Category: Uncategorized

Tom Bender might be a great guy, for all I know.

And he might be a great CEO, too, although he does run The Cooper Companies, a contact lens maker whose news flow has been uniformly bad of late—so bad that its stock happens to be one of the only companies in the world trading closer to its 52 week low than its 52 week high.

But if the company’s recent conference call was any indication, the outside observer would not know how great he is.

I say this not because the word “decline” appears nine times in the earnings call transcript—bad things do happen to good people and good companies on occasion.

I say it because, after recounting the litany of woes resulting in the latest earnings miss, Bender says the following about the objectives he’s set for the upcoming year:

Let me talk a little bit about some of the objectives that we have for 2007. Number one, most important and most important to all of you is to hit our guidance.

I am not making that up.

Now, if Mr. Bender honestly thinks that the “number one” objective of his company should be “to hit our guidance” for the sake of Wall Street’s Finest and their precious earnings models, then he is about as far removed from what really makes a company great as a CEO can be.

Not only can the focus on hitting a meaningless, and often unsustainable, profit forecast result in stupid, short-term decision making; it can also, as in the case of Tyco, Fannie Mae, Enron, and a list of other companies large and small too lengthy to bother with, result in fraud.

As with morons writing blogs, beware a guy at the top whose chief goal is to “hit the numbers.”

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

[Author’s note: the following was posted prior to this morning’s announcement that Overstock.com had sold $40 million worth of stock to institutional investors at $14.63 per share.]

Overstock.com (OSTK) leveraged buyout and takeover rumors are fairly recent. We first reported them on December 1, 2006 when the stock was still at $15.00 per share. This takeover chatter has helped drive OSTK over 10% higher in less than two weeks.

So begins a recent entry in a blog (“Stock Rumors”) that does precisely what its title suggests: it passes along rumors about stocks.

How it gets those rumors in the first place is not clear.

One thing that is clear, however, if the above-cited Overstock.com rumor is any example, is that the author of the blog is not exactly plugged into the prop desk at Goldman Sachs or the trading floor at SAC Capital.

For starters, while Overstock.com may very well at this moment be the subject of a dozen private equity investment committee meetings—so vast is the pool of private equity these days—the notion of a “leveraged buyout” as reported by the blogger is, I think, a howler, for several reasons.

Reason number one is that Overstock.com has, thus far, proven unable to report an annual profit since its 2002 public offering.

Reason number two is that Overstock.com has frittered away so much cash in the last few years—among other things by buying back its own stock at something like double the current share price—that it has less cash than convertible debt on its books.

Reason number three—and this is something Mr. Rumor apparently never bothered to check—is that Overstock.com has already collateralized “all or substantially all of the Company’s and its subsidiaries’ assets” towards obligations under a Wells Fargo Retail Finance Loan and Security Agreement, fully described in the latest 10Q. (Page 12, footnote 9.)

The restrictions of said Loan and Security Agreement are spelled out quite clearly, and might appear to the average reader to have some bearing on Mr. Rumor’s ideas about Overstock.com’s future:

The WFRF Agreement includes affirmative covenants as well as negative covenants that prohibit a variety of actions without the lender’s approval, including covenants that limit the Company’s ability to (a) incur or guarantee debt, (b) create liens, (c) enter into any merger, recapitalization or similar transaction or purchase all or substantially all of the assets or stock of another person, (d) sell assets, (e) change its name or the name of any of its subsidiaries, (f) make certain changes to its business, (g) optionally prepay, acquire or refinance indebtedness, (h) consign inventory, (i) pay dividends on, or purchase, acquire or redeem shares of, its capital stock, (j) change its method of accounting, (k) make investments, (l) enter into transactions with affiliates, or (m) store any of its inventory or equipment with third parties

I can’t think of too many other restrictions Wells Fargo could have slapped on Overstock, except, maybe, always saying “please” and “thank you.”

Still, all these do not stop Mr. Rumor from putting forth Overstock.com as a “leveraged buyout” candidate.

Nor does it stop him from mentioning Amazon.com as a possible suitor, with such blazing insights as follows:

With a market cap of almost $16B and cash of over $2B, the acquisition of OSTK for $400M or $500M that would [sic] increase its yearly revenue by almost 10% could be quite positive.

Now, maybe Amazon.com really does want to buy a money-losing outfit for “$400M or $500M”—anything can happen in this business. But Jeff Bezos has never bought a direct competitor, and he has never expressed any interest in salvaging turnarounds for the sake of juicing his company’s annual sales pace.

Nevertheless, our blogger warms to the unfettered freedom of rumor-mongering and expands his list of would-be suitors to include Google, Yahoo! and eBay. (Why he didn’t also mention Starbucks, Apple, Home Depot and Circuit City while he was at it is beyond me.)

