Dear Readers,
As the economic recovery drags on at a turtle-pace, several commentators have begun to make the inevitable predictions of a “lost decade.” This description is often thrown about when discussing Japan during the 1990s – although as Japan’s malaise continued into the 2000s, “lost era” is perhaps a more accurate description. Before this description is applied to the US, it is helpful to look first at whether the performance of the US economy over the past decade truly mirrors that of Japan. Moreover, what should be the metrics by which developed economies are measured against each other? By these measures, does the Japanese experience of the 2000s even qualify as a “lost decade?”
In the United States, the economic history of the 2000s began with the bursting of the technology bubble that, combined with September 11, created a circumstance about which former Federal Reserve Chairman Alan Greenspan said “historically can result in the undoing of a society.” In response, the Fed quickly initiated a series of aggressive interest rate cuts. Other central banks around the world followed suit in order to prevent, as several central banks directly stated at one point or another, a prolonged period of Japanese-style stagnation. Most economists, all the way up to Greenspan himself, did not anticipate the extent to which these interest rate cuts would inflate bubbles in the housing and credit markets.
After the housing collapse and subsequent credit crisis in 2007-08, central banks once again acted quickly to ease monetary policy and prevent a prolonged period of low growth. In addition to cutting rates to zero, the Federal Reserve initiated a program of quantitative easing in March 2009 and expanded the program by $600 Billion in early November 2010. One of the reasons given in defending this practice was to expedite the current recovery to the point that it becomes self-sustaining. This would prevent a double-dip recession that could, in turn, lead to a repeat of the Japanese experience.
As often as one may hear that the Fed is trying to prevent a “Japanese experience,” it is helpful to establish whether Japan truly underperformed given its circumstances. Since 1990, the Japanese economy has faced a real estate collapse and subsequent banking crisis more damaging than the recent US recession, battled deflation, and dealt with unfavorable demographics. While the banking problems are largely behind it, deflation and an aging population have continued to linger. Through that, Japanese GDP growth averaged 0.6% over the past decade according to the World Bank.
In general, the rationales behind much of the economic policymaking since at least the 19th century have been dominated by “lessons learned” that are drawn from throughout the course of economic history. However, it is debatable whether the example of Japan is an economic scenario that should be avoided entirely. Daniel Gros, Director of the Centre for European Policy Studies, stated recently that “the basis for the scare story about Japan is that its GDP has grown over the last decade at an average annual rate of only 0.6% compared to 1.7% for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6% qualifies as a lost decade.”
If that is the case, GDP growth in much of the Eurozone might also fit the popular definition of a lost decade. According to the World Bank, in the 2000s Germany experienced nearly the same growth rates as Japan (0.6%) and Italy was even worse (0.2%). France and Spain performed somewhat better, but the Eurozone as a whole was not much better off. With sovereign debt problems now engulfing the continent over the past year, growth rates for the 2010s will likely not be much better.
Nonetheless, while this may look like economic stagnation on the surface, it elicits the often-asked question of how to properly measure the economic performance of developed countries against one another. The answer lies in the economic trajectory of countries that industrialize, as emerging markets transition into developed countries. The development of industry brings hundreds of millions of people from the countryside into the cities, fueling a rising industrial sector. All of a sudden, a former farmer or migrant might be a factory worker, contributing a bigger, and more easily measured, piece of a national GDP. This happens to millions of workers who are within the “working-age population” (WAP), those who are not too old or too young. Therefore, a more accurate measurement of the economic performance of developed countries might be GDP per member of the WAP as opposed to the widely-accepted GDP per capita. With regard to Japan, this is important because of demographics.
In Japan, that 0.6% average GDP growth was achieved despite a contracting WAP. This number is shrinking rapidly as the Japanese population declines, as birthrates have fallen since the 1980s and Japanese couples have chosen to have children later in life - and have had less of them (the same trends that are currently taking place in the US). When charted, the Japanese population is taking the shape of an inverse pyramid, with the greatest percentage of its population over 60 years old. Consequently, Japan actually performed better than the US and most European countries during the 2000s based on GDP per WAP (GDP/WAP). Indeed, these demographic differences are relevant to comparing the US not only to Japan but to the developed economies of the Eurozone as well. By the GDP/WAP figure, many European nations, especially those with shrinking populations, have also done better than the US.
