sense of discipline to the company. Mr. Frissora says he has to have weekly conversations with Mr. Tamke, and monthly updates with the private equity owners, who often pepper him with questions and suggestions. Those conversations are on top of the regular board meetings.
And the private equity firms have added new, more complex measuring sticks: return on capital; Ebitda, for earnings before income, taxes, depreciation and amortization; and a focus on cash flow. “They hadn’t thought about that before,” Mr. Frissora said.
In contrast to previous Hertz executives, whose salaries under Ford were so low they didn’t have to be disclosed, Mr. Frissora has been paid handsomely for his work. His salary is $950,000, but with bonuses, stock options and other grants he was given before Hertz’s I.P.O., his payout is now worth more than $30 million, at least on paper, and he stands to make even more money if Hertz’s share price goes up. He also has invested $6 million of his own money in Hertz.
At a Hertz outpost in a parking lot on the outskirts of O’Hare Airport in Chicago, the changes under private equity’s watch are easy to see.
When Mr. Frissora joined Hertz from auto supplier Tenneco last year, he sent a team of managers to O’Hare for a “waste walk-around.” Armed with stopwatches, digital cameras and clipboards, the group members evaluated every aspect of the business, from the airport shuttle buses to the lighting in the bathrooms.
What did they find? The time it took to refuel and clean cars between uses was far too long. There were too many steps.
When a customer dropped off a car, it would be moved to a waiting pen, then taken to a gas pump. From there, an attendant would have to pull the car up to the cleaning station, where it would be vacuumed. It would then go through a washer. “And someone would run out of supplies every 15 minutes,” Mr. Frissora said.
At the end of the evaluation, he made changes almost on the spot. Within days, the seven cleaning stations were moved to where cars are refueled so cleaning could be done at the same time. Eight hours of supplies were provided so that nobody ran out.
According to Mr. Frissora and his private equity bosses, the changes doubled the number of cars that could be processed every hour. That meant Hertz could have more cars on the road and fewer cars in its fleet.
Mr. Frissora also noticed another inefficiency: Too many Hertz cars were sitting idle on the weekends at airport areas, but were sold out in locations away from the airport in Chicago and nearby cities, where renters needed them for short trips. So now 20 employees, called “transporters,” arrive every Thursday night at O’Hare and shuttle more than 300 cars off the airport lot into cities for the weekend. On Sunday nights, they take them back to O’Hare.
Now Hertz plans to use more transporters all over the country. The various changes at O’Hare have added $1 million in revenue.
Then there is the greatest inefficiency: the buying and selling of cars. Some rivals, like Enterprise, are so good at it that rental income is just icing on the cake. Hertz, however, had been getting so much of its fleet from Ford for so long that it didn’t bargain hard on price with other companies. “I’m used to beating each other up a bit on price,” he said.
So Hertz has put into place professional purchasing methods, centralizing the process so it can wring better deals from automakers. Hertz was also taking too long to sell cars; it took an average of 36 days once Hertz took the car off the lot, found the title, fixed the car and found a dealership or auction to sell it. “Every day that the car sits it’s depreciating,” Mr. Frissora said.
Now, Hertz has cut the time to 15 days, saving the company $30 million a year. And it is selling cars directly to the consumer online and using its facilities as a virtual dealership.
Hertz is aggressively renting environmentally friendly hybrids, a move that has helped in marketing and the bottom line. The hybrids have been so popular with customers, who pay $6 a day more to rent one, that it plans to expand its fleet to about 3,500 by the end of 2008.
And if Mr. Frissora can pull it off, Hertz will solve most rental car customers’ biggest nightmare: paying sky-high prices for gas when returning a car. He wants to offer gas at a competitive rate — which alone might make the buyout worth it.

From Russia With Cash: Seeding a Hedge Fund (NYTimes, 09/23/07)

September 23, 2007
From Russia With Cash: Seeding a Hedge Fund
By RON STODGHILL
ANDREI VAVILOV — Russian multimillionaire, well-connected energy magnate and nascent hedge fund manager — smiles broadly in a Manhattan restaurant as a lawyer, a lobbyist, an economist and a former congressman praise him over shots of vodka and a lavish spread of lamb, salmon and beef tenderloin.
