IA on Sony/PS3 and Microsoft/Xbox 360: Did I Get it Right?

It has been some time since I've written about gaming, but the recent spate of industry news has prompted me to take a look back at some of my writings and ask: did I get it right? After a little time and reflection, my answer is an unequivocal yes. I'm not going to discuss Nintendo/Wii or EA right now, as I clearly nailed them both - hard - and I'm in no mood for gloating. I reserve my right to do that a different day. However, how about my reading of the Internet tea leaves as it relates to Sony/PS3, Microsoft/Xbox 360? Here is a little wrap-up of the last nine months or so:

THEME #1: SONY'S STRUGGLE WITH PS3 AND TROUBLE MAKING MONEY IN NEXTGEN GAMING

IA's Legacy Positioning:

1. Bad culture and communication within Sony

Related posts:
5/08/2007: Me on CNBC: Getting Down and Dirty on Sony (and Apple)
5/02/2007: Gaming and Razors - a Hopelessly Broken Metaphor
3/04/2007: Howard Stringer of Sony: The Corporate Britney Spears?

2. Sales goals inconsistent with strategy and execution - "All things to all people" sales goals with a hard-core gaming strategy

Related posts:
7/03/2007: IA to PS3 Fanboys: Buy the Console, NOT the Stock
5/15/2007: Marketing-Push vs. Evangelism-Pull: Microsoft/Sony vs. Apple/Nintendo
3/19/2007: Nintendo vs. Sony: It's like Atari vs. Betamax
2/11?2007: From Inside EA: Buy Xbox 360 and/or Wii - NOT PS3
12/07/2007: Update on Sony, EA and Nintendo: The Internet Got it Right
11/20/2006: Sony - "Wii are in Trouble"

3. Poor product positioning - "Window to the living room" multimedia player price point for features many customers neither want nor need

Related posts:
8/09/2007: Gaming Consoles are for Playing Games: All the Rest is Flash
7/09/2007: Sony Cuts the Price of PS3? In the Right Direction, But...
5/19/2007: Nintendo Wii: A First Six Months for the Ages
4/24/2007: Microsoft, Sony and Gaming: Fighting a Battle, Losing the War

Recent Online Commentary:

9/20/2007: Kaz Hirai Talks Nintendo, from Go Nintendo

“We belong to the same industry, and I think we seem to be aiming at different targets. Whatever the industry in question, there is no way that just one company can have everything.” - Sony Computer Entertainment group CEO Kaz Hirai

Well I agree, one company cannot have it all.  One company can sure have the lion’s share though, and that’s looking to be Nintendo as of right now.

IA comment: Kaz and his pals at Sony STILL don't get it. Yeah, the market is big. So what? It is possible to do poorly in a big market, especially if your messaging is poor, your product expensive and the cost of developing games for the platform absolutely and relatively high. Oh, and then there is that trifling issue of subsidizing billion-dollar losses on the hardware with software sales, but if those sales don't come through quite as expected because the hardware sales aren't in as many living rooms as you had hoped... This is a very distressing message that shows Sony management singing the same old song, a song virtually unchanged since I started writing about gaming almost a year ago.

9/19/2007: Sony's Plan to Cut PS3 Costs, from BusinessWeek.com

In the video-game industry, it's the oldest trick in the book. To keep a console from collecting dust on store shelves, game console makers will periodically cut prices and watch as buyers flock. Since the PlayStation 3's global launch last November, Sony (SNE) has already dropped the price of its two models, originally $599 and $499, by $100 apiece. But with PS3 sales growing at a slower-than-expected pace and trailing Microsoft's (MSFT) Xbox 360 and Nintendo's Wii, Sony could be mulling over another price reduction in the coming weeks. Some observers think an announcement might come as soon as this week's Tokyo Game Show.

How can Sony afford such deep discounts? After all, the Tokyo technology giant takes a hit on every PS3 it sells, to the tune of hundreds of dollars a console. Analysts say it will take time to whittle away at production costs, and don't expect Sony's gaming division to break even for another year and a half.

But Sony appears to have a plan. The company is now in talks with Toshiba (TOSBF) to sell the factory in Nagasaki where the high-performance Cell chip that powers the PS3 is made, according to a Sept. 15 report in the Japanese financial daily Nikkei. (

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The sale could bring Sony an estimated windfall of $870 million. In the best-case scenario, Sony would gain another benefit: With Toshiba's expertise in production efficiency, Sony could get a cheaper price on chips that would lower the PS3's costs. Sony now spends about $89 on each Cell chip, or about a tenth of the overall cost per console, market researcher iSuppli estimated in a teardown analysis last November. "The point is this would have the effect of driving down costs for Sony's gaming division," says Macquarie Securities analyst David Gibson.

That would be a huge help for gaming boss Kazuo Hirai, who took over in June. He needs to show that he's the right guy for the job by restoring video games to profitability after a massive $2 billion operating loss last year.

The potential downside is that Sony would have to rely on a competitor for a key PS3 part. And as Sony rushes to develop the Cell for other gizmos, such as flat TVs, laptops, and cell phones, it puts a promising technology in a rival's hands. Sony would also be giving up on microprocessors for video cameras and older generations of gaming consoles.