But the best line of all comes beneath the heading, “Carl Ichan, A Possibility:” and it is written as follows:

Carl Ichan has been rumored as a possible suitor for OSTK. Recently his bid for Reckson (RA) was rejected, and he may be looking for a place to put the $1B in cash he was planning to spend on that deal. OSTK could be a good opportunity for him.

Now, you and I know that Carl Icahn is a famous corporate raider of days gone who reinvented himself as a kinder, gentler corporate activist with a terrific track record.

And you and I know that it is Carl Icahn whose “bid for Reckson was rejected.”

But Carl “Ichan”? I don’t think so.

Still, the fact that he did not even get the man’s name right did not stop Mr. Rumor from the aforementioned Leveraged Buyout speculation of a company whose main lender has a rather substantial say in whatever outcome Mr. Rumor foresees from the array of takeover possibilities that appear to be sweeping the Overstock.com chat rooms.

As I say, anything can and could happen to Overstock.com and any other public company in this takeover-happy feeding frenzy of a market.

But Jim Cramer advises home-gamers to do their own homework, and I suggest both the readers of Stock Rumor.com, as well as its author, to take that wise advice.

And beware morons writing blogs.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

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Shell May Cede Control of Project To Russia’s Gazprom

The “project” to which that headline in today’s Wall Street Journal refers is the Sakhalin-2, part of a 4.5 billion barrel-equivalent sub-Arctic oil and gas development off the coast of the former Soviet Union.

Sakhalin is a large island: look it up on a map and you will see it actually appears to be an extension of the islands which constitute Japan.

And that’s exactly how Japan thought of Sakhalin, too, until the Russians—pay attention here, I am making a point—forced out the Japanese at gunpoint after invading the island on August 11, 1945. Sharp-eyed readers will recognize that date as coming the week after Hiroshima and Nagasaki had been obliterated by atomic bombs.That Joe Stalin really knew how to hurt a guy when he was down!

And so, it seems, does Vladimir Putin, today’s Strong Man at the Kremlin, who appears to have successfully muscled his country’s way into majority ownership of a major LNG project now that Shell has done much of the heavy lifting.

Readers may recall that Royal Dutch Shell could certainly use its 55% stake in Sakhalin-2 to replenish so-called “proved” reserves that became distinctly unproven several years ago after it was discovered Shell’s engineers had been using Fannie-Mae-like juggling of its oil and gas reserves. Which is to say, Royal Dutch’s bookkeepers were making them up.

Smelling desperation, Putin’s men cleverly used a cost overrun for the Sakhalin-2 project as a device to muscle Shell out.Like all good citizens with their backs to the wall in a dark alley and no recourse to either a gun or a passing officer, Shell is putting a very good face on the situation: Shell has proposed ceding a controlling stake in the Sakhalin-2 project in Russia’s far east to state-run OAO Gazprom, an official close to the situation said. Another person close to the talks stressed they are continuing and an agreement hasn’t been reached. Such a move would underscore the Kremlin’s opposition to foreign control of large energy projects in Russia at a time when an increasingly confident Russian state, buoyed by high oil prices, is determined to restore its domination of the country’s oil and natural-gas industry.

So this is what it’s come to in a country with the largest untapped reserves of energy in the world: muckraking journalists get shot, anti-Putin KGB veterans get poisoned, and major oil companies like Royal Dutch Shell get squeezed out of large energy projects in the manner of the old Monty Python “Army Protection Racket” bit, in which Luigi and Dino Vercotti pay a visit to a starchy old colonel:

Dino: ‘Ow many tanks you got, colonel?

Colonel: About five hundred altogether. Luigi: Five hundred! Hey!

Dino: You ought to be careful, colonel.

Colonel: We are careful, extremely careful.

Dino: ‘Cos fings break, don’t they?

Cononel: Break?

Luigi: Well, everything breaks, dunnit colonel?

Fings are breaking in Russia too.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

We all know the joke about “adjusted” inflation numbers.

I’m referring to the fact that in an effort to find a “core” rate of inflation unencumbered by the ups and downs of volatile commodity prices, the Fed (and its pals in the bond market) routinely strips away the costs of the two most essential staples of human life: food and energy.

Not to mention the other adjustments the Fed makes, such as the “rent-equivalent” housing cost calculation that bears so little relation to the reality of home-ownership in America that the accounting scam artists at Fannie Mae, who we now know inflated the profits at that mortgage buyer by precisely $7.9 billion, would blush. (Fannie Mae’s new slogan: “Buy a House on Us, What the Hell”)

Still, I’m not sure how the Fed will adjust away other real-world numbers now hitting my email inbox, such as the basic cable television price increase going through in one major Midwestern city that amounts to double the current “core” CPI of 2.5%.

