On the heels of the news of Citigroup’s WorldCom settlement and increase in litigation reserves for other (i.e., Enron) investor litigation, this Wall Street Journal ($) article reports on the pressure that other financial services firms are facing to increase the amount of their reserves because of the darkening litigation environment.
Believe me, “dark” does not begin to describe the litigation environment surrounding the Enron litigation. “Black hole” would be more appropriate.
At any rate, the WSJ article notes that several other financial institutions are assessing what to do in light of the Citigroup action:

Because Citigroup also raised its reserves for liability associated with Enron Corp. — another company that like WorldCom hit the rocks after overstating its earnings during the market bubble of 1999 and 2000 — some legal and stock-market experts said the action put pressure on J.P. Morgan Chase & Co. to consider boosting its reserves for Enron as well.
“Citi’s move would appear to put pressure on [J.P. Morgan] to do something similar, given that JPM and Citi had business relationships with Enron that appear, in our view, to have been broadly similar in exposure,” Guy Moszkowski, who follows banks and securities firms at Merrill Lynch & Co., said in a note to clients late yesterday.

Funny that the WSJ article would quote a Merrill analyst:

Another firm with significant exposure to Enron-related liabilities is Merrill Lynch, which like Citigroup and J.P. Morgan settled regulatory charges, without admitting or denying wrongdoing, that it aided Enron in overstating earnings. . .
Citigroup yesterday added $3.3 billion, after taxes, to its litigation reserves, bringing the current total to $6.7 billion — which Chief Executive Charles Prince said was for “Enron, research and IPO litigations,” including some remaining WorldCom exposure. Mr. Moszkowski, the Merrill Lynch analyst, estimated the biggest chunk of that was about $2 billion for Enron.
As of year-end 2003, J.P. Morgan had $745 million in reserves for litigation, including $524 million for Enron. Bank analyst Susan Roth of Credit Suisse First Boston said that if J.P. Morgan brought its Enron reserves up to the Citigroup level, that could result in a charge of $2.5 billion, or $1.19 a share. Accordingly she reduced her price target for J.P. Morgan stock to $45 from a range of $45 to $50 a share.
. . . Last July, J.P. Morgan Chase agreed to pay $135 million to settle charges by the Securities and Exchange Commission that it helped Enron defraud investors. Citigroup also agreed to pay $120 million to settle charges that it helped Enron and Dynegy Corp. defraud investors.
Without admitting or denying wrongdoing, both institutions settled charges that they helped the companies mislead investors by characterizing loan proceeds as cash from operations. Merrill paid $80 million to settle SEC charges that it aided and abetted Enron’s fraud with two deals in late 1999, also without admitting or denying wrongdoing.
Citigroup’s WorldCom settlement “probably re-prices the cost of Enron- and WorldCom-” related liability, said Brad Hintz, who follows securities firms at Sanford C. Bernstein & Co.

“Re-pricing” the cost of Enron-related liability? I can already hear the plaintiffs’ lawyers using that term.

In performing research on a company or a particular director on a company’s board, it is often helpful to identify the company’s other board members and the other corporate boards on which those board members serve.
“They Rule“ is an extraordinary website that uses flash player to visualize a database that the rather interesting Josh On has created on certain publicly-owned corporate and institutional boards. You can choose either a particular board member or simply a corporate board. Then, the site will map the corporate board by identifying each board member, and then you can select a particular board member and it will map out each corporate board on which the board member serves. This process has amazing possibilities for tracking relationships between various corporate boards. Heck, I even expect Kevin Bacon to pop up before long!
To test “They Rule,” I plugged in the name of former Georgia senator Sam Nunn. He is on four boards and this is the map that “They Rule” produced:

Hat tip to Boing Boing via Alex Tabarrok over at Marginal Revolutions for the link to this useful tool.

Floyd Norris notes in this NY Times article that Securities and Exchange Commission chairman William Donaldson is not sounding or acting like the go-slow regulator that many expected when he was named to the post. As Mr. Norris notes:

[Mr. Donaldson] compared the current system of electing corporate directors, in which the incumbent board nominates a slate and no other candidates are on the ballot, to elections in the former Soviet Union: “It’s not really an election at all.”

[Mr. Donaldson] also emphasized the need to do something to change what he called the Lake Wobegon system that has caused pay for corporate bosses to soar. He said boards all conclude their chief executives are above average, as are all the children in Garrison Keillor’s mythical Minnesota town. He also said he was determined to force hedge funds to register with the S.E.C.

