value and opportunity

In my quest to learn more about the oil industry, I came across this book. It is a quite long book with about 700 pages and is covering basically the time between the Exxon Valdez accident in 1989 until around the time the book was written in 2012.

The chapters are to a certain extent random, jumping between how Exxon influenced politics to problems they encountered in various countries, among others Indonesia, Nigeria, French Guinea and Iraq.

The book itself has a rather critical tone, for instance they make a pretty good point that Exxon denied global warming for a long time, even when evidence and opinion even within the company pointed to the opposite. The ties from Exxon especially to the Bush administration are critically commented. The author claims that Exxon to a certain extent was (or still is) a kind of state within a state and using the US Government facilities only when it fits them.

Most interesting for me were the chapters about Exxon itself and its corporate culture, as well as the merger with Mobil and the later acquisition of fracker XTO.

Overall one gets the impression, that Exxon, especially before the Mobil merger was a true “outsider company”, doing business very differently than other oil companies.

Under the old CEO Lee Raymond for instance, Exxon abandoned any oil price forecasts for its planning starting in 2004 as the CEO judged all efforts to do so completely worthless. The book even quotes Exxon that they couldn’t figure out why oil prices went up so much in 2008 despite putting a lot of effort in to do so. This might be a very important message from the book: Do you still believe in all those incredibly sexy conspiracy theories about oil price manipulation if even the largest private oil company in the world cannot predict the oil price ?

Other examples of “outsider behaviour” are:

– military like control style with regard to safety, expenses and purchasing
– purely engineering driven culture, no “swashbuckling” oil wildcatters
– total discipline in allocating capital to projects

This was especially true under the old CEO, Lee Raymond.

But less so under the current CEO who, among other spent 41 bn on XTO and had to admit later that the deal was not a very good one.

Another interesting aspect was the continuous struggle of Exxon to be able to book new reserves. For a time they used a different reserve definition to the one allowed by the SEC, similar what frackers seem to do now.

All in all, despite the length of the book, I found it very interesting. To me, it offered new insides into an Oil giant like Exxon and the oil industry in general. Although it does not offer any “actionable investment advice”, the book is a good read for anyone interested in the Oil industry and Exxon.

“The Go Go years” was how the late 1960ties were called at Wall Street. Although covering a time almost 50 years ago and written in the early 1970ties, this book is still a very good read as a lot of things that happened and a lot of things invented in the 1960ties still influence capital markets.

Among the innovations of the 1960ties were Mutual funds, conglomerates, earnings per share games via acquisitions, financial “innovation” like convertibles, letter stocks etc. etc. Especially the interaction between the new and red-hot Mutual funds and the acquisition hungry conglomerates pushed up stock market levels significantly over the 60ties.

The book gives a very good account especially how stocks were actually traded back then. Paper certificates had to e moved from seller to buyer and due to the increasing trading levels, a lot of transactions wer not correctly settled. Also woman were rarely seen in “real” finance jobs and were denied entry to most of the restaurants around Wall street.

The book contains also some amusing side stories about the beginning the Hippy movement, for instance that many of the back office guys were pretty much on drugs all the time which further added to the back office problems.

There is also good coverage on some of the most “notorious” conglomerates and early “Raiders” like Saul Steinberg, who, finally unsuccessfully tried to take over one of the biggest banks back then, Chemical Bank.

Although this isn’t mentioned in the book we all know that Warren Buffett closed his partnership in 1969 because he didn’t find anything interesting to invest in, but he was definitely not a houshold name back then. Funnily enough, Buffet’s Berkshire itself became the most succesful conglomerate ever over the next 50 years, although with a clearly more conserative structure then the “Go go” guys.

The whole story culminates in the “almost fail”of two of the biggest brokerage houses at that time, Goodbody and Du Pont in the early 1970ties. Du Pont was actually rescued by Ross Perot, founder of EDS and future billionaire presidential candidate.

This part of story almost reads like a 1:1 copy to Bear Stearns and Lehman Brothers 40 years later. Too much leverage, aggressive deals etc. Interestingly, the partnership structures did not prevent those problems as “partners” could take out their capital with a 30 day notice. of course those institutions “had to be saved”, a 1970ties version of to big to fail. Goodbody by the way was “saved” by Merril Lynch, which as we all know now had to be saved 40 years later by Bank of America. Other than now, no tax payer money was involved though.

There is a pretty good Wikipedia entry about the author John Brooks, a “New Yorker” staff writer who has written a couple of other interesting sounding books.

Overall I found this a very very good book and a “must read” for anyone interested in the history of Wall Street and the stock markets in general.