As mentioned, the difference between Japan and the US over the past decade was about one percentage point in favor of the US on an annual basis, but in terms of working-age population growth rates, the difference was about 1.5% annually. This is because the US’s WAP increased by 0.8% on an annualized basis (though not necessarily the workforce, if one considers illegal immigrants and such). In Japan, this same figure contracted by 0.8% annually over the past decade. Additionally, another reason the “lost decade” has been expanded to include the 2000s is that Japanese unemployment has remained more or less constant over the past decade. It has held around 4-5% even after the late 2000s recession. Compare that to the US, which approached 10% in 2010, although it fell slightly based on data released last week. Therefore, despite a stagnant unemployment rate and falling WAP, Japan managed to eke out growth. The point is not that the Japanese model is one to be emulated, but the fact that it has managed to grow in such an economic environment should be looked at by the Federal Reserve and corporate leaders who seek to squeeze out growth from an environment of deleveraging, increasingly unfavorable demographics, and stagnation.
What does this mean for the next decade? The use of GDP/WAP as presented here suggests that it can be used to predict the growth rates of the G-7 and other developed countries based on the growth/contraction patterns of their WAP. These can be predicted for at least two decades onward, as WAP consists of a country’s population aged 20-60, so the future workforce that will enter at age 20 has already been born. In the case of a few nations, particularly the US and the UK, immigration trends should be factored in, but obviously this cannot be predicted as accurately as the number of new births. Based on these facts, Japan will continue to fade as a major economic power, especially within Asia due to the rise of China. Nearly all of the Eurozone members are showing similar trends to Japan, albeit at an earlier stage. The WAPs of Germany and Italy are already in decline, and they and the rest of the Eurozone will have similar growth rates over the next decade. In the case of Germany, the decline will be even faster than Japan beginning shortly after 2015. In contrast, the US, UK, and France are likely to grow faster because the WAPs of all three are continuing to grow, even if it is at a slower pace than in previous generations.
There are two main takeaways from this confluence of demographics on economic growth. First, the popular notion of a Japanese-style “lost decade” may be misleading even if applied to its nation of origin. The slow growth in Japan was not entirely due to what one commentator described as “insufficiently aggressive macroeconomic policies.” Since Japan’s banking crisis in the 1990s, the stagnation has arguably been more demographically-caused. While these demographic trends have played a big role in Japan’s difficulties over the last two decades, the US will not be confronted with the same degree of difficulty in that respect due to an increasing WAP. Second, a decline in the growth rates of many developed countries appears to be unavoidable, particularly in the Eurozone, as the WAPs decline. Even in the western countries that are still in good shape in this respect (US, UK, France), population growth rates are declining. Within Europe, even some of the countries that are viewed as healthier because they have not experienced the debt problems that swept the continent in 2010 will eventually succumb to this, Germany in particular. For countries such as Italy, which have existing debt problems and an already-declining population, the outlook is even worse, with stagnation perhaps being a best-case scenario. Add in the inevitable austerity measures and budget cuts that will need to take place, and stagnation begins to look optimistic. In either case, it is going to be an interesting decade as governments throughout the western world will need to come to grips with these trends.
Respectfully Yours,
Matthew R. Green
January 10, 2011
Monday, January 10, 2011
Sunday, September 26, 2010
Issue XXI - YHOO/MSFT Part II
In the August 24 issue, I discussed the history, business climate, and the events that led to Microsoft’s (MSFT) offer to buy Yahoo Inc. (YHOO) in early 2008. In this issue, I plan to briefly discuss the implications of the deal if it had gone through, and what the effects on both companies and the industry would have been.
To begin, many question marks exist concerning the feasibility of the deal. In early 2008, the economy was just beginning to feel the effects of what would become the credit crisis and recession. In late January 2008, MSFT made an initial offer of $31 per share to YHOO management. As I highlighted last time, it was a good opportunity for stockholders that had seen Google (GOOG), Research in Motion, Apple and Amazon soar while YHOO got left behind during the 2000s to cut their losses and walk away. For that reason, many investors, institutions, and hedge funds were pushing for the deal to be consummated. In a clear sign of this, activist investor Carl Icahn took a stake in YHOO and a seat on its board to push for the deal in May, 2008. As far as investors were concerned, there should have been very few hurdles to the deal’s consummation. Obviously, the mandate of any company’s management is to maximize the stock price. YHOO’s management was already engaged in turnaround initiatives, and continually pushed for a better deal because they felt success was just on the horizon. Their overly optimistic projections for the next few years after 2008 were clearly unrealistic, and their unwillingness to bend to MSFT’s advances and the prodding of their own shareholders would prove to be the undoing of the deal.