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Meanwhile he's eager to close the gap between production costs and retail prices as quickly as possible. When the PS3 went on sale, market researcher iSuppli estimated that Sony was losing $306 on the lower-priced 20GB model and $241 on the pricier 60GB version. Outsourcing the Cell chip in-house may buy Hirai time to delay another PS3 price cut.

Now this actually makes some sense. It is a strategy that does carry risks, and gets Sony away from its historic model of vertical integration that served it well in the past (and serves Apple well today), but I think it is a necessary move. Sony needs to focus on customers. I've written in the past about Sony being an engineering-driven firm, a strategy that worked well when pure technology was the source of competitive differentiation, but the market and competitive landscape has changed. Firms who best understand and are closest to the customer are winning, and Sony needs nothing short of a radical transformation to achieve this re-positioning. Outsourcing nuts-and-bolts components in order to focus on usability, product design and software will enable them to compete with more customer-centric organizations both through reduced costs and laser-like focus on the most critical parts of the value chain.

9/20/2007: Sony to expand PS2 business, offers no PS3 Price Cut, from Macworld

Sony opened Japan’s biggest computer gaming event on Thursday with a keynote speech that promised a new PlayStation 3 controller and expansion of its PlayStation 2 business, but not an anticipated price cut.

Kaz Hirai, the recently appointed president and CEO of the Sony gaming unit, said Sony plans to put more effort into expanding its PlayStation 2 business. At the same time it will continue to push the PlayStation 3.

The plan is unusual because gaming companies typically de-emphasize old consoles when newer versions become available, but Sony’s in an unusual situation. Instead of snapping up the PlayStation 3, many consumers have shunned the console because of the high price.

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To expand the PlayStation 3 business, Hirai said Sony will begin sharing knowhow built up through its Worldwide Studios unit and will invite game publishers to provide feedback to the company on a periodical basis.

Sony has also acquired two game developers, Evolution Studios and its subsidiary Bigbig Studios. Evolution, which is based in the U.K., is best known for the million-seller “MotorStorm” game, a new version of which is scheduled for release on the PlayStation 3 next year.

Hirai also announced a delay to the “Home” three-dimensional online user community that was due to be released around now. Sony now expects it to be available in early 2008.

Also, Sony Delays Home Coming, from Briefing.com 9/20/2007.

The "Home" online service, which allows users to create and own characters within a virtual community, was originally expected to be launched this fall.  However, the company now plans to postpone the release until next spring in an effort to improve product quality. 

The announcement reflects the ongoing troubles facing Sony's newest game console, which continues to lag its rivals, Microsoft and Nintendo, due to product delays, hardware glitches, and higher prices, as well as few hit game titles for the new-generation platform. 

This to me seems like good news/bad news stuff,. Harvesting the PS2, ok. Why not extract full value from the firm's installed base while penetrating less-developed markets at a lower price point? However, it is still stuck at too high a price point with its PS3, which doesn't address a fundamental issue that's been knocking around for some time now. Acquisition of two game developers and getting closer to game publishers? Good. Delay in its Home user community? Bad. So a mixed-bag at best.

Conclusion:

It doesn't seem to me that Sony has made material progress against the three issues I've discussed over the past year. Sure, they've dropped price a bit, boosted Kaz Hirai while pushing Kurtargi to the side, and are looking to outsource some hardware components in order to focus more on the development end of things. But they are still playing catch-up, have an ambiguous positioning in the market and no clear strategy as far as I can tell to take advantage of the rise in casual gaming. Oh, well. Keep trying, Howard. I'm paying attention.

THEME #2: MICROSOFT'S STRUGGLE WITH XBOX 360 AND TROUBLE MAKING MONEY IN NEXTGEN GAMING AND, IN FACT, ANYTHING IN THE SPHERE OF HOME ENTERTAINMENT?

IA's Legacy Positioning:

1. Pricing strategy inconsistent with mass-market objectives

Related posts:
8/08/2007: Xbox 360: $50 Bucks Less in the US Won't Fix a Broken Strategy
7/11/2007: How to Get Microsoft's Xbox 360 Strategy On Track

2. Abysmal financial performance

Related posts:
7/05/2007: Microsoft Having Profit Problems with Xbox 360? You Don't Say?
4/17/2007: MSFT, Xbox 360 and Japan: Failure-in-a-Box
4/10/2007: Microsoft, Channel Stuffing and Desperation: Old Tricks for a New Era

3. Cultural and customer service breakdowns

Related posts:

7/23/2007: Microsoft's Identity Crisis Rages On - Take a Page from Nintendo, Guys
7/18/2007: Peter Moore to EA: As the Stomach Turns
7/10/2007: Xbox 360 and Three Red Lights: Like Tylenol and Cyanide?

Recent Online Commentary:

9/21/2007: Microsoft: Xbox 360 Can Win the Console War Without Japan, from FiringSquad

It's well known that Microsoft has struggled to gain a solid foothold in Japan in selling both the original Xbox and the Xbox 360. Despite Microsoft courting Japanese developers to make original and exclusive games for both consoles sales have been dismal in Japan. Now Next Generation is reporting that Xbox 360 group product manager Aaron Greenberg is making claims that Microsoft doesn't need Japan to win the current console war over the PS3 and Wii. Here is a snip:

“For us, winning on a global basis doesn’t mean winning every single market,” said Xbox 360 group product manager Aaron Greenberg in a group Q&A session during the Tokyo Game Show. “We’ll win some, we’ll lose some, but the key is to win across the sum of the parts. So we feel like winning in North America, winning in Europe and doing very well in Asia’s important, but I think that if you talk to publishers, you can win on a global basis by leading specifically in North America and Europe.”