Or the healthcare coverage increase being asked of a small business in a different major Midwestern city that is likewise somewhat greater than the current “core” CPI.

In fact, the proposed price increase is multiples of the current “core” CPI: it is a 30% proposed increase.

I am not making that up.

Now, this number is a starting point in a negotiated rate increase that will likely be lower than 30%, but even so it will still be significantly above the “core” CPI.

And while individual claim experience can and does affect the healthcare coverage quotes for businesses large and small, such that 30% is not likely to be the standard asking price of the HMO in question, the small-business emailer who flagged this writes as follows:

“I can tell you there is a complete disconnect between the government statistics and my real world costs.”

That last—about “real world” costs—is key: the Fed can run and it can hide from inflation statistics that don’t tell the right story, but those who buy and sell our currency in the real world aren’t so easily fooled.

A friend recently pointed out that the 30% decline in the U.S. Dollar over the last five years amounts to a 6% annual adjustment in the value of our currency, and 6% seems like a much more realistic notion of the actual underlying decline in purchasing power of assets based in this country than any “core” number the Fed might come up with.

So watch what the Dollar does, not what the Fed says.

And get started on those healthcare negotiations ASAP.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

News traveled slowly during our Civil War, especially if the telegraph wires had been cut, which frequently was the case during that all-out conflagration between the well-equipped, poorly led Northern troops, and the poorly-equipped, well led Southerners.

And that was unfortunate for President Lincoln, because the telegraph was his main source of news and information about events in fields ranging from central Virginia to the bluffs above the Mississippi River at Vicksburg.

Lincoln retreated to the telegraph office frequently, both to get away from the hangers-on looking for jobs and to read first-hand the reports that clicked off the wires. (In fact there is a new book on precisely this topic, “Lincoln in the Telegraph Office.”)

Lincoln learned the hard way that bluster and over-confidence from his commanders always—always—preceded disaster.

It happened so frequently under McClellan, Pope and especially “Fighting Joe” Hooker in the Wilderness surrounding Chancellorsville that Lincoln began to predict imminent defeat whenever a telegram predicting imminent victory from anybody but U.S. Grant crossed the desk from the telegraph operator.

And he was, in nearly every case, right.

It depressed him mightily—both the expectation of impending defeat, as well as the fact that the generals never seemed to learn that overconfidence left them blind to the dangers in their front, which is why they always got whipped.

And I think Lincoln would have had the same visceral reaction to the ultra-confident words from the Ralph Lauren flak in this weekend’s Barron’s, who was responding to a skeptical question about insider stock sales:

Polo senior vice president Nancy Murray says most of the transactions are programmed and tax-related selling. “We think the stock is just beginning to enter its appropriate valuation level,” she says. “And I stress ‘beginning.’ ”

That kind of ultra-confident spin, however justified based on the track record of one of the best-run consumer product franchises in the world, might well have given Lincoln one of his famous bouts of depression, were he running the company today.

After all, he would know, Pfizer’s entire management team hosted Wall Street’s Finest in Groton Connecticut on the last day of November…i.e. last Thursday.

And the result was a batch of optimistic assessments of Pfizer’s ability to renew its cholesterol-drug franchise, as well as increased earnings forecasts…both of which came to grief Saturday afternoon.

Almost as fast as “Fighting Joe” Hooker in the Wilderness.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

The Tiffany conference call earlier this week was instructive, if not merely for illustrating in hard numbers the widening income gap between the fortunates in this country and the less-fortunates (Tiffany’s fastest growing items last quarter were in the $20,000-and-up range—eat your heart out, Wal-Mart), then for likewise demonstrating the impact of the worldwide liquidity bubble causing bull markets in stocks, copper, oil, gold and labor, among other things, on consumers outside our borders.

Meanwhile, the bond market expects Fed Chairman Bernanke to start slashing interest rates merely because Miami condominiums are in surplus.

Rather than paraphrase and summarize management’s own, excellent discussion of the situation, I thought it better—not to mention easier—to simply reprint the key portions of the call, especially the discussion of sales growth in Asia ex-Japan (up 17%), Europe (“strong”) and at new stores in the U.S. (“robust”).

[Note that Tiffany conference calls do not include the usual Q&A session, so in order to get yourself in the mood, just say to yourself (while you read it) things like “great quarter, guys,” “congratulations on a great quarter,” and my all-time favorite, which usually comes after a rambling, nit-picking dissection of something inane, like a sixteen-basis point delta in the reported gross margin versus the analysts’ so-called models: “how should we think about that?”]