They toast Mr. Vavilov, 46, as an architect of Russia’s fledgling market economy and a maverick financier whose philanthropic contributions to universities in the United States and abroad have produced important financial research.
“Congratulations on your newest venture, this hedge fund of yours,” says Thomas B. Evans Jr., a former Republican representative from Delaware. “I mean, I don’t know much about it, but I am sure it will be a big success.”
If Mr. Evans is hoping to learn more about Mr. Vavilov’s new fund, the IFS Hedge Fund, he may have a long wait. Throughout his career, Mr. Vavilov’s bookishness — he is fond of wire-rimmed glasses and a buzz cut — has belied his reputation as a shrewd back-room operator whose business and political relationships have followed a circuitous and largely silent path from Moscow to London to New York. Even by the standards of hedge fund managers, whose activities are often shrouded in secrecy, Mr. Vavilov occupies uniquely murky territory — at the intersection of shadowy Russian oil riches and fast money on Wall Street.
Mr. Vavilov, who survived an assassination attempt about a decade ago while working in the Russian government, says he personally pocketed $600 million when he sold his oil company, Severnaya Neft, five years ago. Since then, he says, he has invested $200 million in his hedge fund, which he incorporated in the Bahamas in 2004. He has yet to raise money from outside investors, but he is setting up shop in New York to do exactly that — at the very time that hedge funds, started by everyone from former Wall Street trading stars to former professional hockey players, are encountering the potentially brutal uncertainties of a national credit squeeze and market turbulence.
In the first eight months of this year, the average hedge fund generated after-fee returns of 6.1 percent, compared with 6.9 percent during the same period last year, according to Hedge Fund Research, a Chicago firm. In each year, those returns only slightly outpaced the Standard & Poor’s 500-stock index, and a basket of stocks linked to the index typically carries less risk than investments in the more highflying world of hedge funds. Investors who place their money with hedge fund managers expect them to handily outperform the S.& P. 500 over time, and they are willing to cede hefty fees to them for the privilege of doing so.
For his part, Mr. Vavilov — who says his fund has garnered annual returns of more than 20 percent since its start in 2004 by placing global, macroeconomic bets that he declines to describe in any detail — remains unbowed by the challenges sweeping across the hedge fund landscape. He says that he is positioning himself to play a central role in the potential privatization of a Russian government fund that holds $130 billion in oil proceeds, and that his hedge fund should be a beneficiary if that state fund is privatized.
He also says he brings another advantage to the table: smarts. “We’ve created a strategy that allows me to get high returns without some of the risks that are associated with volatility,” he says. “I sleep well and don’t have insomnia worrying about what’s happening to my money.”
As the prices of oil and other natural resources like nickel and aluminum have soared, Mr. Vavilov joins the ranks of wealthy Russian business titans trying to put fresh riches to work here and in other markets outside their country. They say they are doing so in order to protect assets from corruption at home and to gain financial legitimacy in the West.
“What you see is a glut of oil money in Russia seeking its way into calmer waters,” says Ariel Cohen, a senior research fellow at the Heritage Foundation, a conservative research organization in Washington. “These Russian tycoons and oligarchs are looking to place their money in jurisdictions with more rule of law, and where they are not subject to expropriation by the state.”
IN recent years, many of Russia’s wealthiest tycoons have gone on an overseas spending spree. Some of their transactions have been high profile, like Roman A. Abramovich’s purchase of the Chelsea soccer club in London and the oil giant Lukoil’s purchase of Getty Petroleum, a deal orchestrated by Vagit Alekperov. Other transactions have drawn less attention, like Vladimir O. Potanin’s acquisition of a 35 percent stake in Plug Power, a fuel cell developer, for $241 million this year.
Many of the financiers behind these deals benefited lavishly from the pell-mell business privatizations of the years when Boris N. Yeltsin was Russia’s president and, having weathered the tumult that followed, now either toe the line in Vladimir V. Putin’s Russia or leave the country. Much of this has occurred against a backdrop of widespread graft.
