Following last week’s news that the price of a New York Stock Exchange seat had fallen to $1 million (a 63% drop from the peak price in 1999), this NY Times article examines the market forces that have caused the lackluster interest in the Exchange’s seats. As usual, the marketplace is the main reason, as it reacts to the NYSE’s increasingly obsolescent business model that has traditionally eschewed automation:

On an average day, the New York Stock Exchange trades 1.5 billion shares worth about $50 billion. Unlike almost all its competitors, it has traders on the floor who execute customer orders as well as their own orders in an effort to get the best price. Now the exchange has to decide how to maintain that identity while allowing more trades to be executed electronically.

The NYSE’s new business model is called the “hybrid market” model:

The . . . exchange’s ability to employ the automated market, called the hybrid market (humans in an auction, and computers matching orders) will determine whether the Big Board will keep attracting orders. If it fails, market share could fall.
. . . [T]he hybrid market will serve the exchange’s customers while maintaining the strengths of an auction market – namely the ability to get better prices rather than just deliver what appears on a computer screen. “The reason people come here is we have the best price 90 percent of the time and we have the best liquidity,” [said John Thain, the CEO of the NYSE]. “The more liquidity you have the better able you are to offer the best price, the more you have the best price, the more often the order flow comes to you. You cannot have one without the other.”

Nevertheless, the competition still expects the NYSE to continue losing market share, even under its new business model:

According to critics, more automation means that the New York Stock Exchange may lose its information advantage – the knowledge of what trades large players, such as mutual funds, are planning. Losing that knowledge could mean fewer orders. “There is a spiraling effect. As you lose the information, one customer takes his order off the floor, that translates to less information and less of an advantage,” said Chris Concannon, executive vice president at the Nasdaq exchange. He said he believed that the S.E.C.’s new rules and a hybrid model would erode the Big Board’s market share. “No single large electronic pool of liquidity will have more than 50 percent” of Big Board stock trading, he said.

And the NYSE’s changing nature better happen fast:

Critics and supporters agree that the New York Stock Exchange is not blessed with time. “The New York Central Railroad saw itself as a national icon and it was obliterated,” said Thomas Caldwell, chairman of Caldwell Asset Management and a buyer of four Big Board seats in the last year. “It ceased to exist. So many did. New York has to have a newer vision of itself and confidence in that vision.”

Now, I ask you, isn’t this a more effective and efficient way to change the NYSE than the method examined in this post and this post?

Dallas-based Southwest Airlines Co. announced Wednesday that start service to Pittsburgh International Airport in May.
Southwest’s move comes on the heels of US Airways Group‘s disastrous performance over the holiday season and the troubled airline’s service cuts at the airport. US Airways has gradually cut about half of its flights from Pittsburgh since the September 11, 2001 attacks on New York and Washington.
This is Southwest’s second move to compete directly with US Airways in Pennsylvania over the past year. In early 2004, Southwest entered the Philadelphia market that US Airways used to dominate, a move that has already increased traffic and lowered fares there. Southwest’s venture into Pittsburgh continues its countercyclical growth, which is reflected by its 10% capacity increase over the past year while most of the other airlines have been reeling.
By continuing to execute its tried and true low-cost business plan, Southwest has been able to remain profitable during the airline industry’s troubled period since the Sept. 11, 2001 attacks, and its strong liquidity position is unparalleled in the airline industry.

The Wall Street Journal’s ($) Holman Jenkins, Jr. finally weighs in on the Russian government’s heavy-handed takeover of OAO Yukos, and he correctly notes that the Yukos case signifies the end of any hope that Russian president Vladimir Putin will lead the country toward a European-style social democracy with an economy based on at least reasonably free markets:

Foreign investors puzzle over Mr. Putin and his seeming ineptitude at making Russia into Thailand writ large, a gracious and dutiful partner for trade and finance. But perhaps Mr. Putin never really had “reform” in mind. Western imaginations didn’t quite grasp that Saddam Hussein fancied himself a conqueror, an empire builder, a man of destiny (and was content to limit his country’s economic potential to the oil under his direct control). Western leaders and investors may be suffering from a similar myopia when it comes to Mr. Putin.

Mr. Jenkins goes on to point out that, despite Mr. Putin’s tactics, Western investors continue to line up to invest in various Russian business ventures. That’s true, but my sense is that it is a relative trickle in comparison to what the West would be willing to invest in Russia but for the Russian government’s takeover tactics. Until that changes, Russian economic development will continue to lag far behind the West.
Along similar lines, Boston Globe columnist Cathy Young — author of Growing Up in Moscow: Memories of a Soviet Girlhood (Ticknor & Field, 1989)– provides this Reason Online article on Mr. Putin and the implications of his grip on the Russian government for the West.