Sales rose nicely throughout the quarter with comps increasing 6% in August, 7% in September, and 4% in October. For comparison, you should note that U.S. comps in last year ‘s third quarter had increased 5% in August and 8% in both September and October. From a geographical perspective, sales in the New York flagship store rose 13% on top of a 12% increase a year ago. We were pleased to finally complete the multi-year renovation of our New York flagship store during the quarter, and the reaction of our customers has been quite favorable.

In addition, comps in the seven New York area branch stores rose 6%. Branch store comps around the U.S. rose 4% and there was no particular geographical concentration of strength. For example, a few stores with the largest percentage increases were in Seattle, Palm Desert, Houston, Coral Gables and Charlotte with varying degrees of change in other markets. However, the softest region was in the Pacific, where we continue to experience sales declines in Hawaii and Guam.

Our price stratification analysis for the U.S. indicated that the greatest growth occurred in sales and transactions over $20,000 and over $50,000 which as many of you know, occur at lower gross margins.

In terms of customer mix, the majority of the comp store sales growth came from higher sales to local market customers, which was also true for the New York flagship store.

Lastly, we are experiencing robust performance in the new U.S. stores we’ve opened in 2006 in Indianapolis, Nashville, Atlantic City and Tucson. We will wrap up our U.S. store expansion for the year when we open a beautiful store on the big island of Hawaii tomorrow.

Also in the U.S, sales in the direct marketing channel rose 11% in the third quarter which was slightly above our expectations and was on top of a 4% increase last year. Growth was generated by increased numbers of orders and increases in the amount spent per order….

Let’s now look at international retail sales which rose 9% in the third quarter but included some very divergent results. The 9% growth was on top of a 7% increase last year and was pretty much in line with our expectations. There was minimal currency translation effect in the quarter, and on a constant exchange rate basis which excludes the effect of translating local currency results into U.S. dollars, international retail sales also increased 9% in the quarter while comparable international store sales rose 4%.

My following comments will refer to sales on a constant exchange rate basis. The international retail channel is composed of several distinct regions with approximately half of the channel sales in Japan while the other half includes the rest of Asia Pacific, Europe, Canada and Latin America.

Total retail sales in Japan in the third quarter declined 3% as a decline in unit volume was only partly offset by an increase in average price and mix….

Recent economic reports confirm that the Japanese economy is growing, although it appears that the environment for consumer spending is challenging….

Sales growth was notably better in the other half of international sales, continuing the strong trends from the first half of the year. In the Asia Pacific region outside Japan, a 17% increase in comparable store sales in the third quarter was above our expectations and was on top of a 4% increase last year with notable strength in Hong Kong and Australia. We’re also pleased with Tiffany’s growing presence in China, with new stores opened this year in Beijing and Macau and a second store in Shanghai opening in December. Asia Pacific comps have gained 21% year-to-date.

Sales in Europe were also strong. Comparable store sales rose 21% in the quarter, which compared with a 1% decline last year and was above our expectations. London represents more than half of our European sales and we noted considerable strengthen all four stores there, as well as strength in our stores in Italy, France and Germany…. European comps have increased 20% in the year-to-date.

Rounding out international sales in the third quarter were solid increases in Canada and Latin America, and we are very much looking forward to opening a prominent Tiffany & Co. Store in Vancouver next week.

Finally, Tiffany’s other channel of distribution, which has several components, posted a 23% sales increase in the third quarter. More than half of that growth came from a meaningful and expected increase in wholesale sales of diamonds that are below our quality standards. As you know, our objective for these wholesale sales is to simply recoup our cost….

From an overall merchandising perspective, the sales strength in the quarter was concentrated more toward higher-end jewelry. There was substantial growth in diamond statement jewelry as well as in fine jewelry such as our Swing and Legacy collections with diamonds and colored stones; and, we saw double-digit growth in engagement jewelry in the U.S. and many international markets except Japan.

“Great quarter guys!”

“Congratulations on a great quarter!”

“Mr. Bernanke, Tiffany saw strong growth in Europe, robust performance in new U.S. stores and 17% sales growth in Asia, while the bond market expects you to cut interest rates—how should we think about that?”

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Anybody else out there finding it interesting how people—even really smart people—can be cowed into not asking an obvious question for fear of looking stupid?

Generally speaking, the larger the room and the bigger the crowd, the less inclined people are to ask a question, particularly an obvious question that begs to be asked.

(Smaller rooms packed with people tend to avoid this syndrome, probably because by definition there is greater interest in the subject matter, which means there is a controversy that those in attendance want to address; hence, lots of questions on people’s minds and no standing on ceremony to ask them.)

As to the reason why the more obvious the question, the less inclined people are to ask it, I suppose it goes back to First Grade: everybody thinks everybody else in the room already knows the answer, and nobody wants to look stupid in a room full of their peers.