“There is really no such thing as local capital in Russia, only local corruption,” says Martha Brill Olcott, an analyst at the Carnegie Endowment for International Peace in Washington. “The challenge for Andrei Vavilov will be succeeding in a market where things are mostly black and white, instead of Russia, a country where deals are done in the gray.”
Mr. Vavilov has never been charged with a crime, and he says that anyone who does business in Russia is unfairly tainted by the country’s image as a haven for rampant corruption. Still, since his days serving as a deputy finance minister of Russia from 1992 to 1997, Mr. Vavilov has been saddled with suspicions that he grew rich through dishonest, insider deals. In 1997, Russian federal prosecutors began investigating whether Mr. Vavilov embezzled $231 million as part of a fighter-jet deal, according to Mr. Vavilov and others with knowledge of the inquiry. The investigation is continuing, and Mr. Vavilov has repeatedly denied any wrongdoing.
“If you succeed in Russia, everyone wants to get a piece of you,” he says. “Unfortunately, envy and jealousy is a big thing in my country and when you make a lot of money, people want some of it. I spend a lot of money on lawyers.”
Mr. Vavilov brings more than attorneys to his new role as a hedge fund manager. He is also a Russian senator, with a seat in the upper house of Parliament. And he has criticized Russia’s central bank as not being more aggressive about how it invests the assets in the $130 billion government fund, also known as a stabilization fund, which the country maintains to protect the federal budget from fluctuations in the price of oil.
Along with many others, Mr. Vavilov has also advocated privatizing the stabilization fund. He is among several business and political figures in Russia angling for access to those billions, and he sees his hedge fund as a logical repository for some of that money — as well as cash from well-heeled American investors.
“I am confident that there will be no shortage of money coming in,” he says. “I don’t have to lift my fingers; people will line up to put money in. The money is the last thing that I am worried about.”
Some people think that such confidence might be misplaced. “It’s a very tough time these days to start a hedge fund, regardless of strategy,” says Nicole M. Boyson, an assistant finance professor at Northeastern University. “Most investors are like, ‘Yikes, why would I go into a hedge fund when I already scared of the plain-vanilla market.’ ”
Still, some experts say, Mr. Vavilov has one competitive advantage over most hedge fund upstarts: $200 million of his own money is invested in the fund. “Look, it’s always a tough sell unless you have an angle,” said James R. Fenkner, chairman of Red Star Asset Management, a hedge fund based in Russia. “But guys like Vavilov didn’t make this kind of money working the night shift. And to start a fund with $200 million of your own money is already a heck of an edge.”
AS Mr. Vavilov recasts himself as a hedge fund manager, he is spending more time outside Moscow. He has also gained entree to the clubby world of top-tier hedgies. In April, for example, he flew his private jet — a Boeing 737 — to Las Vegas to attend an exclusive gathering of fund managers organized by Drobny Global Advisors, where he mingled with other millionaires amid conversations about such arcane investments as Turkish glassmaking stocks and Brazilian farmland. He says his taste for socializing goes only so far, however, and that he passed on participating in the conference’s charity poker tournament, called Hedge Against Poverty.
“It is not fun for me to gamble,” he says. “You know why? I always win.”
He says he relishes being the outsider, a role accentuated by his strained English and need for an interpreter. Born and raised at the boundary of Europe and Asia in Perm City, a small town in the Ural Mountains, he moved to Moscow as an adolescent. He says his father worked as a patent researcher in Moscow; his mother was a construction engineer. He showed an early aptitude for math and science and, after his father died, contributed to the family finances by working as a computer programmer in high school.
He attended the prestigious Moscow Institute of Management, then enrolled in graduate studies in economics and mathematics at the Russian Academy of Sciences, where he received a doctorate in economics in 1987. After the collapse of the Soviet Union, several of his former academic mentors recruited him into government work — Yeltsin made him a deputy finance minister in 1992. Just a few years later, Mr. Vavilov was overseeing major bond issues for the government, working closely with Western banks to structure the deals. He helped pushed through privatizations and a flurry of other market reforms during these years, all of which Yeltsin advocated as a means of modernizing the Russian economy.
