Tim Oren's Due Diligence

The Roving Eye: Poll Bias Revealed, Monetary Tightwire Act, The CRAmel's Nose

Just what you've suspected. Math and computer science professors Mark Schilling and Len Adelman (that's THE Adelman, the 'A' in RSA), analyze the various tracking polls from March through this week, and lay out their systematic bias. An overview here and the original paper here. Unsurprising, the polls run by the MSM are biased significantly to the left. Keep it in mind in the next few days.

A good read for beginning entrepreneurs. It's been out there a while, but I just bumped into it: This piece is a useful reflection on the old 'youth and enthusiasm meet age and cunning' rite of passage. YMMV re the applications to the current scene, but it's worth a read. Via TJICistan.

Deflation again. The MSM catches the meme. Unwinding leverage at all levels from i-banks to consumers puts pressure in this direction. The Fed et. al. are trying to compensate by injecting hundreds of billions in both usual and 'one time' ways. You've only to look at Japan after its real estate bubble collapsed to see what they are worried about. The least likely outcome is stability: What are the odds that this shoot-from-the-hip monetary policy happens to just compensate for the deflationary forces?

And I thought I could get obsessive. Everything you ever wanted to know about bands' recording studio setups and much, much, much, much more.

Dissecting the crash. American Thinker has a well documented blow-by-blow of how CRA lending and Fannie and Freddie helped create the mortgage crisis, and how they were politically forced or enabled. It's damning enough, but I think they err in emphasis on at least one point: Once the GSEs and the regulators and raters had been debauched, it wasn't CRA debt that made up the bulk of the never-should-have-been-written loans. With the door open and no rationale to keep them out, it was real estate punters plus average Joes trying to live above their means who made up the bulk of the bum loans. Update: More here.

You can see this graphically by replicating an experiment I did after my driving vacation in September: Bring up the curiously named but useful real estate service Hotpads, and click on the 'Foreclosures' tab. Search on your own metro area, or one you know well. Unfortunately, Hotpods doesn't have a 'satellite' view, so crank up Google Earth in another window. Now look for clusters of foreclosures in Hotpads, and then use GE to see what's actually on the ground. When I did this for four different metro areas (Medford, Vancouver, Boise and Reno) I found that the biggest clusters were associated with recent tract developments, the kind with the postage stamp lawns and the huge houses packed in tight. That's house flipper territory. When I do this on Bay Area regions that I know, there's a wash of possible CRA foreclosures in East Palo Alto and Menlo Park and Fair Oaks here on the Peninsula. But if you want to see the neighborhoods that have been hammered, you jump out to the growing edge of the East Bay beyond Dublin, or all the way out to Stockton and Merced in the Central Valley.

The Newspaper Crash of 2009: Addendum

(NB: The following is lightly edited from a comment I made in discussion about the "Newspaper Crash" post at Winds of Change. While I'm assuming that readers of this blog are more likely to be familiar with the art of reading corporate financials than those at Winds, it occurred to me that some here might find this interesting as well. So consider this a sort of 'footnote' to the last post that didn't make it in due to length.)

How can the linked newsosaur post about high newspaper profits be correct if my crash-and-burn forecast is as well? The second half of the newsosaur post does go into the tricks used to prop up profits, to some of which I alluded, and which are now running out. My best reply is to lay out some of the logic I used when spelunking through the newspapers' corporate financial statements to develop my thesis.

The best thing to have, of course, would be some actual churn, margin per sub, and acquisition cost figures. You can bet the newspaper know these. A decently managed subscriber business not only will track them in aggregate, but will stratify cost, churn and margin figures by source of subscription, age of account, and any other variable that seems relevant. Looking at them comparatively, or as a time history, is one of the most important tools for enhancing profitability overall, and figuring out where to grow and where cut back. Given how sensitive this information is competitively, and to future values, it never gets published openly. You have to make deductions based on metrics that must be publicized.

One of the most interesting is balance sheet 'goodwill'. Here's a nice layman's level article about goodwill. The basic notion is:

When recording a business acquisition, a company is required to recognize the assets acquired on its financial statements at fair market value. Any excess of what the company paid beyond the fair market value of the assets acquired is goodwill.