This is a shame because the more obvious the question, the more likely it is everybody else is itching to ask it.

I’ve witnessed this syndrome at “back-to-school night” and at church board meetings, and I’ve seen it in a room full of high-testosterone Wall Street types who are not usually cowed by anybody.

And now I’ve witnessed it in the Wall Street Journal—specifically a recent interview with Microsoft CEO Steve Ballmer.

Here’s the first question of the interview:

WSJ: As more storage and other PC functions are offered on the Web, it raises questions over the value full-blown Windows software will continue to have in the future. How do you factor that in with future Windows development?

That’s a pretty good question.

After all, the heart of Microsoft’s dilemma, as I see it, is and always has been that every product Microsoft has ever made, with the single exception of Xbox, has been designed to further the use of the Microsoft operating system.

This is not a criticism, but a statement of fact. Hey, if I had a monopoly like Microsoft has a monopoly, I’d want to push it onto every device possible, too.

Problem is, this kind of product development doesn’t work. It is, I think, no coincidence that Xbox has been Microsoft’s only non-desktop-monopoly related success, for reasons the Wall Street Journal reporter was getting at in that question, which is why it’s a good one.

And this is Mr. Ballmer’s response, which I include from start to finish:

Mr. Ballmer: The best chapter in “Good to Great” by Jim Collins should be reread, and it will help explain a little bit of what I’m about to say. The chapter called “The Tyranny of Or” talks about how in great organizations, things don’t always come down to A or B. People innovate because they see the value in A and B.

The innovations that will continue to come forward are the innovations that bring together [PC] client and [online] service as opposed to the sort of people who want to be provocative with a “Tyranny of Or” kind of discussion about it being A or B.

Basically everybody in the industry agrees that you’ve got to have rich clients and rich servers. There’s nobody who actually, by their actions, disagrees with that.

How can I say that? Let me give you some evidence. Cell phones are going through a very distinct transformation where you’re getting more and more intelligence built into phones, despite the fact that the phones are backed up by rich services coming off the Internet. That’s an interesting data point because you can deliver a better experience with rich intelligence at the client talking to rich servers and service infrastructure on the backend.

How that answered the question is beyond me.

Ballmer’s long-winded response is, however, quite instructive. For one thing, he quotes a book, “Good to Great,” which upon publication in 2001 highlighted a bunch of so-called “Great” companies based on a complicated analysis of many factors, including such vapid notions as the “Tyranny of Or” quoted by Ballmer.

One of those “Greats” so highlighted was a mortgage buyer named Fannie Mae.

Fannie Mae, as we now know, actually achieved greatness not by avoiding the “Tyranny of Or,” but mainly by avoiding the “Tyranny of Reporting Disappointing Earnings” via the “Wonder of Accounting Fraud.”

Those “great” numbers from Fannie Mae have been restated, as has the management team lauded by Collins.

Secondly, I seriously doubt anybody at Google or any of the thousands of companies working on ways to move desktop functions onto the Web—which was the heart of the Wall Street Journal reporter’s question—is wasting time reading hoary old business casebooks.

They are, rather, working on undermining everything Microsoft holds dear, most especially its monopoly on a desktop computing model fast becoming irrelevant. You might say Microsoft is subject to its own kind of tyranny: the Tyranny of a Monopoly.

So if there is a person in the world—including the reporter conducting that interview—who understands a) what Ballmer was saying in his response, b) how it addressed the question that had been asked, and c) how it helps Microsoft deal with the tyranny of a monopoly that keeps them from making truly great, useful, uncomplicated and popular products, I’d like to hear it.

I suspect, however, at least in this case, everybody already really does know the answer.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

A reader once suggested this blog should be called “Cute Stories about Inflation.”

That was his response to multiple pieces over an extended period of time in which I had pointed out the decoupling of government-reported inflation statistics from the actual rising cost of gasoline, heating oil, natural gas, steel, copper, concrete, glass, plastic resin, zinc and other industrial inputs, not to mention health insurance, car insurance, flood insurance, homeowner’s insurance and medical malpractice insurance, plus housing related items such as homes, lumber, appliances, asphalt shingles, cable television—well, you get the idea.

My point was not unique or particularly insightful—after all, many observers had discussed the same thing for some time.

Indeed, some of the more grumpy, perma-bear, gold-bugs I know took it all as yet one more dark sign that the entire system is rigged; that the government puts out whatever statistics it wants to put out in order to make the maximum number of market participants wealthy; and that Alan Greenspan and his successor are nothing more than pawns in a giant game of Squeeze-the-Shorts.