Many of the Russian reforms threatened entrenched political and financial interests in the country and inevitably led to discontent. Critics in Russia and overseas have said that shady transactions followed some reforms and netted riches for insiders.
As an architect of reforms, Mr. Vavilov earned plenty of enemies in Russia, political analysts say.
“He’s a bit of a threat to the old establishment,” says Michael D. Intriligator, a specialist in Russian economic policy at the Milken Institute and a professor at the University of California, Los Angeles. “He’s a brilliant guy, but not very well liked.”
Mr. Vavilov was the target of an assassination attempt in 1996 when his car was blown up in a Kremlin parking lot; he was not in the vehicle at the time. But, some people say, he still has enemies. “I still don’t think he has an appreciation of how many people are out for him,” says Ms. Olcott of the Carnegie Endowment.
When he left the finance ministry in 1997, he founded the Institute for Financial Studies, a Moscow-based research group that today employs 15 specialists in macroeconomic theory and finance. Among its missions has been creation of sophisticated financial models that he says form the core of his hedge fund strategies. He says the work has led to improvements in assessing risks in global currency and derivatives markets.
After gaining a seat on the board of Gazprom, the Russian energy giant, he bought a controlling stake in Severnaya Neft, a small independent Russian oil company on the brink of bankruptcy, with, he says, a $25 million private bank loan collateralized by the company’s assets. He says that under his stewardship, which included extensive cost cuts, the company invested heavily in oil production. Its reserves nearly doubled, he says, after it tapped into four promising oil fields in western Siberia. In 2002, Mr. Vavilov sold Severnaya to a major Russian oil company, Rosneft, for $600 million — in cash, he notes.
“It was a big achievement for me from all points of view,” he said. “When I bought the company, nobody even took it seriously. It became one of the fastest-growing companies in the country.”
Shortly after selling his company in 2002, he was elected to his senate seat as a representative of Penza, a city southeast of Moscow. The transition, some of his political critics in the Russian press have speculated, was shrewdly calculated — anyone who has a seat in the Russian Parliament is immune from prosecution. But Mr. Vavilov scoffs at that notion.
“I joined the senate because I like to work for the public, not just in business,” he says. “The public interest is more important to me.”
Some hedge fund managers question whether his plate — filled as it is with politics, philanthropy and constant travel — is too full to fight it out with some of the sharks prowling the waters in the industry. As Mr. Fenkner of Red Star says of Mr. Vavilov: “He’s not as hungry as most hedge fund managers are.”
Mr. Vavilov enjoys all of the accouterments available to millionaires. He has a palatial Moscow home — equipped with an underground tunnel connecting it to his research center offices — as well as a residence in Monaco. His wife, Maryana Tsaregradskaya, is a Russian actress, and the couple, who have been married 13 years, have a 2 1/2-year-old daughter. Mr. Vavilov sold his Beverly Hills home for $13.5 million a few months ago and is shopping for a home in Manhattan. So far, he says, he is leaning toward a penthouse in the Time Warner Center at Columbus Circle.
“I’m not hungry, I’m O.K.,” he says. “I’m lucky enough to support my family. But I strongly believe in my ideas.”
His grand idea about Russia is that its government, long smothered beneath an unmanageable pile of foreign and domestic debt, is now contending with a very different issue. “The biggest problem in Russia isn’t debt, it’s surplus,” he says.
Thanks to rising oil prices, Russia has $130 billion in the stabilization fund at a time of heated debate among the country’s leaders and economists over how to avert a pension crisis. According to government estimates, its population of working-age adults is shrinking and may fall to 108 million from its current 140 million over the next two decades, a result of fast-declining birth rates and higher death rates among the working class, primarily men.
AS a result, Russian leaders are debating about how to fix the country’s pay-as-you-go pension system, from collecting unpaid taxes from businesses to more radical measures that would shift the country away from a state-guaranteed program. Mr. Putin has even encouraged larger family sizes to bolster the working-age population.