Recently the Financial Times reported that Nintendo's Wii console has surpassed the Xbox 360 in total worldwide sales. Greenberg states that they believe the Xbox 360 will still "stay very competitive with Wii on a global basis."

Conclusion:

So much has been written about Microsoft and Xbox 360 (not to mention the failure of Vista) that it almost tiresome to rag on them any more. Punch line is, there is still a strong sense of arrogance and rationalizations coming out of Redmond, neither of which is going to help get the Xbox 360 console strategy back on track. I think almost everything I've written about Microsoft, their Home & Entertainment strategy and Xbox 360 performance has come to pass. Again, I am just connecting the dots. The real people who know - gamers, industry watchers, key influencers - are the people from whom I divine my perspective, and they've been spot on pretty much since Day 1.

And oh, by the way, I find it kind of funny that EA recognizes the importance of Japan, even if Microsoft doesn't. From GameDailyBIZ 9/20/2007: EA: Japan is a Strategic Priority.

As the world's biggest third-party publisher Electronic Arts already has a major global presence, but according to the Financial Times there's one very significant territory that the company would like to achieve greater penetration in: Japan. 

 

Japan, after all, is home to many of the industry's most important companies and as a region it represents about 20 percent of the $30 billion global games market (second only to the U.S.). That said, EA's revenues from Japan are quite low and the publisher's Asian market revenue in general comprises only six percent of the company's total.

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Similar to other parts of Asia, Niermann believes the big growth opportunities in Japan will come from the online games market. He also sees mobile games as another sector where demand will pick up.

 

Earlier this year EA purchased a 19 percent stake in Korean online games company Neowiz. EA also acquired a 15 percent stake in Chinese online games company The9, which is known for distributing the incredibly popular World of Warcraft.

Is EA making rationalizations for writing off Japan? Are they sticking their heads in the sand and saying "We're big and bad elsewhere; we don't need to win every market." Just read my blog to see the difference in evolution between EA's strategy and Microsoft's strategy over the past nine months. Both firms have been to the abyss, though for one it was a life-changing experience that has altered its strategy in short order (EA), while for the other it was more like "Well, at least we didn't go all the way to hell. Whew" (MSFT). Microsoft still doesn't get it while EA clearly does. I'll expound more on EA in a subsequent review post. But suffice it to say, Sony and Microsoft still are facing many if not all of the issues that existed in late 2006, and their strategies have changed remarkably little. EA, conversely, has taken stock and gotten on a healthy glide path. I'll check back in with a review of these companies towards year-end. But as it stands today, IA 1, Sony and Microsoft 0.

 

If I Had a Column in the New York Times I'd Be...

...Joe Nocera. Why? Because he just penned an article concerning why humans are the worst investors, a topic about which I've written about several times before. I love his subject matter: highly relevant, very interesting, offering both valuable historical context and pithy vignettes. And he provides a solid book review in the process. But my question remains: where's my column? Some highlights from his article include:

Neither are the rest of us ("economic man" aka rational investors). That’s the thing about investing: we may not have invented portfolio theory like Mr. Markowitz, but most of us have some smarts, and we know, absolutely, what we are supposed to do with our money. We’re supposed to diversify, shut out all the white noise of the market, rely mainly on low-expense index funds, sell when stocks are high and buy when they are going down. We should avoid the herd instead of becoming part of the herd. That what economic man would do.

But do we do that? Hardly. When it comes to investing, most of us simply don’t act rationally. Small investors spend hours on chat boards, where the herd mentality is fiercest. They can’t bring themselves to sell losing positions, even when the stock is still going down. They bet everything on one or two high-risk stocks. I do not exempt myself from this behavior: a decade after the Crash of ’87, I was loading up on tech stocks during the Internet bubble, even as I was writing article after article about how the bubble couldn’t possibly last. 

Having watched the way investors have behaved since the Crash of ‘87, I’ve come to believe that most human beings are simply not hard-wired to be good investors. In the 1990s, a new kind of economics arose, called behavioral economics, which tried to show that investors weren’t so rational after all. So I can’t deny that one of the reasons I like Mr. Zweig’s book so much is he provides, at last, a scientific basis for this theory. It turns out that there is a new discipline called neuroeconomics, which combines biology, psychology and economics and tries to understand why we make the often foolish financial decisions we make.

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I came away from Mr. Zweig’s book feeling just the opposite, though: that there is really not much hope that we’re ever going to get the hang of investing. Humans are emotional beings, and that is always going to get in the way. What sets apart investing geniuses like Warren Buffett  is precisely their ability to ignore their emotions —or, perhaps, to use them differently than the rest of us do.

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As our interview was winding down, Mr. Zweig told me a story — “I think it might even be true” — about Charles T. Munger, the Los Angeles lawyer best known as Mr. Buffett’s sidekick at Berkshire Hathaway. “A woman was sitting next to him at a dinner party in L.A.,” Mr. Zweig said. “She turned to him and said, `You’re Warren Buffett’s partner, and a great investor. Tell me, what is your secret?’”

Mr. Munger looked up at her. “I’m rational,” he said. Then he went back to his dinner.