Some lessons to be learned are from my point of view:

1. On Wall Street and in finance generally, “innovation” very often means gains for the guys who run them and big risks and big pain in the long-term for investors

2. Brokerage houses and banks are naturally unstable institutions. Even the best regulation will not make them stable businesses

3. Investors forget quickly, only 10-15 years after that episode, the junk bond mania broke out. After 10-15 years it seems one can run the same schemes again. The current startup, social media etc “craze” is taking place 15 years after the first dot.com boom

4. Whenever the “plumbing” of the market is not working, it gets dangerous. Something similar was happening in 2007/2008 with unsettled CDS contracts

5. Business stratgies relying on ongoing and ever biiger acquisitions are risky and most often do not end well (Valleant anyone ?)

The author closes the book with the expectation that Wall Street will never be the same. To a certain extent he was right as future events were not “The same” but the basic patterns were very similar. Boom bust, speculation, greed, fraud belong to Wall Street, only their appearance changes slightly.

P.S.: The “go go” years were called so because quite often, people would stand before stock tickers in brokerage offices and shouting “Stock x – go go go stock x”….

To be honest, when Waren Buffet last year announced his intention to team up with the Private Equity company 3G in order to buy Heinz, I didn’t know anything about those Brazlian guys behind that company. Especially, the “Mastermind” Jorge Paolo Lemann who is now the 28th richest guy in the world with a net worth of around 25 bn USD was amlmost completely unknown to me.

During the Berkshire AGM, someone (I don’t know who it was, maybe Buffet ?) mentioned that they are selling 250 hard copies of the book which describes how those Brazilian guys got so succesful. However when I went to the bookstore, the copies were already sold out.

So as a kind of additional research when I looked at GP Investments, I downloaded the available Kindle verison of the book.

Jorge Paolo Lemann started his business carreer as a classical banker/trader. Relatively soon, he was able to buy a small brokerage which he renamed to “Garantia”. Over 20 years or so, Garantia was one of the most succesful investment banks in Brazil. The book lacks a little bit in detailed description what they actually did at Garantia, however it seemed to have been a mixture of investment bank and hedge fund, generating huge profits especially in those times when the Brazilian currency was in trouble.

One of Lemann’s key strategies was that he tried to hire “hungry” people and motivated them via huge bonuses which were distributed based on actual results and not, as with many other Brazilian companies based on seniority etc. So to a certain extent, Garantia seemed to have been not unsimilar to a typical “wolf of Wallstreet” boiler room where young and aggressive traders could get rich very quickly.

However the main differentiator of Garantia was the fact that Lemann didn’t pay out the bonuses but required his employees to use the bonus in order to buy shares in Garantia from the founders. So the most susccesful employees also became very quickly major shareholders and partners. In theory and practice, this aligned the interests very well. Lemann is cited several times that he wanted his employees to remain “cash hungry” which doesn’t work well when you pay high cash bonuses.

Relatively early, he also became interested in investing in “real” companies. The first succesful attempt was the Brazilian Retailer Lojas Amricanas. Especially when more and more cash piled up at Garantia, he didn’t want to pay out huge dividends, but used the cash to buy the then struggling Brazilian brewer Brahma for an amount of 60 mn USD. The story about that transaction sounds quite funny. The didn’t do a real due dilligence and only found out afterwards that the company had a 250 mn USD pension hole. Without knowing anything about breweries, they managed to turn around the company pretty quickly.

While being occupied with Brahma, Lemann seemed to have lost interest in banking. While he was still on the board, Garantia almost went belly up and was finally sold for 675 mn USD to Credit Suisse, however the Brahma shares were spinned off before that to the partners. In the book, at thwo instances he seems to have complained about his younger partners that they paid out themselves too much cash instead of adhering to his beloved partnership model.

Going forward, Brahma managed to acquire their biggest rival in Brazil, Antarctica. Further “rolling up” the beer industry, they “merged” with Belgian Interbrew and then finally, in 2008 made the all debt financed acquisition of Anheuser Bush for a whopping 50 bn USD, creating the largest brewing group in the world.

Overall, by only reading the book, it was hard for me to understand if Lemann and his close associates (Telles, Sicupira) are really genius and visionary business men and investors or if they are just aggresive “financiers” who got lucky.

In the time when they build up Garantia for instance, a lot of financial institutions in Brazil prospered, sometimes through questionable ways of information gathering. Also the essential Brahma and Antarctica merger, creating a dominating Brewery in Brazil with 70% market share would have not worked that well in a country with a tougher anti-monopoly regulation.