Yet few in Russia have been more critical of the current system — or strident about how to fix it — than Mr. Vavilov. He has pressed his case for pension reform at international conferences and on the op-ed pages of Moscow newspapers. He argues that the $130 billion fund could be more effectively invested in order to shore up the pension fund’s finances.
“This money is basically under a mattress now,” he says. “Figuring out how to invest this money should be the main goal of this administration.”
He is urging the Russian government to invest the stabilization fund’s assets in the capital markets, using strategies developed at his research organization and which he says he has put to work in his hedge fund. Some analysts think that a more sophisticated approach in how the stabilization fund handles its assets is long overdue, and they say Mr. Vavilov’s thoughts are worth considering.
“You don’t necessarily think of Russians as savvy investors,” says Barry W. Ickes, a professor at Pennsylvania State University and financial director at the New Economic School in Moscow. “They have tended to be very insular and domestic with their wealth. His ideas are very intriguing.”
And if his hedge fund doesn’t wind up being a receptacle for pension fund proceeds, how will Mr. Vavilov raise the money he needs to give his fledgling venture a boost? In response, he, well, hedges. “Right now, I’m talking to everyone,” he says. “It’s like a beauty contest.”

Can Michael Dell Refocus His Namesake? (NYTimes, 09/09/07)

September 9, 2007
Can Michael Dell Refocus His Namesake?
By STEVE LOHR
Round Rock, Tex.
ON a recent afternoon at his company’s headquarters here, Michael S. Dell is seated in a spacious conference room named Dobie Hall — in honor of the University of Texas dormitory where, in 1984, he started the computer giant that bears his name.
He boasts that Dell Inc. has just reported quarterly profits that exceeded Wall Street projections. It’s an encouraging sign, he says, that the company — buffeted by high-profile production problems and accounting shenanigans — is finally regaining momentum.
Over the last few years, Dell, once the gold standard among PC makers, has simply overlooked major growth trends in personal computing. It missed significant shifts in notebook computer sales and the consumer market as a whole, lagged competitors in international sales, and lost the profit edge that it enjoyed from its superior procurement-and-supply network. Hewlett-Packard, having overcome its own woes, passed Dell last year as the largest seller of PCs worldwide.
Dell’s ills also extend beyond the nuts-and-bolts of making and marketing PCs. After a yearlong internal investigation, Dell conceded last month that some managers had falsified quarterly results to meet sales targets from 2003 to 2006. The company expects to reduce earnings over those years by $50 million to $150 million, tiny sums compared with the billions of dollars in profits it earned during that same period. (Dell posted annual sales of about $57 billion last year.) Yet the accounting disclosures suggest a corporate culture in which at least some senior managers felt under such pressure that they doctored the numbers; the disclosures have prompted a Securities and Exchange Commission investigation.
“The company was too focused on the short term, and the balance of priorities was way too leaning toward things that deliver short-term results — that was the major root cause,” explains Mr. Dell, dressed for the Texas summer in a short-sleeved polo shirt and jeans.
The recent setbacks would be humbling for any company, but especially so for Dell, a smooth-running machine for years and a model of the efficiencies that the shrewd use of technology and customer information can produce. Dell was widely admired beyond the technology industry, and it was cited in business-school studies alongside companies like Wal-Mart Stores.
Successful entrepreneurs, of course, are hardwired by inclination and necessity to look beyond immediate hurdles for opportunities, and Mr. Dell is no exception. He says he is not leading a simple turnaround, but rather a long-term campaign to transform a company known for a cultlike adherence to a certain way of doing business.
As the company surged to the lead in the PC industry, the “Dell model” relied on direct sales over the Internet and by telephone rather than through retail stores, cutting prices to gain market share, focusing on computer hardware rather than services, leaning heavily on the American market and avoiding acquisitions. But since Mr. Dell reclaimed the role of chief executive in late January, he has changed all that.