And for a while it looked like the Conspiracy Theorists might be right, because despite the persistent rise in the cost of all those aforementioned items, the various price indices—particularly when “adjusted” to exclude food and energy, which the government as well as bond buyers deem too volatile to pay attention to—stayed at or near historic lows for longer than it seemed possible

All the while, the consensus in The Market held that as long as America’s 100 Million Dollar CEOs could keep outsourcing not only manufacturing but also, as in recent years, telemarketing, contract research and anything else that didn’t threaten their own bloated pay structure, then the wage growth of working stiffs in the U.S. would remain close to zero, and the “core” inflation rate—unlike the South—would never rise again.

Now, for the record (and for those who grew weary of my “cute stories about inflation”), I actually posted the last of my inflation updates in May—six months ago.

It was called “Don’s CPI,” and it reported on the fact that Don, my car guy, had raised his prices by 6%. This meant two things: it meant that instead of costing us $700 every time we take in a car to Don’s, it was now going to cost us $742; and it told me that inflation was real, it was happening, and it was here to stay.

(It’s true: no matter what we take a car in for—oil change, wiper blade, tune-up—it used to cost $700, which is now $742. But Don does great work, and the way I see it, cars are life-or-death conveniences, not toaster-ovens. So I don’t screw around when it comes to keeping them in shape, nor do I begrudge Don sending his several fine children to college on us.)

Around the time of that piece there was a coincidental awakening of the bond market and the Fed to higher inflation rates creeping into government statistics, adjustments or no adjustments. This spooked the markets and led to an extended and hopeful debate as to when the bursting of the U.S. Housing Bubble might ease the upward price pressure.

Since everybody else was talking about inflation, I decided to let sleeping dogs and “cute inflation stories” lie.

But now that the Housing Bubble has been burst in a far more spectacular manner than generally expected, markets appear convinced all is well and inflation is contained, and I feel the time is right to pass on another, not-so-cute inflation story.

It comes from a private equity guy whose firm owns several companies in the heartland of the American industrial supply chain.

And one of his companies with operations in the still-hurricane-rebuilding Gulf Coast recently raised wages 12% in order to retain workers it was not otherwise able to retain, owing to the many better offers they were receiving.

This was not, I should make clear, a 12% wage increase for a CEO or a CFO, which nobody at the Fed or in the bond market or at the White House would blink an eye at.

This was a 12% wage increase for hourly American workers whose jobs can not be outsourced, no matter how fast the T-1 line between Bangalore and Chicago.

I should also note that according to my contact, the company in question was able to raise prices to cover that wage increase, “no problem.” Lest you think this data point should be dismissed because it covers just one company in one region of the country, my private equity contact tells me all his portfolio companies have likewise been able to put through price increases with no resistance.

For the record, the current 10 year rate is 4.6%.

A year ago August—in response to a snide question about when I was going to put my negative views on the U.S. Housing Bubble into the form of a market call on homebuilding stocks, which is something I am not in the business of doing here—I wrote that ‘anybody who buys a house they don’t need is an idiot.’

I don’t think that was bad advice.

And while I am no more inclined to make a bond market call today as I was making a homebuilder call back then, I’ll say this: given the accelerating rate of wage increases in the U.S., the rising cost of products sourced from Asia, and the global call on natural resources that’s keeping prices high despite the collapse in spec housing in Reno Nevada and condos in Miami Beach, I have now come to think—for what it’s worth—that anybody who buys a bond they don’t need is, down the road, going to regret it.

Perhaps, some day, those grumpy, perma-bear gold-bug friends of mine are going to be right.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Core inflation is spreading slower than we expected (core CPI up 0.1% in October), while the correction in housing and autos came more abruptly (Q3 GDP increased 1.6%). The result may be a smoother path for the overall economy. Growth in the second half of 2006 may be 2.3% or less, leaving room for a reacceleration in 2007. the [sic] risk of the Fed having to overshoot to regain confidence has declined markedly.


So reads the summary of one Wall Street economist’s early morning comments today, summarizing the “Goldilocks” economic scenario prevailing on Wall Street these days—at least, if stock and bond prices are any indication.

This is all quite a turnaround from just three months ago, when markets were depressed by fears the Fed had tarried too long in switching from deflation-fighting mode to inflation-fighting mode. Back then, both stocks and bonds feared the resurgent “core” CPI would not be tamed until several more Fed rate hikes had done their worst on the U.S. Housing Bubble, not to mention the U.S. Consumer.

But gasoline prices began dropping a week or two before Labor Day, and two things happened in response: the U.S. Consumer began to spend like drunken sailors, boosting third quarter earnings reports and helping the stock market recover; while whatever inflation measure economists chose to follow began decelerating, lifting bonds.

Lost in the current Goldilocks euphoria—as strong today as was the bearish gloom of late summer—is what companies are seeing coming down the pike in the way of costs.

And what they are seeing is, generally speaking, cost increases. Significant ones.

