Big Red Horseshoe - Vanderbilt Owen MBA Students on Business Strategy

China goes shopping

China finds US banks on the bargain aisle.

Now that US banks are trading lower due to the sub-prime debacle, foreign investors are buying exposure to the US financial markets. It remains to be seen if the lower valuations are due to an over-reaction to a small segment of the riskiest loans or just the tip of the iceberg. The problem is that we don't know how much bad debt is on the balance sheet of the US banks. China is pursuing their normal cautious route by making small investments in US institutions, Bank of America, Bear Stearns, UCBH. They know a thing or two about bad debt as they have had to inject huge sums of capital into their own state-owned banks to help off-set bad loans to state-owned enterprises. The most interesting part of the story is how the US reacts when the shoe is on the other foot.

In the November 5 issue of Business Week :

"This strategic shift poses a dilemma for U.S. regulators. The Fed must sign off on any transaction in which a foreign investor takes more than a 5% stake in a U.S. bank as well as approve any applications to open branches in the states. When it comes to evaluating Chinese banks, regulators are in uncharted territory. On one hand, the government is supposed to be committed to unfettered cross-border deals; the U.S. certainly agitates for them when American companies try to buy stakes in China. At the same time, Chinese banks operate in a very different regulatory environment—one with a history of lax oversight and corruption. Some observers say that's why the U.S. has dragged its feet on letting Chinese banks set up U.S. branches."

Now that the tables are turned, you have to appreciate the irony. US investors have been clamoring for access to China since it opened up in the 1990's. The Chinese have come to the US to find a place for their cash, but we are not exactly practicing what we preach when it comes to foreign investment in our financial institutions.

"U.S. banks—many of which want more exposure to profitable Chinese markets—could benefit if U.S. regulators are more welcoming to China. Trade rules in China limit foreign investment in its banks to 25%. But China Banking Regulatory Commission Chairman Liu Mingkang has hinted that if his American counterparts approve the applications of Chinese banks to open U.S. branches, China may raise those caps. Says Babak Nikzad, a partner at KPMG's financial-services practice in Hong Kong: "U.S. regulators need to be consistent and see China the way they do other major countries."

Miscellaneous 'Shoe: MySpace Grows Up, Microsoft Pays Dearly For Facebook Stake, Blogs Are Hot

-- It's kind of fun watching a young Internet company figure out what it wants to be when it grows up. Recently MySpace teamed up with Skype. Now the News Corp-owned social networking site has announced it will offer an online gaming channel with Oberon Media. With Facebook showing far more growth and creativity, these kinds of partnerships are very needed. MySpace's owner has received some grief for how it has let the competition (see below) steal its thunder. These types of partnerships will help unlock some of the value in MySpace's $580 million price tag.

-- Speaking of (possibly) overpriced social networking sites, Facebook today got $240 million from Microsoft for a 1.4% stake of the company and rights to sell ads on the popular site. At that price, Facebook is valued at $15 billion! Microsoft held off Google to win the ad deal. The company has been expanding its presence in online advertising: Microsoft recently bought aQuantive for $6 billion and last year paid somewhere between $200 million and $400 million (analyst estimates) for in-game advertising company Massive. Microsoft's stock closed up about 1.1% today and is up about almost 9% in the last six months.

-- Netflix added 286,000 customers in the third quarter and its profits exceeded expectations. How has the company excelled at a time of increased competition from similar DVD-based outfits as well as increased digital competition? A good ol' fashioned price drop. Prices were lowered by $1 per month. In the fourth quarter, Netflix expects to add another 300,000 to 500,000 subscribers to its current level of 7.03 million.

-- Continuing with the new media angle...Standard & Poor's asks if blogs will be the next big acquisition target. The business model certainly is nice: Critique the work of and use as talking points the news of the old media, work with a decentralized and office-less organization and use cheap blogging software that does most of the heavy lifting. I have to wonder, though, if it wouldn't be possible to build rather than buy. As the Huffington Post has proven, a new market entry doesn't take long to rise to the top of the rankings. As soon as old media figures out how to correctly blog (hint: don't write like your journalism professors taught you, don't treat it like it's going to be in print) they can make up a lot of ground. Blogging is a state of mind more than anything else. The blogs mentioned in the article will work better as mainstream media outsiders and the owners know it. Gawker Media, TechCrunch and BoingBoing will lose their anti-establishment souls if they sell out. Old media companies seeking growth, new readers and new identities should save their money and build blogs themselves. Case in point: The New York Times' Freakonomics blog.

Gladwell On The Future Workplace

Writer Malcolm Gladwell (The Tipping Point, Blink, journalist at the New Yorker) spoke with the Globe and Mail about changes in how people work and what businesses will need in the coming decades. Workers, he says, are going to need to be a lot smarter, and he feels the best way to meet that goal is for corporations to help to improve eduction. It's in their best interests, he argues, and their competitive advantage depends on it.

I would just say if I were a CEO of a major company in Canada or the United States, I would be much more involved in public education. I know there are many who are, but I would consider that a priority along the lines of things that are specific to my own company. The competitiveness of any organization is so dependent on the quality of the work force, and it would be so much easier for us to improve public education if corporations publicly and loudly lined up behind the public school system. I think that would make an enormous difference. They should be a lot freer with their time and with their wallets in supporting public education.