At internal meetings, he repeatedly emphasizes that the Dell model “is not a religion,” according to staff members. Moreover, Mr. Dell — who once ran a company famous for its laserlike devotion to next week rather than next year — no longer champions short-term goals and fixes. “We’re moving the needle in terms of getting focused on the right long-term issues,” he says.
But re-engineering the Dell model will be a daunting challenge. “Dell continued to do the same old thing, when it was no longer working,” observes David B. Yoffie, a professor at the Harvard Business School. “This is going to be about changing the way they do business at many levels.”
“Dell can do it,” Mr. Yoffie adds, “but it’s going to take a lot more innovation on more fronts than the company has shown in the past.”
LAST year was, to borrow a term, the annus horribilis for Dell. Its problems kept building throughout 2006: sluggish growth, disappointing financial results, complaints about customer service, even a high-profile safety recall of notebook computer batteries. Not all of these were the company’s fault. For example, Sony made the batteries that could overheat and catch fire, causing other companies like Apple to also issue recalls.
But there was no disputing that Dell had stalled. Wall Street, as well as Dell’s own board, had become impatient with the company’s management. So a change came quickly early this year, at the end of January. Dell’s outside directors voted unanimously that the company needed a single leader instead of having a chairman (Mr. Dell) and a separate chief executive (Kevin B. Rollins, who had been C.E.O. since 2004).
At the time, Mr. Dell was attending the World Economic Forum in Davos, Switzerland, and when the board asked him to become chief executive, he agreed. There were a few long walks, he recalls, when he was “deep in thought” about how to proceed, but he did not hesitate about taking over. He had built the company, after all, and his name was on every box it shipped.
“I have a responsibility,” he says.
So, on Jan. 31, Mr. Dell became chief executive — again — and Mr. Rollins, a former Bain consultant who joined Dell in 1996, was out. Mr. Dell describes Mr. Rollins as a “great business partner and friend.” Other executives at Dell also point to Mr. Rollins’s contributions over the years, as the operating field general beside Mr. Dell during the years of torrid growth. But Mr. Rollins, they say, was seen as the foremost practitioner, and advocate, of the old Dell model, even when pushing the same buttons no longer worked.
Still, Dell executives are quick to say that Mr. Dell’s return as chief executive has nothing to do with any sharp differences between him and his predecessor. Rather, it was due to the depth of Dell’s troubles and the need for someone to assume control and forcefully take the company on a different path.
“It’s not all about Michael versus someone else before,” says Paul D. Bell, a senior vice president. “Michael was here. He was chairman. But it was up to Michael to take the first-mover role in driving change and he did it.”
Mr. Dell began shaking things up immediately. He has recruited senior executives to lead the company’s marketing, consumer products, operations and services business. He is also paring layers of middle management as part of a plan to trim Dell’s payroll by 10 percent, or roughly 8,800 workers.
In recent months, the company has stepped beyond selling over the Internet and by telephone — the famous Dell direct model. It has forged retail agreements to sell computers at Wal-Mart stores in the United States, at Carphone Warehouse outlets in Europe and at Bic Camera stores in Japan. More retail deals are in the works.
Rethinking the retail business was a matter of necessity. A lot has changed, Mr. Dell notes, since the company tried and abruptly exited retail sales in 1994. The shift in the consumer computer market and toward notebooks, which customers want to touch before buying, is part of it. So is Dell’s need to do better in markets abroad, where people are less comfortable buying computers by phone or over the Internet. “We’re going after those new customers with retail partners,” Mr. Dell says.
He also moved quickly on another front. Whereas the Dell of old shunned acquisitions, the company is now willing to go shopping. It has made three deals in the last two months — business and consumer software companies — and there will be more, Mr. Dell says. But he says that they will be limited to purchases of smaller companies and start-ups, with 50 to 500 employees, to add technology and expertise that promise to “turbocharge growth” in businesses earmarked for investment and rapid expansion, like services, consumer offerings, international sales and building data centers tailored for big Web companies.
The consumer market looms large for Mr. Dell. Consumers were traditionally an afterthought at Dell, which garners more than 80 percent of its sales from corporate customers. Home computer users generally had to settle for business computers that were tweaked a bit for the masses and were little more than bland, generic boxes.