At least they were more cautious than another former Brazilian superstar, Eike Batista, who stayed in Brazil with his investments and almost lost it all in the last 2 years or so.

For me, the most crucial part of the “Lemann” story is his view on how to align Management and owners. Its seems that in the long term, the owner/manager model where managery invest their salaries back into the company is able to generate exceptional value compared to a “cash bonus/option” model for management.

Interestingly, there was a story earlier this year the Brito, the Brazilian AB Imbev CEO seems to have “gamed” his targets in order to earn a massive bonus. This would not be in line with Lemann’s philosophy. Still it doesn’t seem to have impacted the stock price of AB Inbev which has trippled over the last 5 years.

Overall, the book is written OK, not exceptional like Michael Lewis but still interesting to read. I think it is worth a read especially if one is interested in the Brazilian market and its history and in the alignment of management and shareholders. It is clearly not an “how to invest” book.

Other sources:
Bloomberg story on Lemann & 3G

Following the current hype, I read over the weekend the new book “Flash boys” from Micheal Lewis.

Michael Lewis is most likely the best “writer” of finance books and the new book is now exception. As in most of his books, he focuses on specific person who are usually some kind of outsiders.

In this book, the focus is mostly on an equity trader named Brad Katsuyama who stumbles over the fact that he is not able to make a profit any more in equity block trading at his old job at Royal Bank of Canada (RBC).

Step by step he discovers more and more details how so-called “High Frequency traders” (HFT) are able to exploit tiny timing advantages to squeeze out riskless profits from big orders. This goes as far as HFT companies paying loads of money for direct fiber connections and for the privilege to put their machines directly next to the stock exchange computers in order to get any “micro second” advantage they can get.

In HFT, suddenly knowledge about how computer signals are being transmitted are becoming more important than any kind of fundamental knowledge about stocks, so he assembles a team of TelCo and computer experts in order to understand what is going on.

AFter Katsuyama discovers that the markets are pretty unfair, he decides to quit RBC and starts to build a new, slower and fairer stock exchange called IEX which does not allow HFT to conduct their strategies.

Lewis weaves in 2 other stories, one from an entrepreneur who digs out a fiber optic line between Chicago and the east cost and the other, which Lewis had already published separately in 2013 about Serge Aleinikov, the Russian born Goldman Sachs programer who got tracked down and arrested for stealing computer code.

In my opinion, the book is written very well and despite being an easy read, is pretty helpful to understand what is going on in the HFT area.

Lewis covers specifically the time difference arbitrage between the fragmented US exchanges, which interestingly became only possible because of regulation which was targeted to prevent abuse but backfired.

To a lesser extend, he also touches the issue that at US exchanges, professional players can use hundreds of different order types which gives them a big advantage. SOme f them seem to work that they seem to offer a certain price but when you want to buy, they suddenly disappear and/or get more expensive. Finally, he also looks at the so-called “dark pools” of the banks where a lot of trades are made without any transparency for clients.

Personally, I do think that HFT creates certain issues as seen in the Flash Crash some years ago. But overall, I do not have the feeling that HFT is the only reason why the market is “rigged” as Lewis implies in many parts of the book.

For instance, algorithmic or program trading is much older than high frequency trading. People atbank equity desks like Katsuyama used those algos to trade their large orders before. Those programs created nice profits for the banks without much risk. Usually, a client would give a “VWAP” order to the broker, who then would bill the client the VWAP, but would execute the trade via an intelligent algo who would make sure that the bank would make a profit. I actually met I guy once who had programmed such an algo for Lehman in the 90ties. The profits from this algos and the resulting bonuses for him allowed him to retire in his 40ties.

What those HFT shops seem to do is to “sniff out” the algos of the banks and then trade against them with lightning speed and exploit their weaknesses. In my opinion this is also one of the reasons why the banks created their “dark pools”.

As a little guy, I do not care that much of an extra penny or so per trade.I pay substantial fees in any case and trade once or twice a month. A flash crash for me is a non-event as I just sit it out. For me, “market rigging” comes much more in the form of things like low ball take-overs from Private Equity shops with CEO consenting and getting big bonuses, unfair minority shareholder provisions, stock lending fees in ETFs with an unfair fee split, classic insider trading, “adjusted” earnings etc.etc.

So as a summary I would say: It is a very entertaining book and HFT is clearly an issue. However for the “small guy” which gets referred to quite often in the book, there are a lot more other issues in the market. HFT for me seems to be rather an issue for banks and institutional investors than for a little guy with a “slow trading” stock portfolio.