July 22, 2005
Ronald Cass on Congress and the CNOOC Bid
In an editorial in today's Wall Street Journal, Ronald Cass, the ex Dean of the Boston School of Law, pilloried the House of Representatives for passing and amendment to an appropriations bill that attempted to block the CNOOC takeover of Unocal. CNOOC is a Hong Kong company, 70 percent owned by another state-owned Chinese company. In essence CNOOC is a Chinese state run company. The House, he argued "tilt[ed] the game-board in mid-play" and did not "repect the rule of law." He equates Congress's action on CNOOC to bowing out of international rules when "it suits its political fancy." This is, of course, nonsense. Congress's unilateral action on CNOOC is very different than bowing out of an international obligation. In the former unilateral action is permissible without violating any international agreement and in the later it is not (absent the agreement of the counterparties to the treaty).
No only is Congress's action on CNOOC permissible, it may have been sensible. Congress created the review process in CFIUS and empowered the President to block deals that threaten national security in the first place in 1988 legislation. Congress certainly has the power to supercede or even revoke the authority if Congress views the process as ineffective. Are we so enamoured with federal administrative agencies that we view a Congressional grant of authority to an agency as somehow permanent or quasi-constitutional, vesting rights in all those affected by the original grant? I hope not (excepting civil enforcement actions or executed contracts of course). The ultimate authority for the commercial health of the country is in Congress and it is delightful to see them still recognize the fact. It was troublesome that the rider focused on one deal rather than a more general category of cases but Congress has done so many times -- recall the deals with the first transcontinential railroads for example.
The House was, Mr. Cass, negotiating with the Chinese in its own way and using the power of a resolution to demonstrate that it was serious. There would be many steps before the resolution would become law (Senate vote, Conference Committee, President Signiture or Veto) and in those steps was negotiating time and power. The result? The yuan finally gets revalued and China is on notice that we take reciprocity (let us buy or control Chinese companies) seriously. The House did act quickly, another pleasant happening as in most cases it takes years to get anything done, but it did have a great deal of information about the bid -- as we all did -- as the public filings and press coverage were extensive.
When Congress steps up to the plate and gets involved in a matter of national interest we should not hammer it for not giving total deference to often very isolated federal agency personal that Congress itself empowers and pays.
Google Stock Price Falls on Good News?
Last night Google reported great business news -- its second quarter profits were up 400 percent from the same quarter last year and its revenue ($890 million) doubled from the same quarter last year. Earnings per share were a whopping $1.37 a share. The revenue and earnings per share exceeded analysts' published predictions for the quarter (of $842 million and $1.21 respectively). The company ended up the quarter with $2.9 billion in cash and marketable securities, up $500 million from the previous quarter. Profit margins increased over 24 percent from the same quarter last year.
What did the trading market do with the good, no, outstanding business news -- it hammered the stock. The stock dropped six percent in after-hours trading. I watched the stock decline on the tape while I was viewing Mad Money at 6:00. This is crazy. What do traders except out of this company?? It just tells me that there is irrational interest in this stock.
NYSE Trading Costs Up??
The New York Stock Exchange released a 844 page filing with the SEC in anticipation of its merger with Archigpelago Holdings. The Exchange, a private, not-fot-profit organization has not been subject over the years to the periodic filing requirements of the 34 Act that apply to a publicly traded company in the United States so the filing is a rare bit of information into the Exchange's planning and operations. The New York press has picked up on the Exchange's plans to charge members for trading licenses after the merger and its plan to cut staff by ten percent. These plans affect the New York trading insiders in the New York financial community.
Deep in the material is a far more important projection -- the NYSE plans to raise trading costs for some transactions. After cutting costs, the NYSE plans to increase profits by raising trading fees, fees that will be passed on to all those who trade through brokers/dealers on the exchange -- the public. The NYSE could do this only if they did not face serious competition from other trading venues for order flow. Otherwise to raise prices would mean they would lose trading volume. When the SEC and the Justice Department assess the merger for antitrust problems, they should note this plan to increase profits by 600 percent while increasing trading prices. It is an admission of market pricing power that would occur if the merger goes through. It is also an admission that the current SEC rules, emboddied in Regulation NMS, consolidate market power in the NYSE. This is not good.
