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Leveraged Populists

Posted By Frederick Sheehan On February 22, 2012 @ 1:00 pm In Think Tank | Comments Disabled

[1]Frederick Sheehan is the co-author of Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve [2].

His new book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession [1], was published by McGraw-Hill in November 2009. He was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans.

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Leveraged Populists

The recent offering of Facebook stock was the biggest news since a man landed on the Moon. The story was everywhere. Someone said the company is worth $100 billion and that was repeated one-hundred billion times. It is the saturation of noise, more than the supposed price, that should warn investors. This too, shall pass.

Technology stocks such as Facebook are a means for investors to put their money where their hearts lie. At the turn of the millennium the world lost its mind over technology stocks. This eerie atmosphere is too well known to require description. A merger of the time will substitute.

The America Online-Time Warner combination proved the thesis of “convergence.” Stock phrases and Star Wars’ linguistics had inflated AOL stock. (“To you, peering through your spectroscope, mapping the mazes of electromagnetism in its path, the web appears as a global efflorescence….the physical phase of the telescom, the radiant chrysalis from which will spring a new global economy.” – George Gilder, widely hailed technology expert)

Page one of the New York Times Convergence Edition in January 2000 frames the all-telling photograph, captioned: “Steven M. Case, chief executive of America Online, with tie, and Gerald M. Levin, chief executive of Time Warner, without tie, announcing the merger.”

What beckons of course, is the haberdashery insight. “Left” and “right” would have fully explained who dressed down. So why the phrase? (To youngsters: Dressing down was still relatively new on January 5, 2000, so notable.)

It was an underscore. Here we had the Old Economy, and older man, agreeing to be bought out by the New Economy. Gerald M. Levin surrendered to the young man’s conquest of the Old Media. Levin had embraced the New Era, albeit, disrobed, demoted and humiliated before the public like Chuck Connors in Branded. Steven M. Case, an internet idol, wore his tie, a sign of respect for the old, shrunken media mogul who had seen the future in the nick of time. An industry analogy might be a silent movie studio that refused to make talkies in 1930.

In 1927, a third-rate movie studio, Warner Brothers, released the first talking picture: The Jazz Singer. Practically breaking the bank with a $3 million publicity campaign, the studio’s technological escapade swept the nation. We might compare the mass hysteria to the Facebook or AOL-Time Warner silliness. Every studio was soon borrowing and then borrowing some more to catch up with the People’s latest need. That was a period, like our own, when cravings equaled needs. A substantial proportion of the lower classes in Muncie, Indiana (Middletown) mortgaged their houses that they had owned to buy a car. Twenty one of twenty-six families that bought cars (in the lower strata) did not own a bathtub.

That was also a time when borrowing was easy. Lending to a booming, fashionable, and technologically cutting-edge business was fashionable in itself. By that time, movies were the fifth largest industry in the United States, where 90% of the world’s films were made – indicating the tendency of American minds to admire visual (rather than verbal) expression and drift towards fantasy.

After 1929, financing was hard to come by and the highly leveraged studios needed constant infusions of cash. Most went broke. Those who bought and held Warner Brothers Pictures at its $67 peak could sell it for $1 in 1933. Unambiguous needs during the 1920s turned to superfluous cravings a few years later. In The Crash and Its Aftermath, Barrie Wigmore wrote that movie sales dropped [in 1933] “to $546 million from $831 million in 1931….Somehow a myth has developed that Depression crowds anxious for escape sustained the movie business. This is not even remotely true.”

William Fox and Sam Warner retained control, but investors went broke. How they accomplished this feat might be studied by Facebook executives today presuming the Warners of 2012 can identify their revenues.

AOL bought Time-Warner with 45% of its stock: no cash. This gave AOL 55% ownership – and control – of AOL-Time Warner. The stock offered was worth $165 billion. In return, AOL now owned a company that had produced $6 billion of cash the year before. AOL’s cash flow was about one-quarter that amount. Time Warner stock was trading at about 20 times cash flow, fairly high by historical market measurements, but a pittance compared to AOL’s price: cash flow ratio of 110:1.

Levin’s dressed-down marriage with AOL was quite a miscalculation. Even so, it is worth remembering that the company he headed is an example of the past half-century’s leveraged finance, an aggregation of overpriced miscalculations. For the most part, finance has profited: not the companies, not the shareholders, not the customers, nor the employees.

A source of the late 1960s “garbage market” was identified by John Brooks in the Go-Go Years: “Accountants came to think legalistically rather then conscientiously.” This prompted offerings that, today, could make for a raucous feast on the Daily Show. Brooks writes of stocks for every fad: For nursing home fans, there was United Convalescent Homes. The budding fanciers of a greener world could buy Responsive Environments. For those who predicted a boom in spare time, International Leisure filled the bill.

The headline merger of the millennium gained traction during this rumpus. A funeral-parlor chain bought D.C. Comics and Ashley Famous Talent Agency in 1967; the morticians then bought Warner-Seven Arts in 1969; it renamed itself Warner Communications in 1972; Warner Communications bought cable operator American Television & Communications in 1978; Warner Communications and Time Inc. merged in 1989 to form Time Warner; Time Warner acquired Houston Industries in 1995; Time Warner acquired Turner Broadcasting Systems in 1996, this included Ted Turner’s acquisitions and product launches – the Atlanta Hawks (1977), CNN (1982), the MGM library of movies and television shows (1986), Cartoon Network (1992), Castle Rock and New Line Cinema (1993), Turner Classic Movies (1994); Time Warner acquired Times Mirror magazines in 2000; and America On-Line bought Time Warner for $165 billion in 2000 – without one penny changing hands. As noted, payment to Time Warner shareholders was in America On-Line stock.

The day after Facebook monopolized the news, a proposed merger went relatively ignored. Initially priced at $88 billion, Glencore and Xstrata continue to negotiate with each other. The combination would produce, refine, transport, and sell most of the world’s commodities that are harvested in most of the world’s countries and then sold in most of the world’s markets.

As for AOL-Time Warner, it did not take long for Gerald Levin to be shown the door. Time Warner spun off what little was left of AOL in 2009. In January 2000, Steve Case had taken his winnings and bought pineapple plantations in Hawaii.


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URL to article: http://www.ritholtz.com/blog/2012/02/leveraged-populists/

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[1] Image: http://www.amazon.com/exec/obidos/ASIN/0071615423/thebigpictu09-20

[2] Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve: http://www.amazon.com/exec/obidos/ASIN/0071591583/thebigpictu09-20

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