Krispy Kreme Doughnuts Inc. continued its slide toward chapter 11 as the company announced today that it plans to restate its results for fiscal 2004, that its failure to file financial reports will put it in default on its credit facility by mid-January, and that it has guaranteed payment of money borrowed by franchisees who are also in default of their debt agreements. Here are earlier posts that chronicle Krispy Kreme’s mounting financial problems.
The company said the restatement in earnings would would reduce net income for 2004 by between $3.8 million and $4.9 million, or 6.6% to 8.6%. The restatement is primarily due to improper accounting of the company’s acquisition of its Michigan franchisee, which is a problem that the company had previously acknowledged. Krispy Kreme has borrowed about $91 million under its credit facility, and does not currently have the capacity to borrow any more.
The trendy doughnut retailer has been hammered over the past year by a lethal combination of slowing sales growth, multiple investigations of its accounting and corporate governance practices (including investigations by the Securities and Exchange Commission and a special committee of the Krispy Kreme board), and mounting litigation pressure from various shareholder lawsuits. Today’s news knocked the company’s share price dow 10%, to $11.03 in midmorning trading on the New York Stock Exchange. Krispy Kreme’s stock price topped out at $49.74 during the summer of 2003.
Particularly troubling for creditors was the company’s announcement that about 30% of the $52 million of franchisee debt that the company has guaranteed is held by franchisees who are in default under their debt agreements. Although the company asserts that it has adequate liquidity on hand to pay for current operations, that cash will not be sufficient to pay any meaningful portion of that guaranteed franchisee debt anytime in the near future.
Compounding the company’s problems is an allegation that was made in one of the multiple shareholder lawsuits that has been filed against the company recently. The plaintiffs in that lawsuit — citing confidential former Krispy Kreme employees — contend that the company routinely padded its sales numbers by doubling doughnut shipments to wholesale customers at the end of each fiscal quarter.
It does not look like this is going to end well for Krispy Kreme’s current shareholders. Do you think Krispy Kreme will supply the doughnuts at its First Meeting of Creditors? Stay tuned.

Check out this interesting Cheryl Hall article in the Dallas Morning News that profiles 36 North Texas innovators who have changed the way we live. It’s not your typical place that can produce both the researchers who discovered statin drugs and the fellow who invented the first frozen margarita machine. Hat tip to Virginia Postrel for the pointer.

Houston-based Continental Airlines announced Wednesday that it will order Boeing Co.’s new high-efficiency 7E7 aircraft and accelerate the delivery of other Boeing aircraft that it previously ordered. Continental’s 7E7 aircraft order is the first by a U.S. airline and is a shot in the arm for Boeing’s marketing of the new aircraft.
Continental is buying 10 7E7s from Boeing with the first of the planes scheduled for delivery in 2009. The list purchase price on the aircraft is approximately $1.3 billion, although Continental will probably pay less than list.
The 7E7 deal illustrates that airlines are banking on reducing operating costs in an attempt to gain an advantage in the brutally competitive airline industry. The 7E7 is made of carbon-fiber composite materials instead of metals such as aluminum that are used on other aircraft, so Boeing is promoting the aircraft as being at least 20% cheaper to operate than older aircraft. Moreover, Boeing believes that the aircraft will be cheaper to manufacture.
Continental will use the 7E7s on international flights, and the purchase is part of a deal between Continental and Boeing under which Continental is attempting to increase the efficiency of its international flights, which are already more profitable than its domestic flights. Continental also will take delivery in 2006 of six Boeing 737-800 aircraft that were previously scheduled for delivery in 2008, and it will lease eight Boeing 757-300 aircraft next year. Continental will use those 737s and 757s on its domestic routes and deploy its 757s and 767s on its international routes.

This Wall Street Journal ($) article profiles the Texas Pacific Group, the Fort Worth-based investment fund founded by former bankruptcy lawyer David Bonderman and business whiz Jim Coulter in 1993.
Originally established to invest in and restructure Continental Airlines to avoid a third bankruptcy case for the airline, TGP has raised over $15 billion, with which it has bought control of companies ranging from Continental to the clothing retailer J. Crew to the Enron’s Northwest pipeline subsidiary, Portland General Electric. TGP is now one of the busiest and most-successful private-equity boutiques, controlling companies with combined annual revenue of more than $40 billion. Before fees, TGP’s return to investors have averaged 55% annually.
Interestingly, TGP’s success is directly tied to its policy of never hesitating to take on troubled companies that its competitors avoid. Moreover, despite its strong reputation and track record, TGP prefers to play behind-the-scenes — it is so invisible that it does not even have a Web site.