July 21, 2005
Corporations Hoarding Cash
There have been a flood of news articles in the financial press about the amount of cash being held by American corporations. A Business Week article (July 18, 2005 at 80) noted that tech companies alone in the United States held over $230 billion in cash or cash equivalents at the end of the first quarter of 2005. Microsoft alone holds $38 billion and this is after they paid $35 billion in special dividends. The Economist (July 9, 2005 at 61) noted that American corporations have turned into net savers. Corporations in other developed countries are following suit. The corporations are not using the money to invest in operations or research and development or even in acquisitions. They are sitting on the cash and bemoning a lack of investment opportunities. Of all the recent shameful developments in the business community -- the financial fraud, the excessive compensation of senior executives, the flat returns -- this is the best evidence of a lack of managerial accountability to shareholders. The managers of these corporations should turn the money back over to their shareholders if they cannot invest the funds in profitable projects that create shareholder value. Their failure to do so is painful and stark evidence that accountability to shareholders is less than what it should be. Manager do not maximize shareholder value when they hoard cash.
The Supreme Court, Judge Roberts and Business
There is quiet relief in the business community over the President's nomination of Judge John Roberts for a position on the United States Supreme Court. His position as an appellate lawyer in a top-flight Washington law firm (he argued cases that had been appealed from trail courts in the federal court system), exposed him to the leaders of the business community and their legal concerns and problems. He will appreciate the business community's need for clear legal rules that facilitate planning, for some operating freedom in which businesses can compete, and for judge's who can anticipate the problematic secondary impacts of even well-intentioned rules. He also apparently has an ear for arguments that favor international and interstate trade. His predecessor on the Court is not Chief Justice William H. Rehnquist, for whom Roberts clerked, but Justice Lewis Powell, a corporate lawyer from Virginia who served on the court in the 70s and 80s. President Nixon appointed Justice Powell directly from the bar after a term and President of the American Bar Association. During Powell's tenure on the Supreme Court the Court took more business cases than was its custom and after Powell left the court in 1986, the Court took decidely fewer business related cases -- a trend that continues today. Powell led the Court through a series of cases designed to narrow Rule 10b-5 litigation, countering federal circuit courts, and he convinced the Court to take a hands off approach (and thereby sanction) state anti-takeover regulation.
The business community's stake in the decisions of the Court is slight relative to the stake of those participating in the country's cultural and social conflicts. The Supreme Court rules infrequently on anti-trust cases and securities law cases, interpretating open-ended statutes and agency rules. The heavy work in these areas is now done in the federal circuit courts. The Court does periodically rule on definitions of the Commerce Clause that affect the regulation of American business -- at issue is whether the federal government or the state governments have supreme authority to pass the type of rule in issue. But the business community is now split on their preference for a victor -- while historically business has preferred state regulation (it is local and easier for local business to influence) many in business, particularly those with national operations, now prefer to comply with one rule rather than fifty and therefore prefer federal rule-making. So the Gonzales v Raich case (federal statute outlawing marijuana use applies in California despite the state's medical use law) of the last term is, to some, not a problem. Similarly on property rights issues the business community can split. The Kelo v City of New London case, allowing local governments to take private land and turn it over to private developers, an attack on a robust version of private property, aids businesses seeking development help from local authorities (which is most all of them). And the Supreme Court's rulings on class actions and damage awards are also infrequent and limited by the Court's narrow room for discretion in these areas.
The business community should be much more concerned over the Presidental appointments to the governing boards, particularly the chairs, of selected federal agencies and departments -- the Securities and Exchange Commission, the antitrust division of the Department of Justice, the Federal Communications Commission, the Federal Trade Commission, the Departments of Treasury, Commerce and Justice. These individuals have much more power over the day to day operations of business in the United States than do Justices of the Supreme Court. For a case study, consider the rule-making initiatives of William Donnaldson, the just departed Chairman of the SEC. In his short tenure he changed industry governance structure for mutual funds, he changed the struture of the American securities trading markets, he changed the internal control system of all American corporations, he changed how investment banks can offer securities to the markets, just to name a few of his initiatives. There can be no doubt, the real power over American business operations now rests in hands of those who run our federal agencies.
July 20, 2005
China Goes 0 for 2
The Wall Street Journal reported this morning that Haier has dropped out of the bidding for Maytag, leaving only Whirlpool and Ripplewood Group, a private equity firm, eliminating some of the intrigue from the deal from an international perspective, but leaving the question of anti-trust scrutiny.
Unocal rejects CNOOC bid
Unocal accepted a sweetened offer from Chrevon and thereby has rejected the CNOOC bid ( here ). Unocal shareholders still have to vote on the offer.
Fuji, Livedoor, and Japan's Version of a Takeover Battle
Now that the dust has cleared on Japan first true hostile takeover attempt, Liverdoor's attempted takeover of Nippon Broadcasting Sytem (NBS), there is tangible evidence on the plight of a Japanese shareholder. It is not pretty.