Gladwell sees workplaces becoming more flexible, jobs become more demanding and employees becoming more thoughtful. "I'm quite prepared for the possibility that the next revolution is not going to come from a machine," he said. "It's going to come from creating a more thoughtful work force and giving people the opportunity to be thoughtfu."

A few year ago I saw on TV Gladwell's speech at the New Yorker Festival; it was a preview of his book Blink. Maybe Gladwell, who has been quiet for many months, is working on a book about the changing workplace? Or maybe education.  A few days ago, Gladwell told a sold-out debate at the New York Society for Ethical Culture that the Ivy League admissions process should be banned.

The Splits

Today's post is sponsored by the word split. Splitting off companies or divisions can be good for a number of reasons. In the first case listed below, the end product will result from an increased level of creativity and the removal of corporate shackles (and the company that was split off will be much, much happier). In the second case, the functions of the divisions are so distinct (even though they're all technology companies) that each could function more efficiently if operated separately.

-- Microsoft will split off Bungie Studios, the maker of the popular Halo video game series, and retain an equity stake in the company.

-- A Sanford Bernstein analyst believes the sum of Yahoo's parts is worth more than its sum. By breaking down the company's divisions into display advertising, search and subscriptions segments and comparing to multiples of comparable companies, the analyst values the three separate divisions at $54.3 billion. Yahoo's current market cap is $37 billion.   

Merger post-mortem: Why Ebay overbid

Two posts on Ebay in 2 days?  I know, it may be overkill, but it is too interesting to pass up. You have to appreciate the irony of the online auctioneer overpaying for a company that is only tangentially related to their core business of auctions. How could a pro make such a mistake?  It's more complicated than bidding for that 1982 poster of David Hasselhof and Kit from Night Rider. 

The value of Skype's stand-alone business in 2005 was $1.9B after factoring in their healthy growth rates. How does Skype generate revenue?

CNET reports: "The only way that Skype makes money from its subscribers is when people use its Skype-In or Skype-Out services. Skype-In allows users to pay to rent a phone number, which people on regular phones can call. Skype-Out allows users to call traditional phones or cell phones for a fee."

Ebay falls in the synergy trap: Flush with cash from their stock's run-up and trying to build out the functionality of their site, Skype seemed like a great overlay to connect the buyers and sellers in the largest online marketplace. Instead of emailing your question about the condition of an item, a buyer could just pick up the headset and talk to another Skype-enabled seller for free. EBay was also attracted to the European customer base as a way to expand outside of their core US market. Given the $1.4B write-down, this assumes that either none of the $1.2B in synergies materialized, or the stand-alone valuation was overblown.

Maybe eBay should have applied some good old economic rationale for whether the acquisition makes sense. Economists love to discuss the allocation of resources to the highest valued use. Luke Froeb, a Vanderbilt MBA professor and former chief economist for the Department of Justice says corporations often merge for the wrong reasons. "Unless a target is worth more to the buyer than it is to the seller, there is no reason to transact." Check out his treatise on mergers in the Dealmaker's Journal,  "If merger is the answer, what is the question?"

Could it be that the auctioneer was caught up in the frenzied buying of interactive web companies? You have to imagine that Skype was also being courted by the likes of Google and Yahoo as well as old-line media companies like News Corp. In hindsight, it looks like News Corp's crafty old Rupert Murdoch got Myspace for a song at $580M. Google raised the bar with its 1.65B purchase of YouTube - a company that had not even figured out a revenue model.

Buying eyeballs hasn't been this expensive since the late 90's.

Skype, A Rare (And Big) Stumble For eBay

News hit this week that eBay plans to take $1.4 billion in charges related to Skype -- $530 million to complete the 2005 purchase and the rest for goodwill impairment due to eBay's lowering of its long-term financial outlook. The company also announced a management change. Investors reacted by pushing up the company's stock about 1.4%, indicating that Skype's poor performance had already been figured into the stock's price.

Journalists are postulating what happened and what should/could come next. An Internet analyst at RBC Capital Markets told News.com that it's not a management problem and that free just doesn't work. "It's a business model issue." Information Week lists five reasons why Nokia should buy Skype (long story short: Skype needs mobile and Nokia needs to get serious about VoIP). The Wall Street Journal thinks MySpace or Facebook could achieve more synergies with Skype (because they "connect groups of like-minded individuals quickly and efficiently"). The Globe and Mail goes as far as to say Skype's overvaluation could make things hard for Facebook, a rising Web 2.0 company that many believe is overvalued.

So what went wrong? eBay wanted to branch out from its traditional business and saw huge upside in Internet-based calls. Like the analyst said, it's a business model problem. Vonage, as BusinessWeek.com pointed out, is another Internet phone company that isn't living up to expectations, and SunRocket recently announced it is shutting down operations. People are increasingly familiar with VoIP but are decreasingly likely to pay for it. The business model hinges upon an "upsell" to the free customers, getting them to pay for calls made to phone lines, or selling them on upgraded features.

The bottom line: Other than a niche group of international callers, who is going to opt for a subpar service when long-distance rates are fairly reasonable and most cellular plans have an abundance of available minutes?