“The market often thinks we are crazy when we invest,” Mr. Coulter told the WSJ. “We have, however, made a decent living proving the market can be wrong.”

Read the entire article.

The airline industry in the United States is beset with an oversupply of airlines, a number of which have been wallowing in chapter 11 while unsecured creditors try to come to terms with the fact that their claims will never be paid. Here are prior posts from over the past year that examine the battered condition of the U.S. airline industry.
But US Airways Group Inc. may have done the rest of the American airline industry a favor — its management and employees outraged thousands of its customers by providing inadequate staffing, canceling flights and losing large amounts of luggage over the hectic holiday weekend.
US Airways pulled this stunt while operating in a chapter 22 bankruptcy case that it filed earlier this year after emerging from its prior chapter 11 case less than two years ago. While a big winter storm in the Midwest and Northeast complicated travel, US Airways’ incredibly poor performance alienated thousands of customers, many of whom will never even consider a US Airways flight again. Already faced with crucial financial deadlines in its bankruptcy case for reducing labor costs and persuading various lenders to provide additional forbearance, US Airways’ weekend performance should be the straw that breaks the camel’s back and pushes the company into a liquidation.
For its part, US Airways blamed more than 450 canceled weekend flights and thousands of pieces of stranded luggage on the winter storm and higher-than-usual numbers of sick calls during the crucial travel period. Over the weekend, US Airways’ flight-attendant sick calls ran around 300 a day instead of the usual 100 and that staff shortages were common among ramp workers at its big Philadelphia hub. As a result, unclaimed baggage continued to sit at Philadelphia International Airport and Washington’s Reagan National Airport, although the carrier had fewer than 1,000 pieces of luggage left to deliver on Monday, down from a peak of 10,000 lost bags over the weekend. The federal Transportation Department has already commenced an investigation into whether the staff shortages were a deliberate attempt by employee groups to undermine US Airways’ operations over the holiday weekend.
Is there any compelling reason for US Airways to continue operating?

As a part of a management shakeup, Fannie Mae decided late last week to fire KPMG LLP as its outside auditor after 35 years of service because its financial statements from 2001 through mid-2004 can “no longer should be relied upon.”
Oh well, announcements of accounting scandals are no longer any big deal in this post-Enron era where auditors are viewed by many as business cops that go on the take to cover up financial improprieties when they get too cozy with a client’s management.
However, what is not as widely reported is that Fannie Mae’s decision to dismiss KPMG is providing a glimpse of the big accounting firms’ increasingly precarious state of affairs. Indeed, with the firing of KPMG, it is not at all clear which big accounting firm is in a position to take on Fannie Mae as a client.
For all practical purposes, of the Big Four accounting firms — KPMG, Deloitte Touche Tohmatsu, Ernst & Young LLP and PricewaterhouseCoopers — Fannie Mae is left with essentially two choices: Deloitte & Touche LLP and PricewaterhouseCoopers.
Ernst & Young likely will not be the choice because it has already been advising Fannie’s audit committee and management in responding to various ongoing government probes. Similarly, Deloitte will not be the choice because it has been advising Fannie Mae’s chief regulator, the Office of Federal Housing Enterprise Oversight‘s (“Ofheo”) examination of Fannie’s accounting practices.
Normally, PricewaterhouseCoopers might be the choice because it does not currently provide any services to Fannie Mae. However, PricewaterhouseCoopers is the auditor for Freddie Mac, for whom it identified numerous accounting violations after replacing the criminalized Arthur Andersen LLP in 2002. Fannie Mae regulator Ofheo might not approve of both major mortgage corporations using PricewaterhouseCoopers as their outside auditor.
Consequently, the Fannie Mae situation highlights one of the largely ignored consequences of the federal government’s dubious decision to prosecute Andersen out of business over its role in the Enron accounting scandal: There are simply not enough big accounting firms left to provide audit services for the big companies that need them. Complicating matters even further is that each of the Big Four are literally under siege from civil lawsuits seeking large damage awards that could cripple any or all of them.
So, we already know that the government’s regulation of Andersen through criminalization of their audit services cost the marketplace thousands of jobs and one of the relatively few accounting firms that could provide the specialized services that big companies need. Now, we are coming to understand that this dubious governmental policy of criminalizing auditors may result in big companies not being able to to find auditors capable of providing adequate audit services at all.
Remember that the next time that you read a Justice Department press release touting its “success” in its prosecution of Andersen in connection with the Enron scandal.