From a big ore mining supplier expecting steel price increases for next year no matter what the current spot price says, to a well-known branded apparel makers whose Asian suppliers have jacked up the landed cost of next fall’s product line by 5%—the first general all-purpose increase this company has seen out of its formerly deflation-inducing Asian supply base, ever—I am hearing a consistent message: the cost of doing business around the world has stopped going down.

It is, rather, going higher, not matter how many houses remain unsold in Stuart, Florida or Sacramento, California or Reno, Nevada.

Now, along these lines, it is no new news to anybody that UPS last week announced a 4.9% rate hike for its all-important services in 2007.

But what the bond market may not have noticed—so eager is it to see Goldilocks out frolicking in the woods as opposed to something that might interrupt the current picnic—was that 4.9% represents the net rate increase, after a 2% decline in the fuel surcharge to match the recent drop in oil prices.

Which means that the UPS “core” rate increase (have we not been trained by the Fed to look at the “core” rate?) is actually 6.9%.

So not only is the cost of stuff coming out of Asia going to rise in 2007, but the cost of getting it from the docks in Long Beach and Charleston to your house in Menlo Park or Newton Massachusetts will rise as well.

The bond market, as I understand it, suspects that we are on the verge of a significant cooling down of inflationary pressures.

But unless China and the rest of the world is about to hit the wall like a Sacramento tract house, I don’t see that what the Fed does or does not do next month or next year will be relevant.

It’s not “the economy, stupid.” It’s the “world-wide economy, stupid.”
And that ain’t slowing down.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

I’ve walked stores with Bernie Marcus, and it’s an experience.

If you don’t know who Bernie Marcus is, he’s one of the two geniuses (the other being Arthur Blank) who invented The Home Depot.

Bernie was a whirlwind: loud, brash, and eager to help any potential customer who walked in the door, even if it meant turning his back on whatever number of Wall Street’s Finest were getting the store tour at that moment.

Just to help the guy find what he was looking for.

Bernie seemed to know every sales associate who ever walked the floor—and for good reason, because he’d hired them and trained them. And it was within the sales associates that he’d also imparted his passion for helping the customer so well that it made his company what it became: a place where people who don’t necessarily know how to use a hammer could come in and get help and advice so that they could actually install a door or fix a faucet or add a deck—meanwhile spending oodles of dollars in the process.

Not for nothing the motto was “You Can Do It, We Can Help.”

Now, it is ancient history to point out that the Home Depot under Bernie and Art developed growing pains, and that the founders stepped aside for a new breed of operations-based management under ex-GE big Bob Nardelli.

And it is old news that today’s customers may have less free time and be less inclined to do it themselves, and are, therefore, more apt to want somebody to do-it-for-me, requiring an updating to the original Home Depot motto.

And in any event it may soon be ancient history to talk about the Home Depot as a public company, what with rumors sweeping Wall Street that Sears Holding’s Eddie Lampert has been looking at adding Home Depot to his real-estate rich retailing empire, plus all the private equity money desperate to buy anything with cash flow, which Home Depot has in spades.

But it is, nonetheless, worth keeping up with how Home Depot has been doing under the Nardelli regime, and if this week’s earnings call proves anything, it proves that Nardelli is masterful at spinning his story to Wall Street’s Finest.

He begins right away, in his opening remarks:

Thanks, Diane. In August, we predicted that the third quarter was going to be soft, and it was actually more challenging than we anticipated. We felt the impact of the U.S. retail home improvement market slowing significantly.

Note how Nardelli manages to paint himself and his company as both prescient (“we predicted”) and a victim (“we felt the impact…”). This is masterful spin-doctoring: it’s as if nothing bad happening at Home Depot is the fault of management.

But that’s not the whopper.

The whopper comes in the very next sentence:

However, during the quarter, we did stay on strategy by accelerating our investment in our core retail business and growing our supply businesses.

Right now I’ll bet there’s a would-be customer—I’m one myself, so I know how this works—trying to figure out which size floodlight to buy for his stupid kitchen ceiling lights, who is walking around the cement floor of a huge cavernous Home Depot looking for anybody wearing an orange apron with a “You Can Do It, We Can Help” button that isn’t already being trailed through the store by four or five desperate fellow potential-customers with hollow eyes looking like those émigrés in “Casablanca” following around somebody who has their visa papers.

And I seriously doubt that would-be customer is thinking,

“Well, I may not be able to find somebody in an orange apron who can help me figure out which size floodlight to buy for my stupid kitchen ceiling because apparently this is a store run by self-service checkout robots, but at least they’re staying on strategy.”