I love that last story. True or not, it is the defining characteristic between Messrs. Munger and Buffett and the rest of investment-kind. But just as an FYI, here are some of my writings on the topic that dovetail with Mr. Nocera (and Mr. Zweig's and Mr. Munger's) central themes:

09/21/2006: Social Networking for Stock Picking? Give me a Break

It is particularly interesting to read some of the comments to the TechCrunch article. The diversity of comments pretty much represents that of the investing public - most comments have no appreciation for history or empirical research, a few are so far off the reservation (citing "wisdom of crowds" as the reason why such sites make sense) as to hardly warrant comment while a few actually raise the fundamental issues of indexing, risk management and diversification. The feel one gets from looking at these sites is that investing is somehow supposed to be FUN. For those of you who have lived in the markets for a long time, we all know this to be the kiss of death.

Investing life should not about being the next Jim Cramer - or if it is, may the force be with you. Investing in equities for long term profits is HARD, and unless you are professional (and, I might add, one of the few rare professionals whose record is empirically proven to be due to something other than pure chance), then it is best to get out of the way and to focus on the one thing that really matters to building and preserving personal wealth - asset allocation.

11/30/2006: Why I Hate Jim Cramer

So TheStreet.com issued a press release today saying that Jimmy Baby is going to spend less time on radio and more time in front of the camera. Hooray! Barf. Now I don't particularly like being the 300th person to pile on 'ol Jimmy, who has been taking some body blows as of late, but what I have to say has a somewhat different spin that most of what's out there. My thesis: he is helping to perpetuate addictive, stupid, self-destructive behavior, and he has to be stopped. Except now he is only getting a larger platform. What does this say about our society? I'm not sure, but I don't like it. Professional investors love this, so they can make money off of the sheep-like behavior of hopeful, drooling retail investors. Sorry, pros, to be "outing" you. You must be paying Jimmy on the side to keep him talking. What's bad for retail is good for the pros, that's for sure.

His Mad Money bs is really no different than Philip Morris selling cigarettes: they're bad for you, they effect those around you, and you shouldn't smoke them. Jim Cramer: he makes you think you know what you're doing when you don't, you tell your friends about it, when you really should be in some good equity index funds and high-grade bonds. But hey, call me a cynic, call me harsh. This is just one man's view.

08/16/2007: Retail Investors + Complex Investements = Failure

When I hear of retail investors engaging in multi-legged option strategies, trading foreign exchange and commodities and shorting stocks, I cringe. How many lumps are people going to require to wake up and grow a little humility? I get it - the psychological phenomenon, that is - but I DON'T GET IT. There have been countless stories documenting the sheer idiocy of so many retail investors, being in way over their head and getting killed. So why do people continue making the same mistakes? For the exact opposite reason of why Warren Buffett really is a once-in-a-generation type investor: discipline.

Discipline, especially when it goes against one's native instincts, is hard. When your friend brags about a particular stock or strategy on the golf course, you are jealous, right? And when you hear stories of people making tons in _____ (choose your era - tech stocks, commodities, currencies, gold, etc.), regardless of a lack of documentation (self-reporting is notoriously poor as people tend to remember wins and forget losses), you want in, right? It is very hard to be the tortoise when you are seemingly surrounded by hares.

08/19/2007: Retail vs. Institutional Investors: Compare and Contrast

Ergo, carrying a card that reads "Institutional Investor" does not somehow imbue you with skills and abilities that automatically make you successful, just as being labeled "retail" does not, by definition, correspond to the word "idiot." My belief is that almost all investors, be they retail or Institutional by stripe, are not good. Those who can generate true, sustained, statistically-significant outperformance over long periods of time are rare. No, more than rare. But I care less about the failures of Institutional investors as people because they, quite frankly, make a lot of money as a group, while retail investors span the economic strata. This is why I choose to write about retail and my wish for them, as a group, to think smart, be humble, and take a rational and serious (read: "This is not fun - this is business") approach to investing. If this is arrogant, so be it. Excuse me. But I think someone without a vested interest needs to write this stuff because it is a perspective too often lost amidst the hype.

09/23/2007: Bridging the Gap Between Economic Models and Reality

While discussions of utility in neoclassical economics are generally absent of behavioral impacts, and merely seek to quantify rational trade-offs among economic goods, utilitarian explanations take into account consumer psychology and offer a more robust framework for understanding motivations and their implications for policy-making. Preference utilitarianism, as put forth by Peter Singer, seems to be the most useful model for understanding the behavior described in today's article than more classical economic frameworks. It takes into account the uniqueness of each individual's perspective and validates their actions as being rational - for them. And this happens to describe the world in which we live, a world that is perceived differently by each economic actor.

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There is a psychological barrier to taking a loss, admitting a mistake, even if it is economically prudent to do so. How many people do you know that held on to stocks from $60 down to $1, even when they really thought they should get out at $30? I personally know dozens. The concept of sunk costs gets thrown out the window when emotions get involved. As I've written previously, humans are not wired to everywhere and always make rational economic decisions, though they are wired to always seek to maximize their utility. A discussion of consumer behavior in the absence of psychology and utility is almost valueless, IMHO.

So thanks for the interesting and well-written piece, Joe. Next time you need a quote please feel free to give me a call. You know where to find me.