As one might expect, Mr. Donaldson’s proposals are not particularly pleasing to some elements of the Republican Party:

Mr. Donaldson’s efforts are frustrating to those who expected that the Bush administration would roll back regulation. The proposal received a D- average grade from Wendy Gramm, director of the regulatory studies program at George Mason University. “The S.E.C. offered no evidence that existing solutions to poorly performing boards do not work,” wrote Ms. Gramm . . .

Say what? Wendy Gramm, the former Enron director, is the “director of regulatory studies” at George Mason University? And is a spokesperson against Mr. Donaldson’s rather lame recommendations regarding corporate governance?
Could there be a worse spokesperson for maintaining the status quo in regard to “solutions for poorly performing boards?” Mrs. Gramm sat on an Enron board that blithely approved a staggering number of off balance sheet debt vehicles that admitted felon Andrew Fastow engineered to disguise Enron’s foreboding debt load, approved the clear conflict of interest that allowed Mr. Fastow to become enriched from such off balance sheet investments while he was Enron’s CFO, sat on Enron’s board (and was well compensated for doing so) while her husband — former Texas Senator Phil Gramm — was receiving campaign contributions from Enron and its upper management, and sold over a quarter of million dollars of Enron stock before the scandal broke.
My sense is that Mrs. Gramm’s above quote just might make it into the hands of the plaintiffs’ lawyers who are suing Enron’s board and its insurers for billions.
Update: Barry Ritholtz over at The Big Picture is even more incredulous than me over this.
Update II: Just for clarification: I tend to agree with Ms. Gramm’s position that less government regulation of corporate governance is generally better than more. But I just don’t think she should be out front for that position on this particular issue. Her Enron legacy is serious baggage.

Steven Pearlstein of the Washington Post (free subscription required) has written this fine article on the problems in the American horse racing business.
Horse racing was one of the three — along with baseball and boxing — most popular sports in America in the early 20th century. However, abolition shut down almost all tracks in America and horse racing did not make a comeback until the 1930’s. That’s when state governments utilized pari-mutuel betting to generate revenue during the Great Depression era. Racing quickly became popular again, as the recent fine book and movie “Seabisbuit” relates well.
However, as Mr. Pearlstein’s article describes, racing struck a devil’s bargain by accepting dubious state regulation and taxation in return for its right to exist. Accordingly, while other professional sports skyrocked in popularity and value during the generation after World War II, horse racing remained mired in mud of governmental micro and mismanagement.
So, how is the industry attempting to change this course? The less creative approach is to beg the state governments to allow horse track owners to turn their facilities into “racinos” — that is, allow the owners to install slot machines at the tracks and split the take with the state.
On the other hand, Churchill Downs, Inc. is pursuing this consolidation business plan that would create what amounts to a national tour of quality tracks that would host competition of top horses similar in the same way the Tour Players’ Association puts on professional golf tournaments around the country. This approach seems to have at least a flavor of creativity that is utterly absent in the “racino” stategy.
One anecdote about horse tracks. Houston’s race track — Sam Houston Race Park in northwest Houston — was built in Houston during the early 1990’s, and promptly went into bankruptcy a year or two after it opened. A bright client of mine who was thinking about making an investment in the track to bring it out of bankruptcy asked me to sit in on a meeting with a representative of Churchill Downs, Inc. to determine whether they would be interested in being a co-investor and manager of the track.
During the meeting, the Churchill Downs rep indicated that the company had down a feasibility study on building a track in Houston several years earlier before deciding to pass. He disclosed that their study indicated that the best approach to developing horse racing in Houston was to start relatively small and expand the facility as the popularity of the product developed over time. Consequently, the study indicated that initially spending about $40 million (I may be off on the numbers a bit) and placing the track in a corridor between the Astrodome area on the north and the Gulf Greyhound Dog Racing track near Galveston on the south was the way to go.
“So,” I inquired or the Churchill Downs representative. “Where do you think the current owners went wrong with the Sam Houston Race Park?”
“Well,” he replied. “Except for spending more than twice as much as they should have in building it, and then placing it in the wrong location, nothing.”
My bright client passed on the investment opportunity.
Hat tip to Professor Sauer over at the Sports Economist for the link to article and this issue.