But in recent years, consumers became picky. Where users once focused on price, processing speed and storage capacity, they now looked for stylish, well-designed machines as well — a trend common throughout the entire consumer electronics business, but one that was lost on Dell.
“On the consumer side, we’re drastically changing what we’re doing,” Mr. Dell says. “We’re only touching the surface of the opportunity now.”
Ronald G. Garriques, who joined Dell from Motorola in February, is guiding the change in Dell’s consumer strategy. Selling machines with more flair in retail stores is part of the plan, said Mr. Garriques, president of the global consumer group, a new position at Dell. But he suggests that Dell will take a hybrid approach, offering hardware options, extra features and services through its Dell.com site on machines that it also sells in stores.
Dell’s direct online relationship with customers, Mr. Garriques says, can help it develop services that link PCs, software and cellphones. To illustrate Dell’s thinking, he describes as a possibility a service that would allow parents to use Web maps and cellphone signals to track family members on the screen of a Dell PC in the kitchen. “With Dell’s direct-to-consumer model,” he says, “we can bring that as a solution to families.”
Such offerings, he says, don’t have to generate big profits on their own. “Great services sell a lot of devices that use those services,” says Mr. Garriques, noting how Apple’s iTunes music service has fed iPod sales.
Dell also hopes to offer services on hardware beyond PCs. Last month, the company agreed to buy Zing Systems, a Silicon Valley start-up that makes software for hand-held devices that manage and exchange entertainment wirelessly, without the need for a PC. Zing’s founder is Tim Bucher, a former product designer at Apple.
Stale design remains an issue, and something the company has to continue to address if it wants to lift consumer sales. It recently recruited designers from around the world and more than doubled the size of its design group, to 80, in the last year. Dell designers now speak of product “love” and “lust,” observes Ken Musgrave, the director of industrial design — a far cry from just a few years ago, when design always took a back seat to competitive pricing.
In June, Dell introduced notebook computers in eight colors. And color, Mr. Musgrave says, is merely the “first level of personalization” for Dell. He showed off prototype notebook shells in different materials and designs, noting that Dell’s build-to-order system gives it the freedom to make highly stylized and personalized machines in limited runs of just dozens to a few hundred. “There are a lot of different design levers to pull for the future,” he says.
AS soon as he took over as chief executive, Mr. Dell declared a two-month “amnesty” to encourage people to discuss problems and deal with them quickly, without fear of being fired or demoted. Otherwise, Mr. Dell says, managers might have understated troubles and defended past decisions.
One common issue, he says, was that there was “no central leader” in areas like manufacturing, services, sales and marketing. A decentralized organization of many go-it-alone groups, focused on regional markets, made sense when Dell was growing from $5 billion to more than $55 billion in annual revenue over the previous decade, faster than any technology company in history. Then, chasing growth opportunities was the priority.
Dell’s marketing epitomized the fragmented approach. When Mark Jarvis joined Dell as its chief marketing officer in April, he did an inventory of the advertising and marketing firms that worked for the company worldwide. The total count was 869. “The company didn’t really evolve, it just grew,” he says.
Mr. Jarvis is now moving to streamline Dell’s marketing. In the last month, he has cut in half the number of the company’s marketing and ad agencies. By the end of October, he says, Dell will select a lead worldwide agency. One goal, he says, is greater consistency in the themes, message and approach of the company’s marketing. The new internal marketing slogan is “One Company, One Brand, One Beat.” Already, there is a change in the look of Dell ads. Themes like ease of use and personalization are prominently featured.
Mr. Jarvis, a former Oracle executive, says Dell’s brand is widely known and respected, but often not linked to a clear message. So he wants to give the brand a makeover, saying that in the consumer market, it needs to be “much cooler and go away from low prices; a lot of people see us as a cheap PC company, and that’s not where we want to be.”
