Citigroup's Model for Risk Management: LTCM?

I had to chuckle when I was pointed to the Financial Times article on Citigroup's new senior risk management hires. As luck would have it, one of the big new hires mentioned was a founding partner of LTCM:

Vikram Pandit, Citigroup's chief executive, has taken another step to stamp his authority on the financial services group by picking a close ally as the company’s new chief risk officer.

The appointment of Brian Leach to replace Jorge Bermudez, a Citigroup veteran who held the position for only three months, underlined the company’s desire to overhaul its risk management practices after suffering $20bn of mortgage-related writedowns.

Citigroup also announced the appointment of three other executives, including Greg Hawkins, a fixed income specialist who was one of the founders of Long-Term Capital Management, to bolster risk controls across the group.

Am I alone in seeing the irony here? I guess one could argue that the experience of having done something so badly in the past creates lessons and learning for the future, and let's hope that's the case. But man oh man, my "blink" response to such an announcement is: are you kidding me? LTCM and risk management? Isn't that kind of like "jumbo shrimp" and "army intelligence?"

And one other point; is it really best to hire an old friend as your new risk manager? Isn't this the kind of position where you'd like to see true checks-and-balances, without the burden of history and legacy clouding the discussion? Personally that's what I'd like to see but hey, I'm not running a trillion-dollar financial services behemoth, either. But the point still remains, risk manager is a role that should be as independent from the CEO as possible; in fact, one could argue that the position should report to either the Board Chairman (who shouldn't be the CEO to begin with) or a Risk Committee of the Board. And Jamie Dimon, CEO of JP Morgan Chase, perhaps had the most telling quote in the FT article:

“It is not risk managers’ job. It is the boss’ job to manage risk,” Mr Dimon told a meeting of Wall Street analysts on Wednesday.

It is comments like this that make me love Jamie Dimon's leadership. Of course he's absolutely right. Risk management should be providing the fodder for management decision-making, not making the decisions themselves. Ultimate accountability has to reside with the CEO as it relates to running the business, and the key drivers of performance in a financial services firm are capital allocation and risk management. Mr. Dimon clearly gets the joke. Whether his other Wall Street brethren take this to heart remains to be seen.

Hat tip: Yaser Anwar

Learning from Scoble - Optimizing Attention

If there is one thing I am, it's overstimulated. Too many activities. Too many obligations. Too many e-mail. Too many social networks. Huge emphasis on my wife and two boys; coaching, playing, living, loving. Which leaves time for - recovery, maybe. Something has got to give. I love to read; I don't read enough. I love to write; I don't write enough. I love art; I don't see enough of that, either. I love meeting interesting people; I do some of that but would enjoy spending more time with really cool people I can learn from. Bottom line: my attention is very broadly scattered and I hold it all together (most of the time), but I feel like I should be happier and more satisfied given my tremendous effort in all areas.

I recently read a post by Robert Scoble that made me feel both crappy and hopeful; crappy because he is so much more evolved than I am and hopeful because he provided some concrete ideas for improving my lot. His post, aptly titled Attention thieves; keeping you from living a "FOOCamp life?", really struck a chord with me having just returned from Foo Camp myself. So, what is a FOOCamp life to Mr. Scoble?

I’d live a FOOCamp Life and have an interesting conversation every day, just like the one I had at FOOCamp that Friday evening at about midnight with my son and a bunch of interesting technologists.

What I get from this is that Robert wants to preserve an environment of lifelong learning, of constantly meeting and making the time to speak with bright, insightful people, and enriching both himself and his readers in the process. Good stuff. And what was it about FOOCamp that fostered this desire to live a FOOCamp life?

How did FOOCamp create that need? ...Soon an executive from AT&T walked in. Then Yossi Vardi did (his kids started ICQ). Then Linda Stone walked in (she gave me some heck for working for Microsoft which struck me as odd at the time since she was a former executive at both Apple and Microsoft). Then the two guys who started Google walked in. Then Tim O’Reilly himself walked in. That was the beginning of my FOOCamp experience and it only got better from there.

This is exactly the way I felt when I was at FOOCamp. Fascinating people at every turn, people with a host of different academic backgrounds, perspectives and experiences than my own. Intellectual nirvana, basically, with a fun, social twist. Though my brain hurt by the end, I didn't want it to end. After a decent sleep and a shower I could have certainly done another day with a small group of people, really digging in to topics of mutual interest without it being quite so overwhelming. Kind of like what Scoble is now doing in his every day life. So finally, Robert asks the salient questions:

What gets your attention off of your life goals? Or, in my case, keeping me from living a FOOCamp Life? For me, this post was conceived because I started up MSN Messenger and instantly got distracted by several conversations with my friends.

So, what is distracting you from your goals?

Twitter? Facebook? Email? An RSS Reader? World of Warcraft? Flickr? Phone calls? TV?

How do you manage attention? Er, how do you manage your attention thieves?

Right now I manage the attention thieves like garbage. I put out the milk and cookies and practically invite them to attack. I react to every buzz of my Blackberry. I hate getting behind in my email. I like to check Facebook and make sure I am keeping up. I recently started playing with Twitter because I was feeling like a loser for not engaging with what has become such a popular and ubiquitous communication medium (at least within my circles). I invest a lot but have done so as a lone ranger, which has taken a lot of time (when you consider the size of my portfolio and the degree to which I am active with some of my companies). Oh, and I've been working on a stupid house renovation for nearly three years that may well have taken a year off my life. All of these things tax me greatly. Could I do it better, prioritize in a much more brutal way and simply opt out of a bunch of current media? Sure. And I am going to give it a good think. Because I ponder Robert's priorities and the changes he's made and I am envious. Attention thieves pervade my very existence. I need to take back my attention. Now.

Wall Street Compensation: Issues, Structure and Accountability

I have touched on the compensation issue before, but largely when it comes to trading. My basic rule is: pay on the basis of realized gains and unrealized gains only on the most liquid instruments. The balance needs to be deferred until realization. William Cohan, the former Lazard and JP Morgan M&A banker and writer, has taken a somewhat broader swipe and Wall Street compensation practices in general in his recent Comment column in the Financial Times.

It is no exaggeration to lay the blame for the financial crisis and a host of others - among them, the internet bubble (1999) and the telecommunications bust (2001) - on Wall Street's compensation system. Ignoring that somewhere between 50 and 60 cents in every dollar of revenue that Wall Street receives is paid out in compensating its employees, is it any wonder that when you reward bankers with absurd sums to generate innovative securities - collateralised debt obligations or mortgage-backed securities - they react the same as one of Pavlov's dogs? Or, since mergers and acquisitions bankers get paid and promoted only if deals close, is there any surprise that their agenda is to push deals to close, not to offer unbiased advice?

Whoa, Billy, slow down a bit. Firstly, I think lumping banking (M&A), structuring and trading compensation regimes into one fungible blob is a big mistake. The cultures are different, the characters are different, and the basis on which people get paid are different. M&A fees are generally a function of deal size and deal completion. Structuring professionals sitting on the trading floor (CDOs, MBS', etc.) get paid on the basis of deals originated and sold. Traders get paid on the basis of P&L, which is highly dependent upon firm-specific policies (as it relates to percentage payout, hold-backs for illiquidity, reserve policy, etc.). I clearly agree with you that as it relates to banking and structuring, deal volume is the principal driver of compensation. But while you are correct in identifying the motives, the fact that you lay the blame almost entirely at the feet of Wall Street seems pretty unfair to me.