Looking at the tech industry landscape at the time, an irony of the deal falling through lies in the fact that Microsoft was one of the only, if not the only, suitable partners for Yahoo. To begin, due to the sheer size/market capitalization, there are very few companies within the Internet sector that would have been large enough to acquire Yahoo. Looking at the larger group of companies under the Technology category, if a company such as Hewlett-Packard or Intel was looking to diversify into the internet services sector (an unlikely proposition), then the list can be expanded a bit. Looking at only those firms that were already in the Internet sector, however, MSFT was likely the only one with the financial resources to buy YHOO without using a huge amount of debt, and a small enough Internet search presence that its acquisition of YHOO would not raise the ire of antitrust regulators. As mentioned last time, after the initial YHOO/MSFT proposition fell through, YHOO tried to outsource its search operation to GOOG, immediately triggering the watchful eye of the Justice Department.
Throughout early 2008 and in the two years since, some commentators have suggested that other suitors could have come from private equity and the buyout sector. At the time, this was also an unlikely occurrence. First, in 2008, the LBO sector had just been through a second period of glory, the first of which came during the mid to late 1980s. By early 2008, the broader economy was just beginning to feel the strain from what would become the credit crisis. However, LBO deal volume was already falling as investment banks were already cutting back on lending to their Financial Sponsors clients. That raises the question of whether an LBO could have even been pulled off from the lender’s perspective. Second, from the buy-side perspective, the numbers simply do not add up. Obviously, the private equity firms that would have been able to pull this off either by themselves or as part of a consortium (Blackstone, Texas Pacific, KKR, etc.) are sophisticated investors. Working within reasonable projections for purchase price, debt, and leverage, the prospective returns would likely have not been high enough. With the amount of debt that would have been necessary, YHOO’s cash flow and EBITDA could not have been leveraged enough to make the deal work. Of course, unrealistic projections are not unfamiliar in this case, with YHOO’s management putting forth overly optimistic scenarios at the time of MSFT’s proposition. Either way, in the end the fact that private equity did not get involved could have been due to either the increasing lack of credit, or the conscious decision of such investors to not get involved.
As mentioned, YHOO management was forecasting an overly optimistic scenario going forward due to their still-in-progress turnaround effort that they hoped would come about as a result of these “Panama” initiatives. Their projections were above and beyond what many analysts at the time were projecting. MSFT was well aware of this, and with any merger, this could have led to internal frictions during the integration process. In this case, there may very well have been a higher amount of friction due to the aforementioned factors and another big question mark: the integration of the two companies.
The integration process, if undertaken, would have been very difficult for many reasons. First, the integration of two companies of YHOO and MSFT’s size is a tremendous undertaking. MSFT has nearly 90,000 employees, and YHOO has thousands as well. As is the case with most mergers, there would have been many redundancies on all levels of the company. Second, the integration of the companies’ technologies would have been quite tedious. The “different technologies” were not limited to their Internet search divisions, but everything from advertising systems to HR. This is one point of integration in which the challenges were much deeper than may have initially appeared on the surface.
In addition to the challenges of integration that are seen in any merger, the companies involved here are vastly different in terms of firm culture. Despite the fact that both MSFT and YHOO are relatively young within the grand scheme of the American business landscape (35 and 16 years old, respectively), within the world of computer and Internet technology, this age gap is huge -- MSFT is like a senior citizen while YHOO is middle-aged. As such, both companies have different primary businesses and came of age in very different eras, which translates into a vast difference in corporate culture. While MSFT’s culture is more traditional and formal, YHOO, coming of age during the late 1990s tech boom, embodies the dot-com, Bay Area culture of casual everything from dress codes to intra-office relations. This vast gap would have been very difficult to close during the integration period, and it could have caused difficulties after integration was complete.