So if one newspaper buys another for a price beyond its book value, the difference goes onto the balance sheet as 'goodwill'. The argument is the buyer is rationally paying a premium because it believes it can turn that asset into value down the road. It used to be that goodwill was amortized over 40 years, but that left too much room for balance sheets inflated by goodwill that was no longer 'good'. So in 2002 FASB changed the rules. Instead the business has to conduct at least an annual impairment review on its goodwill, and mark down the value if it looks like it can no longer be supported by future earnings potential. This has a downside that it can make nominal profit/loss 'lumpy' based on one-time events, but from an analytic point of view it helps because at least once a year you will see the conclusions drawn by an internal assessment of the ongoing business.

When buying a newspaper, almost all of the goodwill value will be due to subscriber lists and the 'masthead' (brand). Any physical plant assets will be included in the 'book' value anyway. So logically, the goodwill from buying a paper is a proxy measure of the potential future cash flows from the subscribers. As described in the OP, those are an outcome of churn and future margins (the acquisition cost is embedded in the goodwill and other purchase price.) So when the accountants and auditors do their assessment on the value of the goodwill, they are in effect giving us a surrogate measure for the business' own estimate of discounted cash flows from that subscriber base. They don't have to tell us the raw churn and margin statistics, but they do have to render an opinion from calculations that are inevitably dominated by those numbers.

What do we find? Take the current whipping boy of the industry, McClatchy. In late 2006, they bought the newspaper assets of Knight-Ridder, and leveraged up to do it. There was some stock in the deal, and they then disposed of a few papers. When the ball stopped bouncing, McClatchy's accountants listed $3.56 billion in goodwill at the end of 2006, which should have some relationship to their estimated discounted cash flows from those subscribers in the future.

Then what happened? At the end of 2007, McClatchy listed only $1.04 billion in goodwill. In both Q3 and Q4 of that year, it had massive write-offs of goodwill, attributed to impairment of the mastheads and other assets they had bought. Since most of that value must be attributed to the health of the ongoing subscriber base, we're given direct evidence that margins and churn must be deteriorating rapidly, the more so since the company felt obliged to take write-offs in two consecutive quarters. This ties back directly to what newsosaur is saying about deteriorating ad revenues, which speak to margin. The company is next scheduled to report on goodwill impairment at the end of 2008. It will make interesting reading.

What about a healthier company? At the end of 2007, Gannett listed goodwill of just over $10 billion. In Q2, its internal review led to a mark-down to $7.87 billion. This was also an 'off cycle' review, due to "softening business conditions within the company's publishing segment..." Gannett will also have its next annual goodwill review at the end of 2008. The remaining goodwill represents better than half the company's listed assets, so it could be interesting as well.

Another financial worth investigating, but harder to describe simply, is the company's cash flows. Actual cash position, and the degree of management discretion over its use, is what you want to know when a company's back is to the wall. (Notional depreciation and amortization, among others, don't matter if you won't survive to see the next fiscal year.)

I like to find something akin to free cash flow though (as the wikipedia article describes) it's not always a formulaic process because you may be seeing side-effects of overall business growth or shrinkage or lumpy capital investments. Take out taxes, which are not discretionary, and you've got some measure of the actual cash that management can employ without hitting the equity or debt markets. Then take out interest and any other debt carrying costs. What you've got left is what management actually gets to use to build the business or keep the wolf from the door. If the debt service gets large compared to the discretionary cash flow, you're set up to get squeezed if either your debt costs go up, or your margins go down. Without going into details, by those measures McClatchy is in deep trouble, Gannett looks pretty good until they have to roll over debt, and NYT looks better because they didn't leverage up.

Oh, yeah, the latest subscriber numbers just came out WSJ and USA Today are hangin' in there. Everyone else is dropping.

The Newspaper Crash of 2009... And How You Can Help

(Cross-posted at Winds of Change)

Could things get much worse for the newspaper industry? After all, right now:

• McClatchy's September print advertising sales dropped 23 percent year on year (YOY).