In late 2004 Takafumi Horie, owner of an upstart internet firm Livedoor announced that he would buy control of a Fuji TV radio affiliate, NBS. Horie was young, did not wear a suit, and captured the imagination of Japan's young high-tech types. Fuji fought back and cut a deal, green mail. Fuji bougt Liverdoor shares in NBS at a slight premium and bought a stake in Livedoor as well. Livedoor shares dropped 25 percent on the news. NBS adopted, and other Japanese companies are rushing to enact, an Amercian style "poison pill" plan.
Whatever justification there may be for "poison pill" plans in the United States (to give the target managers the power to bargain for a higher price), the justification is absent in Japan. Japenese firms often poor returns on capital and have complex cross-shareholdings in each other that make shareholder accountablily next to impossible. The poision pill plans are for entrenchment not for maximizing shareholder value.
The value of poison pill plans is very context specific. Japan's history of ignoring shareholder value is a bad setting for their use (abuse).
Mircosoft versus Kai-Fu Lee and Google Lawsuit
Microsoft's lawsuit against Kai-Fu Lee and Microsoft made all the major finanical papers today. Filed in a trial court in Seattle, Washington, Microsoft argues that Dr. Lee violated a classic "non-compete" agreement he had signed with Microsoft. Dr. Lee's employment agreement contained a one year hiatus in which he could not work for competitors once he had left Google's employment. These agreements were big news during the technology boom of the 90s, when tech companies most valuable resources, their employees, walk out the door every night. Courts and some legislatures are suspicious of the agreements and limit their time and geographical scope; lawyers butress ans supplement the agreements with a rising flood of confidential information protection provisions (duties on handing documents and on revealing all confidential valuable information). Companies rarely sue on the agreement because they themselfs are in the hiring game and are themselves susceptable to suit. Microsoft, for example, sued a start-up, Cross-Gain, on such agreements in the 90s. Moreover, the lost employee will rarely come back. The suit does hold up a competitor for a short time, but the cost is marginal (they would not have otherwise had the employee anyway). In essence, it is only when the defection is very high level and very important that the agreements are enforced, as a way of demonstating to other high level employees that are still on the job that the agreements are important. The agreements and their supplementing documents are in the borderline of the definition of property rights; courts must define what belongs to an employee and what belongs to the employing company. Clarity is critical, for the parties can contract around whatever the rules are. Courts are concerned with uneven bargaining power on the employement agreement (young employees sign anything to get a paycheck), however, and build escape hatches into the rules. The escape hatches muddy the rules, tempt folks to ignore the agreements, and encourage litigation.
July 19, 2005
Mosbacher's Editorial on the CNOOC Deal
Robert A. Mosbacher, chairman of Mosbacher Energy Company and Secretary of Commerce from 1989 to 1992, has written an editorial in today's Wall Street Journal supporting the acquisiton of Califorina based Unocal by Chinese controlled CNOOC, "Trade is a Two Way Street." His argument is an old one, the latest in a steady drumbeat of editorials and public statements touting the deal -- American companies have invested significant sums in Chinese operations and we should let Chinese companies invest in American companies. The investment of American companies far exceeds the $18.5 billion acquisition price for Unocal. The argument has two flaws: First, China permits American companies to invest as minority partners only in Chinese companies. CNOOC seeks to buy control of Unocal. It is a crock to call it a "two way street." Second, American companies are not state controlled, CNOOC is. It makes a difference. American companies compete with each other and are limited by antitrust rules, state controlled companies in China do not and are not.
In a sense the argument is self-interested -- many of the American companies invested in China have generated very poor returns on their Chinese investments. The government controls their returns -- the investments are, rather, a toe-hold in the Chinese market that may generate future returns if and when Chinese policy changes. There is serious question over whether this is a sucker play for many American companies and a waste of shareholder money. In any event, these companies have an interest in acting as a public relations arm of the Chinese Foreign Ministry. If a American company invested in China can make China officials happy by supporting the CNOOC deal (something China clearly wants), perhaps returns will get better.
Those wondering how China will treat its new Unocal assets, if purchased, need to look no further than how it treats its own oil companies. French, "Whose Oil is It," NYT July 18, 2005.
China, Manufacturing and Anti-Trust
Yesterday the Wall Street Journal, among other sources, reported that Whirlpool has made a $17 per share offer to purchase Maytag. On the face of it, Whirlpool's offer is $1 per share higher than that of a consortium of Chinese appliance maker Haier, Bain Capital and Blackstone. This deal, along with the Unocal deal, represent two Chinese forays into non-friendly deals in the U.S. (compared to the IBM/Legato deal). As the Journal article suggests, at the fringes, is the possibility that government concerns over Chinese acquisition of American companies may alter anti-trust policy in the U.S. That is, absent a Chinese offer on the table, would the DOJ assess a Whilrpool/Maytag deal more rigorously?