Finally, the post-merger company likely would have not affected the overall Internet search landscape very much. Google is still the unquestioned leader in the Internet search category with over 70% of the market. Many commentators have pointed out that MSFT’s Bing will have over 30% of the market once the integration of their search engines is complete. While Bing was gradually eating away at Google’s market share for much of the past year after its initial release, recent figures suggest this may be coming to an end. Either way, it has not made a great difference. For example, I have yet to hear someone say, “I Binged it,” and I’m sure we’ve all said or hear others regularly say, “I Googled it.” As it stands now, MSFT and YHOO’s market share is about 30% and declining. In the event of a full merger, the integration challenges could very well have accelerated that decline.
As of now, it appears that a merger of MSFT and YHOO would not have been a tremendous success for either party, YHOO in particular. For YHOO, while the outcome was not applauded by shareholders at first, the ultimate outsourcing of YHOO search to MSFT’s Bing is a long-term positive for the company. The current search outsourcing deal enables YHOO to focus on its core competencies, while grabbing a healthy percentage of the revenues from MSFT’s Bing search engine. Since YHOO’s stock price declined in 2008 and has remained largely stagnant since, the ultimate outcome of the new arrangement could be a major factor in a future renaissance in the stock price, if other factors come together to make the company successful once again.
Finally, one thing that the deal definitely would not have affected is the M&A market for small tech companies. The large cash reserves of MSFT, YHOO, and GOOG (with MSFT being the only one of the three that pays a dividend), enable all three to be active buyers of small tech companies. A merger between MSFT and YHOO would not have changed that. If anything, it would have made GOOG a bit more aggressive in acquiring small tech firms. The robustness of M&A within the technology sector is perhaps most evident to its being at the forefront of innovation and the evolution of technology as an increasingly important sector of the American economy.
Respectfully Yours,
Matthew R. Green
September 27, 2010
To begin, many question marks exist concerning the feasibility of the deal. In early 2008, the economy was just beginning to feel the effects of what would become the credit crisis and recession. In late January 2008, MSFT made an initial offer of $31 per share to YHOO management. As I highlighted last time, it was a good opportunity for stockholders that had seen Google (GOOG), Research in Motion, Apple and Amazon soar while YHOO got left behind during the 2000s to cut their losses and walk away. For that reason, many investors, institutions, and hedge funds were pushing for the deal to be consummated. In a clear sign of this, activist investor Carl Icahn took a stake in YHOO and a seat on its board to push for the deal in May, 2008. As far as investors were concerned, there should have been very few hurdles to the deal’s consummation. Obviously, the mandate of any company’s management is to maximize the stock price. YHOO’s management was already engaged in turnaround initiatives, and continually pushed for a better deal because they felt success was just on the horizon. Their overly optimistic projections for the next few years after 2008 were clearly unrealistic, and their unwillingness to bend to MSFT’s advances and the prodding of their own shareholders would prove to be the undoing of the deal.
Looking at the tech industry landscape at the time, an irony of the deal falling through lies in the fact that Microsoft was one of the only, if not the only, suitable partners for Yahoo. To begin, due to the sheer size/market capitalization, there are very few companies within the Internet sector that would have been large enough to acquire Yahoo. Looking at the larger group of companies under the Technology category, if a company such as Hewlett-Packard or Intel was looking to diversify into the internet services sector (an unlikely proposition), then the list can be expanded a bit. Looking at only those firms that were already in the Internet sector, however, MSFT was likely the only one with the financial resources to buy YHOO without using a huge amount of debt, and a small enough Internet search presence that its acquisition of YHOO would not raise the ire of antitrust regulators. As mentioned last time, after the initial YHOO/MSFT proposition fell through, YHOO tried to outsource its search operation to GOOG, immediately triggering the watchful eye of the Justice Department.