 

Accounting Rules Gone Amok - The Unintended Consequences of Mark-to-Market Accounting

What is the purpose of financial accounting? Without looking at any formal definition, I'd say it's something like the following:

To provide investors with a clear and useful picture of a firm's current financial position, as well as how that position has changed from prior periods as an outgrowth of operating performance.

Yes, there is lots of other stuff that is involved but this, IMHO, is the bottom line. New accounting rules governing the marking-to-market of both sides of the balance sheet, and its related impact on income statement reporting, will likely serve to cloud and obfuscate an already complex picture, especially when it comes to financial institutions' accounting disclosures. This was driven home in an article in today's Wall Street Journal titled The Gold at Crunch's End. The title alone is enough to give me pause, but the content is even more damning if one considers the intention of our accounting policy-makers:

While the bond-market mess made the earnings reports for the big investment banks feel like a game of roulette, there was one area where they were almost guaranteed to win: profits generated by the falling value of their own debt.

That allowed the firms to book hundreds of millions of dollars in profit, helping to offset multibillion-dollar charges they had to take on commitments to fund leveraged buyouts.

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The brokers and banks are doing nothing wrong or improper in booking such gains. The accounting rules as they stand allow the practice. But some investors are crying foul, saying the rules shouldn't have been changed to allow for such gains.

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The emergence of debt-induced gains, even if they only offer a slight respite from overall market woes, has rekindled longstanding debate about whether such profits should be allowed. The opportunity for companies to benefit in this way only recently emerged, thanks to new accounting rules that allow companies to apply market prices to their own liabilities.

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Even some supporters of the use of market, or fair, values remain uneasy with companies booking gains on declines in the value of their own debt. "It was premature to allow the effect of that to come through the income statement," said Leslie Seidman, a member of the Financial Accounting Standards Board, the body that adopted the rule that allows companies to book these gains.

Yet brokerage executives defended the gains, saying they were more than just an accounting gimmick. During his firm's earnings call, Sam Molinaro, Bear Stearns's chief financial officer, said "the gains were real," adding that "there's someone on the other side of that trade who lost money."

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The idea of allowing companies to profit from falls in their own liabilities proved controversial when accounting rule makers debated the idea. But many companies, especially in the financial sector, argued that if the rule makers were going to encourage the use of market values, they should allow companies to use them for all their financial assets and liabilities. In addition, financial firms argued that it didn't make sense to require them to use market prices for the value of a derivative contract that may be hedging the value of a company's own liabilities, which would be recorded at its cost.

Ok now, whoa. There are a lot of moving parts here. Let's take a big step back and sort this out. We've got cash instruments, assets and liabilities. We've got derivatives. We've got derivatives hedging cash instruments. We've got issues of liquidity. Each one of these items needs to be considered before developing a policy that makes sense for firms and financial statement users alike.

Here's Roger's Guide to Intuitive and Useful Accounting Policies and Practices.

Assets: You need to distinguish between trading assets and non-trading assets. Trading assets should have an explicitly low duration, not the instruments themselves but the amount of time they are likely to be held in the book. Trading assets should be marked-to-market. Always. Non-trading assets should be carried at cost, with a valuation reserve that fluctuates based on market values but whose changes flow through the Stockholders Equity account as a discrete line-item. This should also take into account permanent impairments, the impact of which would flow through the valuation reserve. As these non-trading assets are sold their carrying value is removed as well as any valuation reserve associated with their disposition.

Liabilities: Here you need to distinguish based on intention and ability, and there should be a document carried in the file that states the specific intention towards specific financial liabilities and the capacity to exercise these intentions. If a liability is not expected to be extinguished, i.e., it is a core part of a firm's financing structure even if its value declines, it should be carried at the maturity value. I don't buy Mr. Molinaro's argument at all. I think it is disingenuous to say "Oh, well, I could buy back that debt at a discount. The gain is real." Companies just don't buy back debt at the drop of a hat. It is not like selling a trading asset. I'd argue that the pool of liabilities that are true "trading liabilities" is actually very small, and, therefore, most of a firm's debt should not be marked-to-market. That said, if a firm can make a case for and has a history of treating some of its debt in this manner, then it is fair to mark it to market just as it does trading assets. But my sense is that the number is quite small and instances such as these should be documents for absence of doubt.

Hedged assets and liabilities: The accounting profession has gotten this wrong for a long, long time. Believe me I know - as a derivatives pro I lived this nightmare during every single transaction. I think you need to keep it simple. The concept of "effectiveness" exists in the realm of derivatives accounting, i.e., does the change in the value of the hedge offset the change in value of the hedged instrument? Fair question. But the process of testing and designating effectiveness is way, way too onerous and time consuming. Punch line: is a hedge 90% effective using some reasonable tests (and I mean reasonable) set forth by your auditors? If yes, leave the hedged assets or liabilities carried at purchase price/maturity value. If not, then mark-to-market both instruments and have the difference in values flow through the valuation reserve. Preserve the integrity and usefulness of the income statement while providing mark-to-market detail on the balance sheet.

All I know is that the divergence between accounting theory and financial statement usefulness has gotten us off the rails. A little common sense needs to come back into the equation before financial statements become so convoluted and complicated that their usefulness simply erodes. Unfortunately, the wheels of the accounting rule-making process are slow, fraught with politics and sometimes lead to the wrong answer. Mr. Paulson, can you help here?