In the corporate market, Dell plans to pitch itself as the company that can simplify information technology for businesses, part of an effort to gain market share from competitors like I.B.M., Hewlett-Packard and Sun Microsystems. When asked how his long-term agenda will change the company, Mr. Dell is direct: “It will push us much more into solutions and services from products. That doesn’t mean products go away. But there’s going to be a big element of doing more for customers through services.”
The services strategy is long overdue. Services is a bigger market than hardware, and corporate customers were asking Dell to do more to help them manage their data centers more efficiently, according to current and former company executives. But Dell was slow to react, and the lapse illustrates the perils of doggedly sticking to the old model and ignoring a promising new market. Instead of making long-term investments in building a services business, Dell just kept its eye on hitting quarterly sales targets by peddling Dell hardware and other companies’ software.
Dell recruited Stephen F. Schuckenbrock last December from Electronic Data Systems to lead its services business. Today, Dell garners $5 billion a year in services revenue, but most of that comes from technical support and maintenance on Dell machines.
Mr. Schuckenbrock wants Dell to help corporations run their data centers, while reducing hardware budgets, energy consumption and staffing. Mr. Schuckenbrock predicts that services will grow three to four times faster than the company’s overall growth rate. A former Dell executive, who requested anonymity because he is forbidden to discuss company matters, said a recent internal report concluded that the company’s annual revenue from services could reach $20 billion over the next five to seven years.
Dell is already a major reseller of VMware, the dominant maker of virtual machine software used to juggle operating systems and applications on a single server. Dell plans to expand the relationship with VMware by offering virtualization services and its own data-center tools. In July, Dell bought SilverBack Technologies, a start-up that makes software to monitor and manage computers. The goal, Mr. Schuckenbrock says, is to offer “the best point of view, technology and solutions to optimize industry-standard data centers.”
Until a year or so ago, Dell tried to sell its standard products to leading Web giants like Yahoo, Salesforce.com and Microsoft. But those customers wanted something different. Eventually, Dell listened and designed circuit boards, cabling, racks and power management systems to suit the requirements of large individual customers. (Google, which still designs and builds its own computers, is not yet among them.) Prototypes can be built in weeks, with thousands of the custom-made computers shipping in months. That rapid response, says Brad Anderson, a senior vice president, is “really back to Dell’s roots.”
Mr. Anderson says that the biggest initial hurdle for Dell on these big deals is its reputation as a producer of commodity computers. “It takes time to convince them that Dell is committed to novel products and real innovation,” he says.
DELL still faces formidable obstacles as it tries to regain its footing. Just three years ago, Dell’s hyperefficient operations gave it margins that were six to eight percentage points higher than those of its principal rival, Hewlett-Packard, according to a recent report by Sanford C. Bernstein. Today, Dell has no such edge.
“We created this incredible supply chain, and that sort of stagnated,” Mr. Dell acknowledges. “We squandered that away. Some of our competitors jumped over us in a Darwinian way. Now it’s our turn.”
To solve his operating headaches, Mr. Dell brought in Michael R. Cannon, the chief executive of the Solectron Corporation, a contract manufacturer, as Dell’s head of global operations in late February. Mr. Cannon is convinced that Dell can regain its advantage by tightly integrating regional operations into a close-knit global network. “Manufacturing is going to be a core competence at Dell,” Mr. Cannon says, “and there is a lot of room for innovation.”
But the Dell manufacturing machine has sputtered recently. It has had trouble perfecting the bright colors on its new notebook computers, resulting in shipment delays and irritated customers. Dell says it is moving swiftly to correct the production problem, caused in part because it significantly underestimated demand for its new notebooks.
Dell’s corporate comeback, its founder says, will not always go smoothly. “Hey, we’ve got a lot of work to do,” Mr. Dell concedes, “and we’re just getting started.”
And the man once known as a by-the-numbers, short-term thinker is now, apparently, planning many years ahead. Asked about how long he intends to remain chief executive, Mr. Dell compares himself to Wal-Mart’s founder.
“I’m 42 years old. I think that would put me on the young side for C.E.O.’s,” he says. “I don’t think Sam Walton became a C.E.O. until he was 45.”
So how long will he remain C.E.O., then? “A long time,” he responds.