• The entire industry is forecast to lose 16.5% of its annual ad revenue from 2007 to 2008.


• Q2 industry statistics show overall revenue dropping 13.9%, with a whopping loss of 27% YOY in classified.


• Gallup's polling shows that 52% of the American public do not trust news media.

As it turns out, they could get worse, and quite suddenly. Like the housing bubble and the financial crash, the signs are already there, and visible to those paying attention. It could be the credit crunch that puts the capper on the trends above and drives an entire industry sector over the brink. It couldn't happen to a more deserving bunch.

To understand why and how, a brief detour into the financial model of newspapers is necessary.

The Roving Eye: Disharmonic Convergence, Making Accuracy Illegal, TV Guide and AP Down

(I've been working on a few research projects the last couple of weeks. At least one of them will see the light of day here soon. Meanwhile, the latest gleanings from the intertubes.)

Common sense from Laffer. “If you tax people who work and pay people who don’t work, don’t expect more people to work.”

There's a name for it now. Adversarial information retrieval - trying to find what you want (or build an index for same) in the presence of those seeking to bias the outcome. Something I've described before as 'Index as Process'. The 'AIR' phrasing makes it clear what's at stake, and interestingly combines two of my own pet domains, search and security.

Global warming fauxtography. The Telegraph gets spun, running pix of Arctic sea ice sent their way by an environmental organization, that accidentally forgot to include data from this year, which is pretty much back to their 'before' year. And it gets better - per the ensuing discussion both the images are not actually photography, but are Photoshop creations.

Find the truth... and you'll get sued by the state. The New York Attorney General is trying to intimidate Arbitron into withdrawing a new and more accurate radio audience measurement technology. Seems it inconveniently has been showing (right leaning) talk radio stations with more listeners than under the old diary method, while measures for left-leaning minority audiences has dropped. Never mind free speech rights or contract, or simple truth, we can't have that! Hopefully this bit of attempted thuggery will fail, and at any rate the advertisers now know to discount the former Arbitron ratings. Or they can shift to the net, where audience accountability is not considered a sin.

The next punch against working taxpayers. Underfunded defined-benefit pension plans for public employees. While the taxpayers see their 401k's and IRAs head south, and businesses laying off, government continues to hire and pass out unsustainable retirement promises.

Congrats to India. Always glad to see another country getting serious about space. Given NASA's pace, the more bets the species has down, the better.

How the mighty have fallen. Back in the day, I remember a copy of TV Guide in the house every week. The print publication - the entire business, not just a single copy - has now been sold for one dollar.

Hurrying to catch up. The Associated Press, last seen here brandishing DMCA takedown orders, is bleeding. The Tribune Company already served notice that it would leave the news story co-op, and is now followed by the Columbus (OH) Dispatch in pulling out. Annual costs in the high six figures for a regional paper are daunting when the business is shrinking and large amounts of cash flow must be devoted to debt service. More about the shaky finances of the newspaper biz to come.

I Sure Hope I'm Wrong

Well, the House just passed the mother of all pork bill the bailout, and by his own statements Bush will sign it. What's just incredible is that we've had two weeks of 'debate' on this, and there's really no discussion of what securities Paulson is going to buy, from whom, and how they are going to be priced. With $700b on the table, the opportunities for cronyism and payoffs are rife; let's just hope there's some rationality and transparency involved. And hopefully someone is writing up a FOIA request for trades to be submitted as soon as the bill is signed.

There's reason to believe that this form of bailout will not help the commercial credit markets that matter the most. Cash is already flowing away from the private money market deposits that fund short term commercial credit, and further extending FDIC insurance (though a good idea if at the right time) and potentially dumping up to $700b of Fed securities into the short end of the market may well exacerbate things. And it's not like there was shortage of good ideas that didn't involve leaving the foxes in charge of the hen house.