Hedge Funds and PR: Getting Serious - and Fast

Hedge funds are under siege - this is nothing new. But what is new is the magnitude and breadth of criticisms being levied against the industry, and at a time when returns and reputations are at a cyclical low. Here is a sampling of the issues being raised by both the SEC and Congress, from Reuters 9/26/2007:

GREENWICH, Connecticut (Reuters) - The U.S. Securities and Exchange Commission is conducting more than 30 investigations into potential hedge fund manager misconduct in the northeast United States alone, with more in other parts of the country, officials said on Wednesday.   

The investigations into potential insider trading, faulty asset valuation, conflicts of interest and other misdeeds are under way despite the agency's setback last year when a federal court struck down a rule requiring the lightly regulated hedge funds to register as investment advisers.

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Connecticut Attorney General Richard Blumenthal, an outspoken advocate on the need for more industry regulation, said the probes are likely to bear fruit in states like his, home to scores of multibillion-dollar hedge funds.   

"There are indications that the investigations will be very productive," Blumenthal said in a keynote speech at the event.

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The SEC has made prosecuting insider trading at hedge funds a major priority this year, including probing ties between the funds and financial institutions that serve them in prime brokerage divisions, said Karpati, who heads an intra-agency working group set up six months ago with about two dozen executives.   

Agency officials said they haven't been deterred by the setback it suffered when a federal court struck down the rule that would have subjected the industry to such measures as spot financial audits, compliance manuals and increased disclosure.

Insider trading. Asset valuation. Conflicts of interest. These are not good things. And while hedge fund managers certainly weren't the most popular kids on the block (from a regulatory standpoint) during the industry's boom over the past five years, they may well be among the most detested right now. And this hasn't gone completely unnoticed by some of the industry's leading figures, including Paul Marshall of Marshall Wace. From FT Alphaville 9/25/2007:

Hedge funds - the bad boys of finance. Or is that private equity? We lose track of who is finance’s enemy number one from one month to the next. But not so long ago the funds were deeply unpopular - accused of stalking the markets, creating volatility, aggressively targeting respected UK companies through short-selling and looking for decent, hard-working public company executives to unseat.

Then private equity got a touch carried away in the FTSE 100 and the buyout groups found themselves being picked over by the unions, parliament and the media. Now the credit markets have closed for business and it’s Northern Rock, the Bank of England, the FSA and the government in the dock for financial mismanagement and endangering the system.

So should hedge funds, and private equity, skulk away thankfully as the fickle public spotlight has found itself another target?

No, argues Paul Marshall, chairman of Marshall Wace and a member of the UK’s hedge fund working group, in an FT comment article. Hedge funds may not be at the centre of the current storm he says, but there is a web of linkages between the banks and hedge funds. “Plus the the similarity of issues facing banks and hedge funds, particularly in relation to valuation and risk management, demonstrates how integral hedge funds have become to the workings of the financial system.”

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Marshall adds that calls for more regulation, in France, Germany and the US should provide an adequate stick for hedge funds to further the process started by the working group under Sir Andrew Large. “The hedge fund industry must be seen to be taking its responsibilities  seriously. If not, others will fill the vacuum.”

I think Paul is spot on. The hedge fund industry needs to be proactive and help shape the dialogue concerning regulation, or else it will lose control and potentially be subject to illogical and politically-motivated rules and policies. One factor working against this adverse outcome is the working group assembled by Hank Paulson that is drawing up a set of hedge fund "best practices," chaired by Russell Read of CalPERS and Eric Mindich of Eton Park. From the Financial Times 9/26/2007:

The appointments, by the president’s working group on financial markets, are part of efforts by Hank Paulson, Treasury secretary, to formulate a private sector-led response to concerns about the activities of hedge funds and avoid potentially draconian regulations.

Russell Read, chief investment officer of Calpers, regarded as one of the most influential jobs in US capital markets, will chair a committee of investors, while Eric Mindich, the chief executive officer of hedge fund Eton Park, will chair an asset managers’ committee.

The investors committee will include representatives from labour organisations, endowments, foundations, corporate and public pension funds and investment consultants.

Other members of the committees will include Daniel Och, head of Och Ziff Capital Management, William von Mueffling, the former star Lazard hedge fund manager who now runs Cantillon Capital, and James Chanos of Kynikos Associates.

These are smart, cerebral, experienced industry leaders that can bring different perspectives and reason to the proceedings. I have long pushed for private sector-led, self-regulatory solutions governing hedge fund practices. And the time is now for a proactive, industry-driven effort to ensure rational and helpful guidelines are set without regard to the media circus currently engulfing the private equity and hedge fund industries.

The Wii Fueling EA's Prospects? You're SO Late, Mr. Cramer

It's great to have a bully pulpit, Jimmy. Especially when you can duke it out with an analyst on TheStreetTV and let him do the heavy lifting for you (except he did rough you up in the ring - and bad). The Wii has been red hot ever since E3 2006, and the Internet was all over it way before mainstream media got into the act. Myself and others began covering this pretty aggressively throughout Q3-Q4 2006 leading up to its launch, after which strong demand was seen in the offline world just as it had been foreshadowed in the online world. This is old news.