First, consider the sophistication and fiduciary responsibility possessed by most of the consumers of their products. Where are their brains and judgment?  Also, particularly in the realm of creating structured, liquid assets from a pool of illiquid securities, you don't touch on the market benefits generated by the re-allocation of risk to those best able to bear it. This doesn't mean that investors don't make dumb decisions, but it does mean that it isn't Wall Street's fault that the matches they provide aren't simply used to light the stove but to burn down the house. And what about the rating agencies? They threw gas on the fire, to be sure. The were one of the great enablers of the debt bubble, placing their imprimatur on instruments that they didn't fully understand. Again, the investors bear much of the blame for simply relying on the rating agencies but the work performed by those agencies was clearly shoddy, inadequate and presumptive.

These perverse incentives are exacerbated by Wall Street's lack of accountability. Huge bonuses are deposited and consumed long before the bad deals that generated them can slam investors. If Bruce Wasserstein's "dare to be great" advice to Robert Campeau in the late 1980s on his acquisitions of Allied Stores and Federated Department Stores ended up being more than a little off the mark, should Mr Wasserstein be held responsible? Or are bondholders, shareholders and employees left to bear the brunt of bad advice?

If shareholders and bondholders were willing to finance and support guys like Robert Campeau and Robert Holmes a Court, they deserved their fate. Bruce Wasserstein isn't some kind of Svengali, hypnotizing investors in an effort to do grandiose and irrational things. In the late 1980s he frequently told a story, sold it, people bought it, and they lost. Yes, the 1980s was a crazy period and some of those raiders that were backed and the yarns that were spun were a joke, but the biggest deals of recent times have had a distinctly different character. TIme Warner/AOL? Was that the advisers fault? Give me a break. In fact, AOL's advisers should have gotten a bonus for turning vapor into valuable, real media assets. Time Warner's advisers or, more specifically, Time Warner's board? Well... It is completely sour apples. Mr. Cohen knows this.

What is a remedy for this vicious cycle? At the risk of seeming disingenuous, since I benefited from this system for 17 years, I propose an extreme makeover for compensation. M&A advisers should be paid by the hour for their advice, just as their well-paid deal colleagues in the legal and accounting professions. This would rein in unnecessarily massive M&A fees and return to the days of unbiased advice. Changing compensation for bankers who innovate and sell financing is harder but must include a way to hold back a large percentage of the pay until - and when - the success of the product can be determined over time. It is evident that the excess that led to the sub-prime crisis was not worthy of reward.

Ah, here is where things get interesting. His proposal for M&A bankers, while theoretically interesting, is a non-starter. Not because his idea doesn't have theoretical appeal, but culturally I just don't see this happening. What could be done, however, is to integrate Mr. Cohen's proposal with a success-based fee, where a retainer/hourly fee arrangement could be put into place that is not reliant upon success, and then for the success fee to be a small amount than it is today. This would do a better job of aligning motives while still providing the banker's upside in the event that their best ideas get done. It is this incentive that will cause bankers to continue to think creatively about M&A opportunities, not just about mega-transactions but about strategic, fill-in acquisitions and divestitures that are value-accretive for their clients. I think this is a pretty good prescriptive that might actually work in the real world.

As it relates to the structuring professionals, I think the real issue comes down to illiquidity/residual risk of the securities designed and sold. From the standpoint of a bank's shareholders, the "success" of a product is its sale without recourse. The problem is that with much of the structured paper that was designed and sold in the mortgage space, banks found that they needed to retain a measure of exposure either through holding the junior tranches or through the possibility of off-balance sheet assets coming back on books in SIV structures. And, of course, both of these residual risks turned out to bite the banks - and hard. Therefore, in my illiquidity/residual risk framework those structurers and salespeople should have received sharply discounted bonuses until those pools paid out, or the residual risks were disposed of. This would have created the proper alignment of interests between employees and shareholders, an alignment that has not heretofore existed on Wall Street. So in the final analysis I pretty much agree with Mr. Cohan on this point as well.

I really appreciate Mr. Cohan tossing out some "radical" ideas for solving the mis-alignment problem of Wall Street compensation. I just wish he'd taken a broader view of roles and responsibilities in today's  market crisis and not simply tarred Wall Street as is so popular today. Because the story is far more textured and nuanced than that.

Subprime Value Destruction in a Nutshell

I don't know if you've seen this, but a friend of mine from LA recently emailed it to me:

Download explanation_of_sub_prime_issue.pps

Every once in awhile you get something that says it all with a few pictures and words, and this pretty much encapsulates a host of complex issues without a whole lot of verbiage. Lots of culpability to go around, and this little slide show calls out the salient players. I hope you like it. I know I did.

Microsoft: Your Potential is Exponential. So Why the Problems?

I've been bashing Microsoft for some time now. But I'm not sure if I've necessarily been fair or clear in my criticism. I take issue with a whole host of the company's strategic pursuits, financial decisions and the like, and I believe every single word I've written in my time as a blogger. At the corporate level, I think that Microsoft has made some tremendous blunders and continues to make countless errors of historic proportions. That said, Microsoft is filled with some of the brightest, most insightful, most forward-looking professionals I've ever met, so many that it is almost mind-boggling. A bunch of these people were my fellow campers at CI Foo, and I couldn't have been more impressed. These are people that, if given a chance, could give Yahoo, Google or anyone else a run for their money. They are on the bleeding edge, but the edge where there is money, not just science for science's sake. So what does this mean?

I'd say it is a good news/bad news story for Microsoft shareholders. The good news is that some of the human capital at Microsoft is likely among the best on the planet, and doesn't seem overly discouraged by the crazy stuff going on at corporate. If allowed to flourish, who knows how competitive this company could become. The bad, however, is that the decision-making process currently employed in Redmond has and is continuing to lead to simply awful strategic decisions on an increasingly large scale. The company is clearly trying to squander cash as quickly as it is making it, which is not the best formula for building shareholder value. So given this state of affairs, what should Microsoft be doing?

Get a cultural face-lift. As an outsider, I cannot begin to understand how decisions are made. But what I can surmise from the outside is that there has been a consistent string of decisions dating back to the late 1990s that defy logic, and that this is indicative of a systemic issue that desperately needs fixing. "Strategic" investments like AT&T, Comcast and Nextel. $25 billion+ sunk into the Home & Entertainment Division (H&E) over the past five years. Tens of billions in share buybacks at relatively high prices. What are we talking here? $50 billion, $60 billion, $75 billion of foregone shareholder value? Whatever it is the numbers are staggering. Something within the culture near the top of the organization is broken and it needs to be fixed - now. Because there is another $40 billion about to be pushed out the door that is likely better spent in any number of ways. But that I'll leave until later.