Throughout early 2008 and in the two years since, some commentators have suggested that other suitors could have come from private equity and the buyout sector. At the time, this was also an unlikely occurrence. First, in 2008, the LBO sector had just been through a second period of glory, the first of which came during the mid to late 1980s. By early 2008, the broader economy was just beginning to feel the strain from what would become the credit crisis. However, LBO deal volume was already falling as investment banks were already cutting back on lending to their Financial Sponsors clients. That raises the question of whether an LBO could have even been pulled off from the lender’s perspective. Second, from the buy-side perspective, the numbers simply do not add up. Obviously, the private equity firms that would have been able to pull this off either by themselves or as part of a consortium (Blackstone, Texas Pacific, KKR, etc.) are sophisticated investors. Working within reasonable projections for purchase price, debt, and leverage, the prospective returns would likely have not been high enough. With the amount of debt that would have been necessary, YHOO’s cash flow and EBITDA could not have been leveraged enough to make the deal work. Of course, unrealistic projections are not unfamiliar in this case, with YHOO’s management putting forth overly optimistic scenarios at the time of MSFT’s proposition. Either way, in the end the fact that private equity did not get involved could have been due to either the increasing lack of credit, or the conscious decision of such investors to not get involved.
As mentioned, YHOO management was forecasting an overly optimistic scenario going forward due to their still-in-progress turnaround effort that they hoped would come about as a result of these “Panama” initiatives. Their projections were above and beyond what many analysts at the time were projecting. MSFT was well aware of this, and with any merger, this could have led to internal frictions during the integration process. In this case, there may very well have been a higher amount of friction due to the aforementioned factors and another big question mark: the integration of the two companies.
The integration process, if undertaken, would have been very difficult for many reasons. First, the integration of two companies of YHOO and MSFT’s size is a tremendous undertaking. MSFT has nearly 90,000 employees, and YHOO has thousands as well. As is the case with most mergers, there would have been many redundancies on all levels of the company. Second, the integration of the companies’ technologies would have been quite tedious. The “different technologies” were not limited to their Internet search divisions, but everything from advertising systems to HR. This is one point of integration in which the challenges were much deeper than may have initially appeared on the surface.
In addition to the challenges of integration that are seen in any merger, the companies involved here are vastly different in terms of firm culture. Despite the fact that both MSFT and YHOO are relatively young within the grand scheme of the American business landscape (35 and 16 years old, respectively), within the world of computer and Internet technology, this age gap is huge -- MSFT is like a senior citizen while YHOO is middle-aged. As such, both companies have different primary businesses and came of age in very different eras, which translates into a vast difference in corporate culture. While MSFT’s culture is more traditional and formal, YHOO, coming of age during the late 1990s tech boom, embodies the dot-com, Bay Area culture of casual everything from dress codes to intra-office relations. This vast gap would have been very difficult to close during the integration period, and it could have caused difficulties after integration was complete.
Finally, the post-merger company likely would have not affected the overall Internet search landscape very much. Google is still the unquestioned leader in the Internet search category with over 70% of the market. Many commentators have pointed out that MSFT’s Bing will have over 30% of the market once the integration of their search engines is complete. While Bing was gradually eating away at Google’s market share for much of the past year after its initial release, recent figures suggest this may be coming to an end. Either way, it has not made a great difference. For example, I have yet to hear someone say, “I Binged it,” and I’m sure we’ve all said or hear others regularly say, “I Googled it.” As it stands now, MSFT and YHOO’s market share is about 30% and declining. In the event of a full merger, the integration challenges could very well have accelerated that decline.
As of now, it appears that a merger of MSFT and YHOO would not have been a tremendous success for either party, YHOO in particular. For YHOO, while the outcome was not applauded by shareholders at first, the ultimate outsourcing of YHOO search to MSFT’s Bing is a long-term positive for the company. The current search outsourcing deal enables YHOO to focus on its core competencies, while grabbing a healthy percentage of the revenues from MSFT’s Bing search engine. Since YHOO’s stock price declined in 2008 and has remained largely stagnant since, the ultimate outcome of the new arrangement could be a major factor in a future renaissance in the stock price, if other factors come together to make the company successful once again.
Finally, one thing that the deal definitely would not have affected is the M&A market for small tech companies. The large cash reserves of MSFT, YHOO, and GOOG (with MSFT being the only one of the three that pays a dividend), enable all three to be active buyers of small tech companies. A merger between MSFT and YHOO would not have changed that. If anything, it would have made GOOG a bit more aggressive in acquiring small tech firms. The robustness of M&A within the technology sector is perhaps most evident to its being at the forefront of innovation and the evolution of technology as an increasingly important sector of the American economy.
Respectfully Yours,
Matthew R. Green
September 27, 2010
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