The leading expert on the regional economics of the Houston metropolitan area is Dr. Barton Smith, University of Houston professor of economics and director of the UH Institute for Regional Forecasting. This Chronicle article reports on Dr. Smith’s latest report on the local housing market that he gives a couple of times a year to the Houston real estate business community.
In short, Dr. Smith believes that rising interest rates aren’t a good trend, but that the city should escape the serious housing bust that is looming in other markets. Inasmuch as the difference between income levels and home values in Houston is not as wide as it is in some other cities, Dr. Smith believes that smaller difference should help the local housing market relative to other markets. However, Dr. Smith predicts that, by 2006, many regions will experience a harsh housing market correction where home prices will begin to fall.
While rising interest rates are not good for home sales, Dr. Smith believes they will have a more positive impact on one more troubled sector of the local housing market: apartments. Vacancies in Houston area apartments have increased as renters have abandoned their apartments in favor of buying homes at historically low interest rates. However, Dr. Smith reasons, once rates go back up, consumers won’t be in such a hurry to buy homes, creating more demand for apartments.
Nevertheless, due to overbuilding over the past several years, Dr. Smith predicts that it will take at least a year before the local apartment industry records any significant occupancy gains. With occupancy at 86.5 percent and nearly 15,000 units expected to be delivered in 2004, Smith gave the same advice yesterday that he gave to local developers in the early 1980’s immediately before the that decade’s bust in energy prices: “Stop building.”
Aside from the apartment industry, Dr. Smith was more bullish on other commercial sectors of the regional economy. He noted that the local office market had bottomed out and will improve this year. In general, the retail market appears healthy, but Dr. Smith observed that much of the new retail is simply diluting sales of older stores. Barring any unforeseen events (i.e., terrorist attacks), Dr. Smith predicted that the regional economy will continue to improve, and Houston could see 30,000 to 50,000 new jobs this year.Consequently, Dr. Smith overall was quite optimistic about the regional economy in his remarks on Thursday.
Dr. Smith reiterated his previous predictions that gentrification will increase in Houston’s inner core, and that substantial growth will continue in the city’s suburban areas. Dr. Smith predicted that the currently under construction Grand Parkway (Houston’s third and outermost “loop” outside of the existing 610 Loop and the outer Beltway loop) will be congested by 2025. To help alleviate congestion and environmental problems, Dr. Smith encouraged developers to build master-planned employment centers –such as The Woodlands in north Houston — that locate large amounts of workers in a single area near suburban employment centers and that have good access to the other metro area employment centers.

This Wall Street Journal article ($) provides a good update on the now two year old merger between Hewlett-Packard Co. and Houston-based Compaq Computer Corp.
The theory of the HP-Compaq merger was that it would remake HP. However, the new HP looks about the same (albeit bigger) as the old one.
Prior to the $19 billion deal closing in May 2002, HP had a mediocre computing business that was buttressed with a traditionally first rate printer unit that generated most of HP’s revenue and profit. Two years later, that profile hasn’t changed much. HP’s printer unit continues to contribute about 30% of quarterly revenue and 70% of quarterly profit.
HP is a much bigger company now, with annual revenues of more than $70 billion compared with about $45 billion before the merger. HP employs about 140,000 employees in 170 countries. Before the merger, that number was closer to 85,000.
Moreover, HP’s upper management is essentially unchanged since before the merger. Chief Executive Carly Fiorina still runs HP, and the HP executives who were in charge of the tech services and printer units before the Compaq merger remain in those roles.
The bottom line is that HP continues to face the same questions over growth and the relative value that such growth brings beyond its printing business. As of the close of trading yesterday, HP’s stock price was $19.78, just slightly ahead of its closing price of $18.22 on May 6, 2002, the day on which the Compaq merger was consummated.
That doesn’t please money managers, according to the WSJ article:

“At the end of the day, you’re still left with a company that has a great printing franchise but is struggling to sustain profitability in its other businesses,” says Marty Shagrin, an analyst at money-management firm Victory Capital Management. “Our analysis of HP’s business today isn’t meaningfully different from two years ago.”