Allocate capital on the basis of stand-alone businesses. The character of Microsoft's three major business lines, and even the products within those lines, are very different. For instance, the operating systems business is a cash cow. A cash cow that given the dynamics of the mega-shift from desktop computing to web services, has the cash flow characteristics of an oil well. It has high current cash flow, cash flow that can be sustained and even grown somewhat through the use of technology (akin to using better drill bits, injecting natural gas and water to increase yield in the realm of drilling, but in the case of Microsoft means new releases, function upgrades, etc.), but that ultimately the cash flow will decline and then vanish. This part of Microsoft is far and away the most value on a present value basis. And this is not due to rapid growth. It is due to the magnitude of the fortress they've built in the operating systems world. But this fortress cannot and will not last forever. But in the meantime, they can use the cash from this massive annuity to establish a significant dividend and to fund high-ROI R&D, not the kind of far-flung investing they've done in the past.

What this also means is that they should strongly consider spinning off the Home & Entertainment Division, a business that has cost an enormous amount of money with a highly uncertain, long-shot payoff. That said, it has some strong brands and some solid technology. It just has never had to operate with the discipline of a real business since its losses are covered by corporate's seemingly boundless largesse. It is time for the young adult to move out and live as an independent being. This would likely have several positive effects for Microsoft's shareholders: (1) stopping the flow of cash that should be going into your pocket from subsidizing additional H&E losses; (2) providing you with ownership of a potentially high-growth business that is better able to attract talent and flourish due to its independence from Microsoft; and (3) offering you the chance to sell your ownership in the H&E business if you simply think it sucks and you don't want to play the gaming game any more. As a Microsoft shareholder, 1-3 are looking pretty good to me.

Invest in Live. For life. This is the bet to made given Microsoft's competencies and core franchise. Given the IP within Microsoft and their 30+ years of experience with desktop computing, they should be able to make a run at owning the web-services fueled computing environment. Ultimately, Microsoft is going to have to do to themselves what the market will ultimately do to them - kill their desktop franchise. But by then, they should be able to do the present value calculation of foregone annuity earnings from the desktop franchise versus the increase in breadth and long-term growth of a massive, ubiquitous web services offering. I'm not saying do this tomorrow, but senior management needs to acknowledge that this is where things are going. This is a big cultural shift for the company, but given the talent and IP already resident within Live they've go the raw materials to make this happen. I would much rather see corporate invest an incremental $5 billion in Live than as a down payment for Yahoo or some other stupid acquisition. If you want organic growth, invest in the areas you really understand. H&E? Give me a break.

This post is in direct response to my epiphany that as much as I've beaten up Microsoft, it is still one of the world's leading talent magnets. They've got it right in front of them. They just need to reach out and grab it. If they've got the vision, the stomach and the will necessary to make the cultural changes necessary to let it happen.

CI Foo - Day 2

Let me preface this post by saying that I'm fried. Having so many and such intense conversations over a two day period, overlaid with jet lag, leaves one feeling like a dishrag. That said, CI Foo was a huge success as far as I'm concerned and I got so much out of meeting so many bright, insightful people willing to share. Hopefully I was able to hold up my end of the bargain.

930am - sat in on a session discussing "bad actors" among the collective, i.e., those who put up false reviews, try to game the system, etc. Preston McAfee of Yahoo (on loan from Caltech) steered the bus for this discussion, but was heavily supported by John Riedel of University of Minnesota. Using Amazon as a benchmark, we talked about large vs. small comment forums and the likelihood and ability to game the system. The group pretty much determined that the "gaming the system function" is like a hump, with small sites and large sites less impacted by bad actors than those in between. Why? Because sheer numbers make large sites with large amounts of comments like Amazon hard to taint, while small, niche sites aren't often the focus of bad actors. Those in the middle, however, are clearly vulnerable.

10am - Dave McClure's big ideas around the concept of "securitizing happiness." In essence, Dave's goal is to try and use financial innovation as a vehicle for helping several under-served constituencies: lower-income individuals and families (to get better care in order to live longer, healthier, more productive lives); small businesses (to gain easier access to growth capital, akin to the role played by FNMA in mortgage lending) and others. While I'm not sure that some of his financial approaches are necessarily the right ones to address the issues, he is focused on critical issues that warrant additional brainstorming. And I am pleased to help him think through his noble mission.

11am - Identity, Ontology and Fraternite in the context of Wikipedia, facilitated by two smart dudes from Metaweb, Robert Cook and Kurt Bollacker and another smart dude, John Riedel (who was extremely active in countless sessions). After gaining a better understanding of the structure of Wikipedia and the underlying editorial process, we discussed the profiles and statistics of key contributors as well as bad actors and their impact on the overall corpus of data. Bottom line, the numbers are pretty small but rising. It gave me a much keener understanding of Wikipedia, its construction and the issues surrounding its growth and maintenance.

130pm - Prediction markets and elections, run by Eric Zitzewitz of Dartmouth. Eric ran though a slew of data looking at sports and financial prediction markets and compared it to election prediction markets. Bottom line, sports and financial prediction markets are highly efficient and closely track actual outcomes, while election prediction markets tend to systematically underprice favorites. This is the way it is in the US. In the UK, where election prediction markets have existed for over a century, they are much more efficient. Two explanations for the US election markets' relative inefficiency are low repetition vs. high repetition domains (sports and financials have large numbers of contests while elections have far fewer contexts), and that bettors in the US have far less collective experience betting on elections than their UK counterparts. Interesting stuff.

130pm - Modeling surprises by Eric Horvitz of Microsoft Research. I only caught the tail end of Eric's talk but from what we discussed following his presentation I was incredibly excited. I am all about understanding tail risk and also its converse, identifying tail opportunities. I will follow up with Eric in our post-Foo lives. This is one of the great things about Foo - you meet people whom you likely never would have met any other way.

Here is a smattering of other issues that were raised during CI Foo:

• Distributing big tasks among many
• Economies of scale in knowledge
• Parallel vs. aggregate knowledge
• Scale - need taxonomy, time and # of people
• Create an ontology of classes of CI problems
• Connecting opposite ends of the CI continuum - top down/bottom up and implicit vs. explicit
• Collective intelligence vs. collective will
• Reputation
• One person's implicit data is another person's explicit data
• Topology of community members
• Active vs. passive collective intelligence
• Mere parallelism vs. network effects in data

Cool stuff, no? In any event, it was a great few days and I've got to thank all of my fellow Foo campers for making this such an enriching experience. I know I always come out of these Silicon Valley, tech-heavy conclaves sounding like a stupid, fawning idiot, but I get so little exposure to these kinds of communities I am always amazed by the brainpower, the collaboration and culture of sharing and idea exchange. You take a New York boy, a Wall Streeter no less, stick him in Silicon Valley and if he loves technology, big ideas and deep thoughts his eyes will bug out. Like mine. Guilty as charged. Almost makes me want to work in the Valley or in Redmond. Almost.

Update:

1. See Greg Linden's post
2. See Matthew Hurst's post

Yahoo vs. Its Investors: Let the Litigation Begin

It is really hard being right, but someone has to do it. Now we see that some Yahoo shareholders are getting really pissed off with the Board and simply aren't going to take it any more. This from the AP via Yahoo News:

                        DOVER, Del. - Two Detroit pension funds have sued Yahoo Inc. and its board of directors, saying they breached their duties to shareholders in trying to thwart a takeover by Microsoft Corp.