The EA story is also old news. They rested on their laurels during much of 2006, harvesting their legacy franchise on the PS2 console and not placing bets on new and untested platforms like the Wii, notwithstanding evidence that it was likely to do pretty well. As a result, they fell from on high, seeing their 43x PE get whacked and dropping from nearly $60 to $46 on concerns it had lost its edge and its mojo. They reacted by purchasing a Wii game development shop and shaking up their senior management ranks. They have since recovered much of the lost ground, printing at above $56 today. That said, your commentary during your Wii boxing beating seemed to indicate that you are living in the past, neither understanding the rocket ship that are Wii console sales nor EA's rapid redeployment of resources to take advantage of the surge in casual gaming. This is all old news, pal. Go on your favorite RSS reader and check it out.

Anyway, good luck in future boxing endeavors, Jim. Because that left jab needs some serious help.

A New Look for IA

As you've probably divined by now, I just launched a new web design. After all these months of taking a bunch of crap about my black background and other design issues, I decided to take a fresh approach and introduce a totally new look and feel. I've also included a tab for my investment entity, IA Capital Partners, which shows all of my personal holdings as well as a little thumbnail on each company. You can also quickly shoot out to my LinkedIn profile or my Facebook profile as well.

As I am always on the lookout for interesting companies in which to invest, advise or both, please feel free to drop me a note, a business plan, or any interesting ideas you'd like to knock around. I hope you like the new IA design, because I'm not changing it anytime soon. But feel free to send comments anyway, as my kind friend Howard Lindzon has in my Buddy Media post.

Top Talent Sought: Buddy Media

My pal Mike Lazerow, CEO and Founder of Buddy Media, is looking to fill two important positions with super-talented, ambitious people ready to join his nimble, high-performance team:

Director of Business Development

Buddy Media, Inc., a NYC-based start-up that is building the AceBucks underground currency on Facebook, is currently seeking a Director of Business Development. The position is based in Buddy Media’s Columbus Circle office and reports to the CEO of Buddy Media, serial entrepreneur Michael Lazerow (U-Wire, GOLF.com, Lazerow Consulting).

We are looking for a motivated, self-starter who is comfortable working in a fast-paced start-up atmosphere. The ideal candidate is sick of making money for others and wants to create value for him or herself as an owner of Buddy Media.

Primary Responsibilities:

* Create partnerships with media companies, marketers, advertisers, sponsors and other organizations that want to reach the Facebook crowd.
* Form relationships with other Facebook application developers to use AceBucks as their currency or loyalty marketing program.
* Lock down distribution with large media companies and start ups for the AceBucks currency.
* Lead all aspects of deal development, prospecting, sourcing, negotiating and closing. This will include strategic partnerships, distribution deals, and corporate development.

Requirements:

* Minimum five years experience in the internet business or technology company focusing on digital business development.
* Background in loyalty marketing and membership marketing is a plus.
* Excellent negotiating and people skills.
* Must be able to develop Powerpoint presentations that convey complex issues clearly and concisely.
* Strong analytical and financial skills.
* Ability to work independently and as part of a team in a fast paced environment.
* Strong personal interest in and knowledge of social networking and Facebook.

Compensation & Benefits:

Salary based on experience. Equity in Buddy Media is a major part of the compensation package. Full benefits provided

Software Engineer

General Description:

We are looking for a candidate who has experience working with large amounts of data. The position calls for a candidate who is skilled with algorithms, optimization, and efficiency.

Requirements:

• Core competencies are Linux, Apache, MySQL, PHP, and HTML, CSS (emphasis on PHP & MySQL)
• Working knowledge of AJAX
• Strong quantitative and analytical skills
• Must have an interest in excellence
• Enthusiasm for learning our system and for working as part of our team is important
• Excellent written and verbal communication skills, ability to communicate effectively
• Looking for a self starter with the “general get it factor”
• Must have a “whatever it takes” attitude
• Meticulous thinker who can develop effectively by our coding standards
• Must be a quick study and enjoy learning new technique daily
• Must check your ego at the door and be able to work well in a tight group of enthusiastic engineers. Must be able to work collaboratively, listen, and incorporate new ideas into your designs

The Ideal Candidate will have:

• 3+ years of SQL and PHP experience
• familiarity with Linux as a user
• experience with Memcache
• experience with Javascript
• an easy-going attitude, yet are ambitious, tenacious and enjoy solving problems

Preferred Qualifications:

• familiarity with Facebook development API
• linux and mysql system administration experience
• ability to pass

Apply for this position by sending us the following:

• Your resume and cover letter.
• Examples of any projects you’ve worked on.
• Recommend a good book or two you’ve read.
• Work References

So if you've got the goods, run, don't walk, and get your information into jobs@buddymedia.com.

The Integrative Pediatrics Council: Looking at the Whole Child

I have a close friend named Dr. Lawrence Rosen. Larry happens to be a very bright guy, an MIT educated, Mount Sinai-trained pediatrician. He also happens to have a heart too big to describe. Ever since I have known him (which now is frighteningly approaching 20 years) he has questioned traditional protocols for pediatric care. Not that they were necessarily bad, but that they didn't take into account all of the factors or all of the impacts on the child. Emotional issues. Family issues. Environmental issues. The benefits of non-traditional and Eastern therapies. Nearly two decades ago Larry envisioned a model based around the "whole child," a perspective rooted in viewing the child as a complex being in need of an integrated approach to care taking into account the mind, body and spirit. Further, Larry felt that Western medicine didn't corner the market on knowledge or know-how, seeking an amalgam of therapies, protocols and treatments unbounded by culture, geography or discipline, in an effort to deliver the best care that the world has to offer.