Yet even Nardelli could not spin away the fact that staying “on strategy” didn’t prevent Home Depot from earning less money this year than last:

In the third quarter, consolidated sales were $23 billion. That is up 11% from last year, and our diluted earnings per share were $0.73. That is up 1%, while consolidated net income earnings were $1.5 billion, down 3%.

Now, it is a fact that Bob Nardelli runs a company called The Home Depot.

And it is a fact that the home-building industry has, of late, smacked head-first into a brick wall after several years of increasingly testosterone-charged home-building CEOs telling doubters on Wall Street that, like the Internet skeptics of the late 1990s, “you just don’t get it” when it came to understanding why the Housing Bubble wasn’t a Bubble.

And it is a fact that recent results at vendors such as Masco (faucets and kitchen cabinets) and Mohawk (carpets and tiles) demonstrate the difficulty facing anybody selling anything that goes into one of those D.H. Horton or Toll Brothers or Ryland spec homes now sitting empty out in the scorching Las Vegas desert (sales brochure slogan: “It’s the desert so why would you need a yard?”).

So the fact that numbers at The Home Depot are a bit light is not reason alone to pick nits with the sort of spin-doctoring conference call you’d expect from a guy who very nearly made it to the top of one of America’s most ferociously management-by-numbers companies, GE.

(True story: I was at the Greek diner one morning recently when two GE-ers, who clearly worked together several job assignments ago but hadn’t seen each other in some time, began talking, and I am not making this up:

“So how are things?”
“Good. We made our numbers.”
“Good! You made your numbers?”
“Yep, we made our numbers—how about you?”
“Oh, yeah. We made our numbers.”

It wasn’t until then that they got into family, kids and other apparently less important stuff. That is the DNA of the guy in charge of Home Depot.)

And while Home Depot had outgrown its systems and needed serious work behind the scenes to support what Bernie Marcus and Art Blank had created from not much more than a passion for their customer, the GE Culture is not necessarily the kind of culture that’s going to keep retail customers happy.

So it should be no surprise that, unless all the former Home Depot store managers I run into are making up stories about reduced money for staffing labor at stores—what they call “earn hours”—as well as a Sears-like bureaucracy taking over the Atlanta headquarters (which, as far as Marcus and Blank were concerned, took its orders from the stores, not vice-versa), there’s no arguing the Home Depot has changed, for the worse, from a customer-driven operation to a numbers-driven operation.

But don’t take my word for it. Ask anybody who used to shop there. Anybody. I’ll bet we come up with more horror stores than Dell (see “Dell Screws Up a Good Thing” from this site).

Nevertheless, the numbers-agile crew now in charge at Home Depot didn’t get to where they are by not having whatever data could support the upbeat “message” handy in their PowerPoint presentation, and Nardelli did indeed offer up customer satisfaction numbers that seem completely at odds with every anecdote I’ve heard recently:

I want to thank our associates for their hard work and focus on taking care of our customers. Every week, we hear from 250,000 customers through our voice of customer survey. We have seen significant improvements in our survey results. Key customer service attributes, including customer engagement, waiting to check out, find and buy, likelihood to recommend, and associate availability were up over last year and showed sequential improvement this quarter. Overall satisfaction with our company, as measured by scores of 9s and 10s, is up over 2004 and 2005 levels.

Lest anyone think this “voice of customer” might be something he is hearing inside his own head, Nardelli delved into these numbers later in the Q&A with just enough color to make you wonder about how much they reflect reality, or not:

Mark, I think two points, just to be real clear. What we talked about is that overall customer satisfaction, or voice of customer, as we call it, is up across the entire network of stores, and that is the 250,000 customer shopping experiences, that they go online and call and score us on associate availability, ability to find and buy, et cetera. We have seen a sequential improvement month over month in the third quarter for sure, and we would expect the same thing to continue in the fourth quarter. In other words, the customers that are scoring us 9s and 10s.

I may be wrong, but customer surveys—especially online customer surveys—might not be the best way to find the customer who went into a store, couldn’t find anybody to help who wasn’t already under siege from four or five other desperate individuals, picked up the wrong-sized floodlights for his stupid kitchen ceiling, spent ten minutes in line because there weren’t enough live human beings at the registers…and then vowed never to come back again.

Still, Nardelli appears to have great faith in management-by-numbers. He even boasts about a new “organizational structure” that has been in place all of thirty days.

I am not making that up, either:

Before I turn it over to Craig, I just want to comment on our new organizational structure. It has only been in place 30 days, but I could not be happier with the focus, alignment and speed of decision-making we have gained as a result of de-layering. I have a great and experienced team.

What on earth this might have to do with making customers happy is beyond me…yet so it is that “de-layering,” “voice-of-customer,” and “staying on-strategy” are the new buzz-words at The Home Depot.

But it’s the “de-customering” that should have them worried.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.