The lawsuit was filed in Delaware Chancery Court on Thursday by lawyers representing Detroit's police and fire retirement system and general retirement system, as well as "all other similarly situated public shareholders."

According to the lawsuit, Yahoo's board is pursuing "value-destructive" third-party deals in an effort to fight off Redmond, Wash.-based Microsoft, which on Feb. 1 announced a takeover bid of $31 per share in cash and stock, a 62 percent premium over Yahoo's previous day's closing price.

********************

"Yahoo's directors cannot 'just say no' indefinitely to legitimate acquisition offers," the lawsuit reads. "Likewise, Yahoo's directors cannot pursue transactions that do not require shareholder approval for the primary purpose of making Yahoo unattractive to Microsoft."

********************

"An imminent proxy fight necessitates judicial intervention since it poses a deadline for Yahoo's board to place shares in friendly hands," according to the plaintiffs, who allege that Yahoo board members have placed "personal distaste for Microsoft" ahead of shareholder welfare.

"Regardless of their emotional ties to Yahoo and their desire to retain their positions as directors at the company, the Yahoo directors owe fiduciary duties to Yahoo and its shareholders," the lawsuit states.

If this isn't a wake-up call to Yahoo's Board and its advisers I don't know what is. The writing is on the wall, guys. You'd better have some serious cards up your sleeve, arrows in your quiver of whatever other hackneyed phrase you'd like to roll out, because time is running short. Being labeled as un-shareholder friendly and obstructionist isn't the best thing for your company or your careers, so get off the stick and take some decisive steps. Because maybe, just maybe, if you embrace Microsoft you might be able to squeeze a little more value out of the deal. But each day that goes by without this insight will cost both you. Big time.

Ad Inventory: Separating the Theoretical from the Monetizable

Disclaimer #1: I'm not an online ad expert. Disclaimer #2: I'm not an online ad expert. That said, I'm not a dummy, either, and do have a direct view into the area through my investment in Buddy Media. And I am also an active Facebook user, blogger and blog consumer, so I think I get the big picture. And what mystifies me about the big picture is this: why are so many so amped up about things like downloads (applications) and users (Facebook) without a clear discussion of their ability to be monetized?

I mean, I know people are aware that at some point, far far away, such things (apps and social networks themselves) will need to generate revenue bearing some relationship to their (astounding) valuations (Slide at $500mm pre and Facebook at 30x that - nice), but what is observe is an over-focus on the headline numbers (downloads and users, and therefore theoretical "inventory" for advertising) and an under-focus on what inventory is, shall we say, real. And as an investor and as a pragmatist I truly don't get it.

Isn't the point of investing in social networks and application development firms to make money? And if this is the case, and given the valuations we've seen, what are the metrics being used to justify such enormous numbers? I'd gather that the analysis revolves around a calculation of theoretical ad inventory, which is then subject to a massive discount for converting that into a number that is truly monetizable. But how? What are the metrics being used? Because I haven't heard or read anything that bridges the gap for me between the headline inventory number and the real inventory number. And as an investor in such things I really, really want to know.

Buddy Media's business model is different, in its young life is already generating very healthy revenues (so much greater than we could ever have imagined, in fact) and has built brand and reputation for a company focused on monetizing inventory, not simply creating it. But that is not the point. The point is that I see what appears to be a lack of investing discipline of things in and around social networks. And as bullish as I am on the early-stage investment space in general, this is an area ripe for some fresh thinking.

CI Foo - Day 1

Being at CI Foo is a kind of an out-of-body experience for me. As a "Wall Street guy," my experiences, my mind-set and my DNA is a world away from most of these dudes. That said, given my experiences as an entrepreneur and as an investor over the past 3.5 years, I am in tune with the pulse of the conversation. It just feels odd being part of it and contributing. But I am and it is very, very cool. It is always a thrill being around so many super smart people whose intelligence is so different than mine. I love filling in gaps in my knowledge by being near people who are smarter than me. And there are plenty of those people here at CI Foo.

I sat in on three sessions today, presented at one, got to spend some quality friend with my friend Paul Kedrosky and had numerous conversations with people from Google, Microsoft, Yahoo, Amazon, MIT, Carnegie-Mellon and other equally impressive institutions of commerce and higher learning. Being at Google is cool as well. Larry Page stopped by to say hi and the environment at Google Ground Zero is simply terrific. One of the amazing things about being in such a setting is that people are very disclosing, far more disclosing than they'd be in "normal" life. And it is particularly impressive that top professionals from Microsoft, Yahoo and News Corp. can co-exist at this conference, participate in conversations, grab a beer, hang out, etc., without any strange feelings arising from the goings-on in M&A land. It is a tribute to Tim O'Reilly and his team for creating an environment for sharing, openness and safety. This is how great ideas are exchanged and foundations laid for future work. It is so different than Wall Street. It truly blows my mind.

10am - participated in a session led by Gary Flake of Microsoft Live Labs on the topic of editorial gatekeepers at the head-end of the distribution vs. long-tail recommenders, their dynamics and movement across the distribution. Paul Gould of Fox Interactive, Joshua Schachter of Yahoo, Dave McClure of 500 Hats and Paul Resnick of University of Michigan were all key participants in the discussion. Peter Bloom of General Atlantic, one of my Wall Street-to-venture investor heroes also shared his incredibly valuable two cents. We spent a lot of time discussing issues of reputation and how reputation is established, how to reduce transaction costs associated with reputation and how to quantify subjective/fuzzy recommendations. Search, music and job boards were all used as examples to tease out the ability of long-tail media and services to move towards the head end. I wouldn't say that the group emerged with any definitive conclusions, but he discussion was spirited and fascinating.

130pm - gave a presentation on Making Money from Collective Intelligence (CI). I dove into the issue of expert networks and proposed a third way of making money from CI (with prediction markets and conventional expert networks being the first two). I will work to put my slides up sometime soon. I was followed by Dave Leinweber of the Haas School of Business at Berkeley and Rob Passarella of Bear Stearns, with Dave speaking about applications of computational finance to different data sets and Rob proposing a model for making money from alternative data. Mike Kearns of University of Pennsylvania and Bank of America and Peter Bloom both had interesting perspectives on the issues. Mike, who is a brilliant guy and a hard-core quant focused on machine-learning and automated processes for parsing news, found our bottoms-up, research-oriented approach anathema to his data-heavy, readily quantifiable model. We agreed to disagree on the value of context-specific, non-quant data. I personally think both approaches can generate alpha; they just reflect two different ways of managing money. It was fun to so actively contribute to a discussion. I felt like I was now beginning to pull my weight as a CI Foo participant.

330pm - sat in on a session chaired by Paul Martino of Aggregate Knowledge. We spent most of our time discussing which data sets are most predictive, as well as the relative value of explicit versus implicit data. Super interesting, highly cerebral yet very pragmatic discussion. Andreas Weigand of Stanford/Berkeley/INSEAD, Peter Norvig of Google and Eric Zitzewitz of Dartmouth were big contributors to this dialog. There was a big battle as to whether explicit data was tainted due to Heisenberg's Uncertainty Principle and therefore less predictive than implicit data, or if the diversity of perspectives offered by explicit data far outweighed its potential corruption. I think the group ultimately agreed that both implicit and explicit data are extremely valuable and have their place, and that it is difficult to put the value of one above the other without the benefit of context.