July 18, 2005
New Bankruptcy Law Will Hurt Entrepreneurs
Anyone who has worked with entrepreneurs in start-ups knows two things. First, they are not careful about creating and using a limited liability entity when they begin and, second, a common form of start-up financing is personal credit cards ("they max out their cards"). The new bankruptcy law, the Bankruptcy Absue Protection and Consumer Protection Act of 2005 signed in April and effective in October, will hurt these entrepeneurs. Entrepeneurs caught in failing businesses will not be able to start anew, using their experience to start successful businesses on their second or third try. The bankruptcy law will bind them to their initial debts. The Ewing Marion Kaufman Foundation in Kansas City, Mo., has sponsored a study on the problem (Elizabeth Warren & Robert Lawless authors). The studty found that Congress did not have accurate data on the number of entrepreneurs that would be affected by the new law. The data used by Congress overstated the number of personal bankruptcies and understated the number of business banruptcies. In essence, the new bankruptcy act creates more traps for entrepreneurs and will, at the margin, discourage some entrepreneurs from starting new businesses.
CFIUS Should Block the CNOOC Acquisition of Unocal
Chevron announced some time ago that it would offer $61 a share in cash and stock to buy California-based Unocal Corporation. It was mildly newsworthy and raised few eyebrows.
Before the Unocal shareholder vote on the offer, however, a new company, Hong Kong-based CNOOC Ltd., made a superior offer for Unocal of $67 a share in cash. A thunderstorm of opposition gathered. Not only was CNOOC a Chinese-owned company, its 70 percent owner was the Chinese government itself.
The United States House of Representatives passed overwhelmingly a resolution asking the President to block the takeover.
The Chinese Foreign Ministry hired well-placed United States investment banks, lawyers and lobbyists and mounted a counter-attack. Unocal, they argued, did not own any United States refineries, was responsible for only a small percentage of United States oil production and owned an even smaller percentage of United States oil reserves. CNOOC would promise to leave all Unocal’s United States assets to the United States; CNOOC wanted Unocal’s rights to Asia oil.
The Chinese media campaign had notable successes. Wall Street Journal editorial page and other financial commentators came out in support of the CNOOC acquisition.
The CNOOC acquisition now falls in the lap of the Committee on Foreign Investment in the United States (CFIUS) and ultimately of the President. In 1988 Congress, responding to the attempts of Japanese companies’ attempts to takeover US companies (specifically Fujitsu attempted takeover of Fairchild Semiconductor), passed an act (the Exon-Florio Amendment) enabling the President to block takeovers that could “affect the national security of the United States.” Furthermore, an investigation by the President was mandatory if the takeover was by an entity controlled by a foreign government.
The President delegated authority to investigate foreign acquisitions to an inter-agency committee, CFIUS, created by an executive order in 1975. CFIUS is chaired by the Secretary of Treasury and has eleven members. There are representatives from the Departments of Treasury, State, Defense, Commerce, and Justice, from the Offices of the US Trade Representative, Science and Technology Policy, and of Management and Budget, and from the Council of Economic Advisors and an Assistant to the President for Economic Policy.
CFIUS will make a recommendation to the President on whether to block the CNOOC takeover and the President has 15 days to decide what to do.
The key term in the statute, “national security,” remains undefined in the statute and supplementing Treasury regulations. The legislative history to the statute favors a broad meaning of the term and the statute itself includes the “capacity of domestic industries to meet national defense requirements.” Oil production and reserves, necessary to run military machines, are obviously included.
There is no limitation in the statute on the source of oil held by a domestic company. The statute does not just apply to United States assets (oil found in the United States) but also applies to domestic ownership of foreign assets (foreign production and reserves owned by a domestic company).
CFIUS should recommend that the President block the CNOOC takeover and the President should agree. First, China is not a market player. It will take the Unocal oil assets off the market and divert them to the use of oil-starved China and its industries. United States refineries will not be able to buy oil from Chinese companies. This is not a country that respects private ownership and private markets. Second, United States companies cannot purchase and, without a government change, never will be able to purchase control of Chinese oil companies. There is no reciprocity. Third, China, as a single major purchaser with tremendous wealth, is seeking a consolidated position in the world’s oil markets. We should not facilitate the creation of a new monopolist in the world’s oil markets.
Short of a sale of military technology or hardware it is hard to imagine a type of takeover more important to national security.