Larry took this passion and jumped into the world of integrative medicine. He went to conferences. He presented papers. He lead discussion groups. And he networked his butt off. What he found was a group of very accomplished, like-minded practitioners from across the globe, each of whom shared the same passion and the same goals as he did. I am proud to say that Larry was one of the driving forces behind the newly-formed Integrative Pediatrics Council:

The IPC is a non-profit dedicated to transforming children's health care. Our mission is to enhance the health and development of children, families and communities by leading the evolution of pediatric healthcare toward integrative, high-quality, accessible care.

Larry also folded his blog, The Whole Child, into IPC, and is moderating the site and taking in commentary, views and approaches from leading integrative medicine practitioners to share with the larger community. I couldn't be more proud of my friend for his leadership in organizing a group of such importance and merit, and for providing the community with a resource for learning, growing and collaborating. Regardless of whether or not you have kids you should check it out. I think what we're seeing here is the future of medicine - not just pediatric medicine, but the way in which we approach care. I can't wait to see their progress and for their vision to become more closely linked to "mainstream" practice.

Buddy Media: Virtually Everything

Congratulations to Mike Lazerow on putting Buddy Media together with a great team and a powerful vision. I am proud to be part of the investor syndicate and a member of the Board. I believe in the power of social networks. I believe in the power of virtual currency as a vehicle for creating excitement, revenues and customer value in both online and offline worlds. And I believe in the power of great people. Mike, joined by investors including Peter Thiel, Mark Pincus, Howard Lindzon, James Altucher, and Bay Partners' Salil Deshpande, has attracted a group of smart, super-connected entrepreneurs and visionaries to help Buddy Media and its AceBucks application rock. And I am confident they will.

Austin City Limits ROCKS (and Interpol Ain't so Bad, Either)

I admit it, I like to FEST. Music festivals in general, and ACL in particular, are one of humankind's greatest creations. Where else can you hang out with your 65,000 closest friends while wallowing in the dust, sweating bullets in 95 degrees, looking like something that got the crap kicked out of it in the desert and come out LOVING IT? This was my second ACL, having attended the (in)famous fest of 2005 that was plagued by fears of Hurricane Rita, 105 degrees with some serious humidity yet with a lineup that was second to none? Bottom line: you go down to Austin, connect with some friends, hear a wide variety of amazing tunes, learn about some new bands, swim in a spring for self-preservation, drink gallons of water (to augment the Makers Mark, Patron and whatever else you might have on hand) and make your reservations for next year before even leaving town. And this is without all the other stuff that Austin has to offer like 6th Street, Stubbs, SoCo and everything else. In short, a sublime experience that transports you from your work-a-day existence into another dimension. A dimension of happiness. Of grooviness. Of peace. Of fun. Run, don't walk, to ACL 2008. I'll be there.

Now I happened to take the first day off because one of my favorite bands, Interpol, was making their Madison Square Garden debut. My wife Carin and I got great tickets and decided to defer our trip, and to fly down crack of dawn Saturday to take in the last two days of the fest. They were in fine, fine form. Paul's voice has never been better, Daniel played the shit out of his axe, Sam played his pulsating and energetic drums and Carlos was, well, Carlos. They played a set evenly distributed among Bright Lights, Antics and Our Love to Admire. It was a great show and more than compensated for our being bummed at missing Day 1 of ACL.

Down at ACL on Saturday we took in Augustana, Cold War Kids, Clap Your Hands and Say Yeah, the Arctic Monkeys and Arcade Fire. In the words of Larry David, "Pretty good. Pretty, pretty good." No, Larry was wrong. They ROCKED. I wasn't familiar with Augustana, had heard of but never seen Cold War Kids, and have long loved CYHASY, Arctic Monkeys and Arcade Fire. They all stepped up and played to appreciative and knowledgeable ACL audiences. The only crappy part was that part of the sound system blew during Arcade Fire's set, so the fidelity was not so high. But anyway, it didn't materially detract from the experience. It was enjoyment, pure and simple.

And now for some pics:

Hanging in the Grove: my friends Mary-Gail, David, Patti and yours truly swilling a cool one. Notice the cowboy hats - truly self-preservation. Tried a baseball hat and it really didn't do the job given searing heat and intense sun. I don't look too much like Billy Crystal, do I?

Cooling off in Barton Springs: a short walk from the fest, this was the late afternoon way of dropping your body temperature by 5 degrees and getting prepped for an evening of music and coolness.

   
Me and my fest-babe. Loving the cute pig-tails.

My friend Dave spent some time during undergrad and grad school at Vanderbilt, where he honed his taste for Makers Mark. And what better place to enjoy than at ACL?

Me with my friends Ed and Dave. It just so happens that two of my music friends also happen to be my counsel, Ed (Intellectual Property) and Dave (Corporate and Securities Law). How lucky am I that I actually like my lawyers - and want to spend time with them off the clock?!

Sunday at ACL didn't disappoint, either, as we took in Ben Kweller, Midlake, Bloc Party, Wilco, Ziggy Marley and the Decemberists. Ben was sweet, Midlake cool, Bloc Party rocked, Wilco rolled, Ziggy bopped and the Decemberists grooved. It was a fitting end to a spectacular few days. I could get all critical of the artists but that's not what this post is about. It is about the experience of being at ACL. An experience I highly recommend you take in one of these years.