HP contends that it is less dependent on printer revenue and profit and has become a more well-rounded company. Revenue from the printing unit accounted for 31% of H-P’s overall revenue in fiscal 2003, down from 43% in fiscal 2001. Although the printing unit made 79% of total profits in fiscal 2003, that percentage was down from 100% in fiscal 2001. Accordingly, HP maintains that trend is good, and is likely to continue.
On the other hand, some analysts argue that HP has simply diluted the profitability of its printer unit by spending on its PC and corporate computing business. One analyst in the WSJ article calculated that a pre-merger HP would have generated earnings of $1.59 a share in fiscal 2003 from its printing unit alone, while HP’s actual earnings were $1.16 a share that year. Indeed, HP’s printer business alone is valued at $21 a share, which means the market assigns almost no value to HP’s other businesses. Accordingly, the WSJ quotes one sage as observing “HP paid $19 billion for the privilege of hardly making any money in some of these other businesses.”
H’mm. As Professor Ribstein might observe, was the Compaq acquisition price so high that it took a near-delusional synergy theory for HP management to justify it?

Holman Jenkins’ WSJ ($) Business World column today examines of the blather that the owners of Google are trotting out to the public to promote their upcoming intial public offering. The entire column places the context of the Google IPO in the proper context of investing in such speculative endeavors, and the following are highlights of a few of Mr. Jenkins’ insightful observations:

Google’s founders don’t want to go public, their company doesn’t need the money, but they’re going public anyway. Why? To create a “liquidity event,” an opportunity for the founders, employees and venture investors to cash out some of the wealth they’ve been working for.
Being a sucker in somebody else’s liquidity event, of course, is not the sort of invitation investors normally leap at. Yet that’s the role IPO investors frequently volunteer themselves to play. In turn, Wall Street underwriters have traditionally seen their job as setting the IPO price low enough so those who ante up will be rewarded with first-day profits when the stock trades up — not just as a bribe, but as a token of good faith.
Yes, this tradition got out of hand in the Internet bubble, when new companies tripled or quadrupled in the first day. Bankers can hardly be faulted for pricing an IPO at a level reasonably related to a company’s earnings and prospects. Blame investors: They’re the ones who behaved strangely. Nor does Google solve this problem with its much-touted auction plan, which on closer inspection is somewhat faux. The company will indeed solicit bids over the Internet but reserves the right to set a final price by the visible hand of its owners and bankers. How come? Google and its bankers fear big institutional money will stay away unless assured of a first-day pop.

And what about that dual stock provision that gives Google’s current owners’ IPO shares ten times the voting power of an ordinary share?

As the prospectus frankly states, the goal is to entrench insiders in control of the company. Cofounder Larry Page’s celebrated Buffett-like letter is devoted mainly to explaining why this favor to himself is really in the interest of you, the potential shareholder:
“Because we’ll be able to focus on the long term without worrying about short-term pressure from Wall Street.” Moralizing about the long term versus the presumably disreputable and unvirtuous short term is mostly an evasion of real issues. The stock market is perfectly capable of taking a long view — witness the share prices of firms that Google hopes to keep company with, such as Yahoo and Amazon, which enjoy huge valuations compared to current earnings precisely because the market is betting on long-term potential.

“We provide many unusual benefits for our employees, including meals free of charge, doctors and washing machines. . . . Expect us to add benefits rather than pare them down over time.” The Googlers don’t mention the $800 heated toilet seats. Investors will have to judge whether such bennies are genuine productivity builders — or whether they count as “on-the-job consumption,” one of the “private benefits of control” that academic economists traditionally regard as the motive for voting-power lockups. To translate, that’s a nice way of saying insiders are living it up at shareholder’s expense.
“Dual class structures have not harmed the share price of companies.” If there’s no cost, then why don’t all companies avail themselves of the advantages Googlers see in the dual-share structure? In fact, a recent study by Harvard’s Paul Gompers and Joy Isshi and Wharton’s Andrew Metrick finds that such companies have reduced share valuations, and invest less in R&D and advertising. The authors conclude with the suspicion that a “misalignment of incentives leads dual-class firms to invest too little, leading to lower sales growth and valuations.”
We aim to “make the world a better place” and fulfill the company motto “don’t be evil.” Nobody fails to couch his or her motives in the higher good.

So, Mr. Jenkins urges investors who are assessing the Google IPO to look past the Google blather and focus on the owners’ motive in establishing a structure to retain control. However, Mr. Jenkins concludes with this salient point:

Google is owned by its owners, and they have every right to offer an interest to the public on whatever terms suit them. Fifteen years ago, a court tossed out an SEC attempt to ban dual-share issues, and quite properly, because there’s no compelling public interest to justify such interference in the property rights of company owners.