5pm - participated in a discussion run by Paul Resnick of Michigan on the application of CI to solve big social problems. Many suggestions were tossed out ranging from collecting more granular data on our health, our diet and our environment in order to data mine and draw conclusions about ways in which people can live better and live longer; to prioritizing needs within communities involving government support; to bringing greater transparency to government. There were far more big thoughts tossed out than I am reflecting here but given my lack of sleep last night it is hard for me to pull anything more out of RAM.

In sum, it is great to be here. I know that I am getting a lot out of my fellow campers and the discussions we are having. I hope they feel similarly. I will report back after Day 2. It should prove to be a barn-burner!

Some More Thoughts on Collective Intelligence

To me the whole social networks "thing" is massively overblown. It is kind of like saying "xxx.com" in the late 1990s that drove valuations to absurd heights. Today calling something either a play on social networks or a social network itself seems to elicit the same frenzied response. And it is totally missing the point.

Here are a few more thoughts I've had on the topic of Collective Intelligence (CI):

• CI is not a function of who you know, but what you know.

• It is particularly potent within vertical communities, where experts and influencers rise to the top and help shape the CI of that community.

• It is often markedly different than simply the sum of a pool of autonomous actors; it takes into account the reflexive relationship among members of the community that helps shape opinion and, therefore, CI.

• It is important to differentiate between objective and subjective questions. Where the matter is factual, having access to a large pool of potential experts is valuable for getting the correct answer. Where the matter is subjective, there is no right answer and the community's CI will be driven by a handful of thought-leaders and influencers who are able to shape the dialog.

• Bonds within social networks are not nearly as impactful on CI as implied bonds with experts and thought-leaders. While these bonds are devoid of a social element, they are based on tastes, preferences and authority, not simply friendship.

• Prediction markets are an incredibly valuable and useful tool for determining group opinion. However, this is only one facet of CI that needs to be explored as part of a more comprehensive discussion of the topic.

I've got to run to catch a plane but I am eager to spend more time thinking about these and other ideas.

Collective Intelligence: Going Deep

Collective Intelligence (CI). Hmmm. It is a concept oft-bandied about but I'm not really sure what it means. According to my first-stop reference resource of choice, Wikipedia, it says the following:

Collective intelligence is a form of intelligence that emerges from the collaboration and competition of many individuals. Collective intelligence appears in a wide variety of forms of consensus decision making in bacteria, animals, humans, and computers. The study of collective intelligence may properly be considered a subfield of sociology, of business, of computer science, and of mass behavior — a field that studies collective behavior from the level of quarks to the level of bacterial, plant, animal, and human societies.

My desire to develop a more concrete understanding of CI is the direct result of being invited to attend CI Foo Camp at Googleplex tomorrow through Saturday. Pretty cool. After looking at the list of attendees, I truly feel like a pretender in their midst. That said, I'll do my best to contribute to the proceedings. Per the CI Foo Wiki, here is their operating definition of CI:

While "collective intelligence" can be defined quite broadly, we're using it to describe instances of networked computers and humans working together to solve interesting problems.CI Foo attendees are working on various projects and products that leverage collective intelligence.

If you look at the tag clouds relating to topics of interest, topics people want to hear about and topics to which people can contribute, the big winner in each of the three categories is "prediction markets." That's fine, I get it. But to me there is a big piece missing, a piece I think about all the time: how does influence ripple across social networks? Because I don't personally conceive of CI as akin to "wisdom of the crowds," where in effect CI is simply an extension of polling. This is part of it. But where does the wisdom come from? Does it simply spring forth from a large number of autonomous entities operating in a vacuum and expressing their own opinions? Or are there influences that play upon people before they vote, before they act with their feet or their wallet? Clearly it is the latter; this is akin to comparing microeconomics to macroeconomics, where one field is predicated upon a raft of simplifying assumptions (the "rational man") while the other seeks to understand the larger world for what it is - complex, interdependent and ever-changing.

Going into CI Foo my operating thesis is that collective intelligence is a direct result of a smaller number of influencers that help catalyze the dialog, around which discussion and debate takes place that eventually yields a collective and reflective result. But the difference between groupthink and my conception of CI is that the influencers change all the time depending upon the topic, the context, the timing and their network status (or reputation), and that the topics get thoroughly debated, tested and argued within and across communities. And this is the way it should be.

So one of my goals is to really dig into this area and to further gel my thoughts around expert networks, how they can best be built and operated for fun and profit. Gerson Lehrman has had it going for quite some time. LinkedIn is on the cusp of leveraging their millions of nodes to a similar end. But even with these two behemoths going at it my sense is that there is much, much more to be done. I will bounce some ideas around with my brilliant and erudite co-campers this weekend and report back next week.

Microsoft Launching a Proxy Fight for Yahoo? Really?

The Big Duh

Come on, folks. This is no big surprise as yours truly has blathered on about, quite accurately, I might add. But let me be clear: just because the tactics are right doesn't mean the deal makes sense. In fact, I think the deal stinks as a strategic matter (technology integration risk, culture risk, etc.) - but who am I to criticize the great minds involved in such a ground-breaking (as in being buried) transaction? But that is besides the point, or my point, at least, which revolves around how to handle M&A situations like the one we have here.

Proxy Fight: Getting Goaded, Getting Serious

So, Microsoft was essentially goaded into a proxy context due to Yahoo management's lack of shareholder focus and intransigence. Now this is not the way one generally wants to run a people-centric technology acquisition, but Microsoft clearly believes that it can financially compensate key Yahoo! personnel such that the huge attrition that will invariably take place won't damage the core strategic rationale for the deal. And given that each additional dollar of acquisition compensation costs Microsoft $1.4 billion, getting hostile, paying for the proxy fight and showering riches over a select group of key personnel will be a far cheaper exercise than giving in to Bill Miller's bluster and Yahoo's advisors' hopes that Microsoft will jack the price by $2-$4 per share. Nice to see Microsoft being so fiscally responsible - thus far.

Fairness Opinions: What's Fair About Them?

Yahoo's advisors' have issued an opinion to Yahoo's Board that the current offer simply isn't fair. Really? Just like so many issues of late, this one is fraught with conflicts of interest. Consider this well-reasoned extract from the Deal Professor:

The highly subjective nature of valuations rears its head most acutely with fairness opinions. A fairness opinion is an opinion typically provided by an investment bank to an acquisition target that the price being paid by an acquirer is fair from a financial perspective. The opinion is often prepared using the valuation techniques above.

But investment banks are usually under pressure from their clients to come to the “right” answer on fairness. Moreover, investment banks are often conflicted in providing theses opinions, because their compensation is often contingent upon completion of a transaction (and, by extension, their finding of fairness) or they may want to preserve a future stream of business. The subjectivity of valuation and the conflicted nature of banks makes the process vulnerable to manipulation to arrive at fairness.

It has been and will likely always be this way. A(n) (un)fairness opinion is a cloak behind which countless Boards have hidden, either as support for completing a deal that isn't necessarily the best for shareholders or for turning down a deal that is in the best interests of shareholders. What we all should keep in mind here is that the fairness opinion issued to the Yahoo Board is worth about as much as the paper it is written on. Crumple it up, start again and you, too, can come up with just about any value you want to justify.

The Bottom Line: Hang Tough, Mr. Softee

If for no other reason than to show how shoddy governance practices and weak shareholder advocacy will not stand, Microsoft should stand firm to its current $31 offer and ram it through with the help of a good proxy solicitor and a world-class PR campaign (one that is better than that for many of its products, hopefully). It will be a boon to shareholder rights' advocates everywhere. They have put a fair offer on the table. No other competing transaction comes close (Yahoo and News Corp. - give me a break). The "just say no" defense doesn't work here because of countless and persistent management miscues and no plan. If Microsoft goes away Yahoo stock will plummet like a stone, causing lawsuits to come out of the woodwork like you would not believe. Get it done, Steve. Take no prisoners. This is what you're good at. Like your other Pacific Northwest friends, Just Do It.

Bond Insurer Break-up vs. Super SIV - Beware Unintended Consequences

All this talk of a government-driven break-up of bond insurers into their municipal and non-municipal (read: structured mortgage securities) components leaves me scratching my head. Why are so few calling bullsh*t on New York State insurance superintendent Mr. Dinallo and his strong-armed tactics? This is not the government urging a solution, this is more akin to the government holding a gun to the head of bond insurers and saying "Restructure - or else..." And it is just not that simple due to the complex webs of financing arrangements among the bond insurers, the banks and the buyers and sellers of credit protection on both the firms themselves and the securities they've backed. His actions may well have unintended consequences that far exceed any benefits that might be created, largely by calming down issuers of and investors in municipal debt obligations.

But given the low historical default rates on such paper, are all of these financial machinations really worthwhile? There is much data to argue that the municipal bond insurance industry shouldn't exist to begin with, given these default rates. If municipalities have to issue at slightly higher rates in the absence of insurance, isn't this a cleaner long-run way to fund itself? As we all know buying insurance is an NPV-negative enterprise for the buyer; all is is really doing is taking unwanted "tail risk" off the table. But can't we withstand a few defaults in order to strip the friction of insurance out of the industry? All this money paid out to bond insurers over the last 30 years is largely a tax on issuing bonds that don't really need the enhancement to begin with. So what's all the fuss?

While the discussion around the a good bank/bad bank approach to the structured investment vehicle (SIV) problem of the banks was largely negative, it was a far more straight-forward, market-driven solution to a difficult problem than Mr. Dinallo's urgings. And as the Super-SIV approach became more real, the banks decided to take care of the problem themselves. A win/win without paying the frictional costs of establishing such a structure. Mr. Dinallo's solution would be maximally disruptive for a minimum of benefits. Maybe I'm just missing it.

But I can see the government-driven bond insurance restructuring program getting mired in a protracted court battle among entrenched interests on all sides. But instead of simply reporting on the bond insurance industry break-up I'd like to see some more critical analysis of its cost and benefits. Because taking this step is a big deal and sets a very worrisome precedent. There is urging and facilitation and then there is coercion, and Mr. Dinallo's steps are falling dangerously close to the latter.

Keep Investing Simple: A Reminder from One of the Greatest

Keeping it simple. Building a diversified portfolio of low-cost investment vehicles like index funds and ETFs. Staying cool in the face of market turmoil by sticking to long-term asset allocation and re-balancing as necessary. Avoiding the urge to try and out-smart increasingly complex and competitive markets. These are the mantras about which I've written since first becoming a blogger, particularly with respect to retail investors that lack the resources, time and know-how to prudently invest in individual securities. Some have other mantras, like chasing the hot stock of the day (read: Jim Cramer), which to me have always created a sense of false confidence in the hearts and minds of many retail investors. So I was quite happy to see one of the greatest long-term investors chime in at a time of awful market conditions to remind us all what really matters: keeping it simple, keeping costs low, staying diversified, staying focused. The investor: David Swensen.

From today's New York Times:

Don’t try anything fancy. Stick to a simple diversified portfolio, keep your costs down and rebalance periodically to keep your asset allocations in line with your long-term goals. That is the advice of David F. Swensen, who has run the Yale endowment since 1988, relying on a complex strategy that includes investments in hedge funds and other esoteric vehicles. The endowment earned 28 percent in its last fiscal year, which ended June 30, beating all other endowments. It finished the year with $22.5 billion.

For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.

Don’t be distracted by market forecasts, he said. “You have to diversify against the collective ignorance,” he said. “I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.”

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“The only people who should get involved are sophisticated individuals who have significant resources and a highly qualified investment staff,” Mr. Swensen said.

“Most people do not have the resources and time to pick market-beating managers” of hedge funds, private equity funds or funds of funds, he said. And he said that the techniques used by hedge funds often result in higher taxes than those of index funds.

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He says it is fruitless for individual investors to pick stocks. “There is no way that an individual can go out there and compete with all these highly qualified and compensated professionals,” Mr. Swensen said.

HE criticized the approach of Jim Cramer, the CNBC host, who encourages investors to trade stocks in strategies that Mr. Swensen says cost heavily in commissions and taxes.

********************

Mr. Swensen says investors should forget market timing entirely. Once an individual sets up a program, it should be rebalanced quarterly or semiannually, he said, “but it should be disciplined.”

When the markets decline, try not to pay attention, he said. “Let yourself off the hook,” he said. “If you pursue the sensible long-term policy, look at it over a 5- to 10-year period. Don’t look at five months.”

 

“There is nothing that Cramer says that can help people make intelligent decisions,” Mr. Swensen said. “He takes something that is very serious and turns it into a game. If you want to have fun, go to Disney World.”

This is the way I invest. A 20-year markets professional. It is startling to see the language I've used to describe my thoughts on the topic and Mr. Swensen's: they are almost identical. And needless to say, our thoughts on Mr. Cramer are also completely in sync. The hardest thing about doing what both he and I suggest is plain to understand: humility and ego. Why can't people be more humble about their investing abilities? Why can't they internalize the empirical research that clearly shows why mere mortals are doomed to fail as investors? Why must so many people have to find fun within investing, something which is, I'm sorry, at any time and always a serious business? In any event, if even one person reads this and changes their investment behaviors I'll be happy. Please, please, PLEASE - be careful out there.

News Corp. and Yahoo? Hopefully Not Sovereign Bancorp/Santander All Over Again

This is so typical. Yahoo!, in the absence of any real defense, may be seeking to leap into the arms of a white knight, in this case the mighty News Corporation (NWS). But no, NWS isn't offering $35 a share or even $32 a share for 100% of the stock - apparently the discussions are centering around securing a ~20% stake in Yahoo! partially through monetizing its stake in MySpace, reportedly at almost-Facebookian levels of $6-$10 billion. And then there might be a little cash tossed in by a private equity partner, call it $15 billion. Now it doesn't take a rocket scientist to figure out what's in this for Yahoo! management and NWS: one group of people get to keep their jobs and their "independence" (just like those at the Wall Street Journal - yeah, right), while the other gets access to a behemoth in display advertising and, oh, the ability to mark those MySpace shares to market. Not a bad outcome for a company under siege and a company dying to see its Internet acquisition prowess validated in a concrete way.

But what about Yahoo! shareholders? Is this really the best deal for them? If this deal was so great, and it has been bandied about for some 18 months, why is it now so terrific? Because NWS gets what it wants and Yahoo! management gets to claim victory? Who cares. It's about the shareholders. I am only interested if the REAL value of the deal to Yahoo! shareholders exceeds Microsoft's very real offer of $31 per share. I haven't run one number and clearly a formal NWS/Yahoo! deal hasn't be announced so I'm using gut and judgment, but my guess is that it is hard to get there without some typical pie-in-the-sky assumptions. $31 a share versus - what? Promises, plans, hopes and dreams. If I am Microsoft I am giggling slightly at this turn of events and taking the offer directly to Yahoo! shareholders. Because this sale-of-a-stub to maintain independence garbage has some precedence, with disastrous effects for the target's shareholders.

Anyone remember Sovereign Bancorp vs. Relational Investors, with Banco Santander coming in as a white night? Here is the backdrop from the Business Law Prof Blog in November 2005:

Sovereign Bancorp, the nation’s third largest savings and loan, has been under attack from its biggest shareholder, Relational Investors, since last May.  Relational is upset because it believes Sovereign’s stock is underperforming and blames this on Sovereign’s CEO, Jay Sidhu, and its conflicted board.  Last month, Relational launched a proxy fight to replace two board members.  A few days later, Sovereign announced it was acquiring Independence Community Bank, a regional thrift, for $3.6 billion.  To finance the deal, Sovereign is going to sell Sovereign shares equal to a 19.8% stake to Spanish bank Santander.  The deal will thus dilute down the ownership percentage of current Sovereign shareholders, including Relational, and will make Santander, who is presumed to view current Sovereign management favorably, Sovereign’s biggest shareholder.  Because Sovereign is buying Independence for cash and issuing less than a 20% stake to Santander, Sovereign maintains that no shareholder approval is required.  Relational asserts that Sovereign is overpaying for Independence and that Sovereign’s prime motivation for doing the deal is to thwart Relational.

Bottom line, the Santander deal went through at egregious terms for the acquirer, the shareholder-value champion Relational was snubbed and Sovereign stock was dead money until January 2007, at which point it began a downward march that has left it almost 60% lower nary one year later. This is what I do not want to see happen to Yahoo! shareholders. If NWS gets terms similar to Santander, which sharply curtail Sovereign's ability to sell itself to the highest bidder, Yahoo! will have effectively issued a massive call option to NWS, the value of which accrues to entrenched Yahoo! management (and NWS), certainly not company shareholders. And that would be just plain wrong.

Is this the way it will play out? Hopefully not. What I'd like to see happen from a Yahoo! shareholder perspective is for Microsoft to go hostile and take its offer directly to Yahoo! shareholders. At that point we'll really see where investors think the value lies. Given Yahoo! management's performance and the possibility of a questionable deal (from a valuation perspective) from NWS, are existing investors really going to look Microsoft in the eye and say "no thanks?" No way. Bill Miller is talking tough, but at the end of the day he is a rational man and a fine investor. Were I him I'd have made similar comments to try and get Microsoft to increase their offer. But given Yahoo!'s bumbling of the situation the only way that offer is going higher is out of sheer pity. Because it is the best deal in town, to be sure.

The iEverything Thesis is Playing Out

Convergence is upon us in the device space. It is just happening faster than I expected. Today's awareness of Apple's patent application concerning a "Universal Device" is exactly what I was discussing with Chris Kohler of Wired Game I Life when he penned his article on iPhone and gaming last night. Once we get the hi-def screens of sufficient size in handheld devices, then the patent filed by Apple can really be leveraged into a category-killer set of work, recreational and gaming apps in one tight, integrated, easy-to-use package. This is what Apple does better than anybody. And a link-up with Google is a lightweight, highly flexible way to address the "virtual machines" back-end of the operation.

Needless to say this vision of an uber-device is a ways off - but clearly not as far off as I thought. Better keep an eye on those hi-def screen suppliers; at this point they hold the keys to the kingdom, IMHO.

Congratulations, Microsoft: You've Killed Yahoo! and Strengthened Google

At this point Yahoo! is dead man walking. Let's see - a $31 per share sword of Damocles hanging over their head, losing top employees amidst a sea of disappointment and uncertainty (see Horwitz, Brad) and no real plan except to say "Go away." Not a formula for success. Microsoft itself has opened itself up to a Pandora's Box of uncertainty, from both the perspective of "What are you doing spending $40 billion on Yahoo!" and "Sheesh, what is this going to mean for our culture and my job?" It seems to me that the Yahoo!, Microsoft and Google dynamic can best be characterized by the following metaphor: three brothers, one which is 5-years old, one which is 10 and the oldest that is 15. 5, 10, 15. Yahoo! Microsoft. Google.

Yahoo! is 5. Hippy dippy, Silicon Valley circa 1999 culture, never having made the transition to economic powerhouse like its older brothers. And this free-loving eco-chamber is now coming crashing down in the face of harsh market realities. Advertising share down. Search share down. Transition to a de-facto media company a failure. Now what? A plunging share price has made both employee retention difficult and rendered it a sitting duck for a potential buyer. And now its older brother, the big meanie Microsoft, is beating on it yet again. But this time it is an all-out scrap. The 5-year old is swinging but the long, powerful arms of the 10-year old are keeping it at bay. And this beating is causing a bunch of collateral damage - like losing friends, losing respect and losing its future. The 5-year old has and will continue to suffer badly from this encounter, no matter what happens from this point forward. His only hope for survival is by begging for protection and support from its tormentor, Microsoft.

Microsoft is 10. Graduated to middle school, feeling important, feeling like using some new tricks to impress the older kids. But still somewhat rooted to the past, in this case the heavy, software-based desktop franchise that is still the lifeblood of the company. And while Microsoft is picking on Yahoo! it is getting trounced in the most rapidly-growing markets by its older brother, Google. And it isn't pretty. MSN and Microsoft Live are just shadows of the Google search and advertising empire, and it appears that Microsoft has concluded that to make a run at its mighty brother it needs to impose a reign of terror on its younger brother. But this fight has left the 10-year old weakened as well. Looking desperate - why beat up on someone half your age? Clearly not a fair fight. Can't you go it alone with all those resources? Looking stodgy - do you really need those Yahoo! hipsters to breathe some life into that software-heavy culture? Looking financially irresponsible - just because you have $40 billion to spend is this really the best way to enhance shareholder value? All good questions.  But in this case 5+10 doesn't equal 15, because this fight has taken years off both of their lives and the big brother remains above the fray, thinking about love, college and the future. What his younger brothers do is of little consequence, except insofar as their might be some good toys and friends to pick up after the fighting is over.

Google is 15. He is laughing - hard. "Boy, are my kid brothers dopes! I'm looking forward, living large, walking tall. I'm in high school but college is around the corner. I'm going to start my own company. And if my idiot brothers lose some of their friends because of the fight, they can come work with me on my company. And if my younger brother falls ill, very ill, I'll come and visit him and send my best but there is little I can do to help." Google must be thinking "Does Microsoft really want Yahoo! or are they simply trying to kill Yahoo! Either way, I win." Google will pick up top pros from both Microsoft and Yahoo!, who no longer want to deal with uncertainty and questionable business strategy, and for this Google will pay precisely nothing. Microsoft may end up spending $40 billion for something that has precious little value, as top human capital which is the real engine of growth will simply walk. Is the advertising engine and the other Yahoo! assets really worth buying the company, much less paying the control premium? And this doesn't even take into account the disruption and value destruction arising from the integration process, which is at any time and always a hairball.

And the end of the day those at Google must be shaking their heads. I think Larry, Sergey and Eric should send Steve a really expensive bouquet of flowers. He has simply made their year.

Yahoo!'s "Just Say No" Defense: What Are They Thinking?

M&A is has a raft of strategies and tactics that were popularized by Bruce Wasserstein but have been practiced by many both before and after he terrorized buyers and sellers alike at First Boston. The "Just Say No" defense is a legitimate tactic for a Board to take, but it generally needs to be played in the presence of a very important condition: an alternative. Historically companies that have simply rebuffed bids containing 60% premiums to last trade talk about things like spin-offs, divestments, share buybacks, leveraged recapitalizations, things like that. Simply saying "this bid inadequately values our fine organization" is simply a joke. Microsoft presents no financing risk and requires no contingencies, while Yahoo! offers no viable alternative worth its weight in dog doo. They are going to be swallowed alive, and the chances are better than not that it will happen at $31, the original offer. If Microsoft pays any more at this point it is simply out of mercy and goodwill, not because they have to or that they should. They outmaneuvered Yahoo! good and deserve to buy it at the bid price.

So what should Yahoo! have done, given that they are in shambles, lack a well-defined plan for maximizing shareholder value and have had ample time to right the ship since Jerry's return? I'll tell you - announce to the world that they are proud and flattered that Microsoft sees the value in the Yahoo! brand, its technology and its franchise, and that it would be willing to engage in negotiations. This way, it might squeeze another $2-$4 per share for Yahoo!'s downtrodden shareholders, providing at least some salve on what has become a gaping wound. But once you tell a supremely-funded, laser-focused acquiror to take a hike, you have put yourself in a world of fiduciary and PR hurt. Microsoft will wage a proxy fight and will win, because the threat of them backing away will cause the stock to drop $5 - easy. That won't make the Board look too good, will it? Further, they'll lose the war in the press, looking like a bunch of incompetent boobs who not only couldn't fix a broken company but spurned a golden offer from the only bidder on the block! Who do these people think they are? Beats me. I hope their D&O policy is paid-up.

Might this saga turn out differently? Sure. But based upon the facts I see before me, Yahoo!'s goose is cooked.

UPDATE - recent related stories:

• Wall Street Journal: Microsoft Stands by Yahoo Bid
• New York Times: After Rejection by Yahoo, Microsoft Hints at a Fight
• Silicon Alley Insider: As Expected, MSFT Stands Firm, Doesn't Raise YHOO Bid

The iGame? Further Leveraging the Consumer Era of Computing

Something is afoot. Steve is lurking in the weeds. New and unusual trademark filings. Curious job postings. A closer bond with former rival Intel around handheld devices. An upcoming event to announce something big. You can feel it in the air. Apple is on the cusp of another move to further cement its legacy as the pre-eminent brand in consumer technology. It kind of feels like the calm before the storm, just like before the iPhone was announced. And you know what? A move into handheld gaming is totally logical.

Apple is synonymous with fun, easy and cool.  And Steve has engineered this first-class user experience by keeping control of every stage of the production process, vertically integrating in a way that hasn't been successful for decades. He has been among the vanguard to usher in the Consumer Era of Computing, something I wrote about over a year ago in the wake of Vista's release. He did it with the iMac; the MacBook; the iPod (and its variants); and the iPhone. The iGame? It's a natural. Nintendo has shown us only too well how much money there is to be made in handheld gaming by delivering a package of hardware, software and a user experience integrated into a seamless whole, unlike others across the competitive landscape. They have adopted the same vertically integrated approach Apple has, maintaining maximum control to ensure that disconnects between engineering, hardware design and the customer experience don't get out of alignment. It may not be the cheapest way to do it but it certainly delivers results when executed to perfection, as Apple and Nintendo have been doing for some time.

I believe the original thesis around the Consumer Era of Computing is continuing to play out, and that Apple's move is yet one more indication that starting with the customer experience is Job #1. Yes, top engineering is needed. Yes, wicked software development skills are the ticket to play the game. But at the end of the day it is the delicate dance among design, engineering and production that separates the good from the great. And this is what both Apple and Nintendo do so well. And for the first time in quite a while Nintendo is likely to be challenged by a worthy competitor, and by a competitor it didn't even know it had.

UPDATE: Chris Kohler, Editor of Wired Game I Life, just put up an article on this very topic. Yours truly is quoted. Check it out.

Opportunity Knocks: The De-Commoditization of Capital

Much has been written about the negative impacts of the subprime mess and the knock-on credit crisis. But what about the flip-side; who stands to gain from general economic and capital markets uncertainty? I'll tell you - those who have balance sheet capacity and abundant liquidity to pick up bargains while others are suffering. Where capital was once incomprehensibly cheap and available it is now both dear and scarce. And this about-face took less than six months to unfold. Quite simply, capital is no longer a commodity.

I was speaking to a friend who is a senior member of an advisory team within a finance company that goes head-to-head against the Wall Street investment banks every day of the week. And they generally do pretty well, leveraging the capacity and appetite to book risk on deals where they are adviser. But things have gotten much better for them as of late, since so many of the investment banks are dealing with their own credit crises and have become far more reluctant to underwrite deals and incur syndication risk. This is but one small example of a firm that is capitalizing upon the adverse conditions in the credit (and now equity) markets.

When it comes to the credit crisis almost all roads run through the largest banks and investment banks. They packaged up, retained and sold (and some actually got into the origination end of) mortgage risk; were underwriters of massive amounts of leveraged loans; and provided incremental leverage and liquidity to hedge funds. And if they had only been middlemen in the process, that would have been ok. But they weren't, and it is these held mortgage securities, retained loans and existing financing commitments that are burning holes in their balance sheets, causing them to both pull in their lending horns while aggressively bringing in new sources of capital. The traffic cop of transactional credit creation is currently on holiday. So given this, who is out there to capitalize on the increasing cheapness of both the debt and equity markets?

Consider the possibilities for these types of firms:

• Private equity firms: The leaders are generally awash in liquidity and have patient investors, indicating a vast opportunity set. And while their ability to lever acquisitions has dropped precipitously, the decline in purchase prices will help to dampen the effect of more equity-heavy capital structures on returns. Will returns reach the heights of the mid-2000s? Likely not in the near term. But these firms have the resources and experience to create value in both U.S. and overseas markets, and will have plenty of opportunities to deploy massive amounts of capital to capture the bargains that will inevitably emerge from today's market crisis.

• Hedge funds: While jittery and highly correlated markets are generally not good for stat arbs and other quantitatively-oriented investors, value-driven long/short equity and even-driven managers should do pretty well. In the global market sell-off value should once again rear its head, giving excellent stock-pickers with intermediate time horizons fertile ground to build an attractive portfolio and to watch it pay off over time. Event