Perhaps this is a West Coast thing; I see Michael Malone shares my contempt for the proceedings in DC. (Update: Not just the West Coast.) Unfortunately, California was not only perhaps the single biggest example of the housing fiasco, the state hasn't even put its affairs in order from the last bubble. Today the Governator has had to go hat in hand to the Feds asking for help in rolling over $7b in short term state debt. It's actually a sign of returning sanity in the markets that he has to do this. California not only spent the tax windfalls of the dotcom bubble, but thanks to its Democrat government it built the assumption of that revenue into its base budget. In spite of the tough guy image, Ahnuld has not had the stones to force cutbacks, but has connived in various accounting tricks to keep kicking the structural deficit can down the road.

The largest chunk of the state's revenue is derived from an income tax that hits mostly the top 10% of earners. This bracket derives much of its income from capital gains from securities and (secondarily) the housing market - neither of which is going to show up this year. Having the credit crunch flush out this kind of folly at the state and local government level would be a good side effect, and there's no reason the nation's taxpayers should be called upon to save them. It's time for the tax eaters to feel the bite along with the taxpayers.

Which Can You Trust: Congress Or Markets?

Congress' trust levels have flirted with single digit percentages for the last couple of years. Its current proceedings confirm that's where they belong.

Now that the first version of the financial bailout bill has failed in a display of partisan incompetence, some have been taking time to actually read what was almost passed. Far from a 'clear bill' to reassure the nation and markets in a time of crisis, it was larded with the type of earmarks that has become a hallmark of our degraded national legislature. Including at least the following:

• Film and Television Productions (Sec. 502)
• Wooden Arrows designed for use by children (Sec. 503)
• 6 page package of earmarks for litigants in the 1989 Exxon Valdez incident, Alaska (Sec. 504)
• Virgin Island and Puerto Rican Rum (Section 308)
• American Samoa (Sec. 309)
• Mine Rescue Teams (Sec. 310)
• Mine Safety Equipment (Sec. 311)
• Domestic Production Activities in Puerto Rico (Sec. 312)
• Indian Tribes (Sec. 314, 315)
• Railroads (Sec. 316)
• Auto Racing Tracks (317)
• District of Columbia (Sec. 322)
• Wool Research (Sec. 325)

Credit to commenter 'gabriel' at Winds of Change. As you can see, these are all clearly related to the financial crisis. </snark> Any questions about how Secretary Paulson's three page request grew to over a hundred pages? Curious as to what might be going on here, another Winds commenter tracked down the Wool Research item, finding a crony capitalism program that allows the government to dole out import tariff relief to politically selected corporate beneficiaries.

Who wrote these programs into the bill? Not known as yet, but it originated in the Democrat-controlled House of Representatives. And by the way, while they were stuffing the bill with pork seriously debating the financial crisis, they also had to pass a continuing resolution to fund the government, since there wasn't time to run a real budget through a public debate. Perhaps leading them to believe no one would notice the 2,760 earmarks totaling $19.1 billion inserted into the bill with no public debate or vote.

Not disgusted yet? Then maybe you can take eight minutes to watch this youtube of our Congress at work. Back when the Fannie and Freddie debacle might have been manageable. And yes, it's those same fine folks that you'll see telling how wonderful and reliable Fred and Fan are that are in charge of fixing things, at least if they manage to pass a 'bailout'.

The deeper you dig, the worse it looks. The US legislature cannot restore trust to the markets, because it has and deserves no trust itself. It already proved the point by almost passing a 'bailout' larded with special favors and political payoffs. The spectacle in Washington now is about log-rolling so that another bill, even longer and with more hidden payoffs, can get through the House.

There are some good ideas out there. Take care of those who took the word of bankers and brokers and put their moneys into savings and money funds. They were lied to, and deserve recompense. (No, it won't be free, and yes it will draw money away from other investments.) Temporarily suspend mark to market rules for illiquid positions. (Yes, there's moral hazard there as well, that's why temporary.)

But no bailout for those who took loans knowing they couldn't repay, and for those wrote them knowing they were fraudulent. Liquidate Fannie and Freddie, and bring on the FBI and forensic accountants to follow the money trails.

Open up the Fed window for sound banks, but let the negligent ones go to the wall. Those hyperventilating about a sky-high LIBOR miss the point. It's high because no one knows who can be trusted, which institutions are sound. How is letting a corrupt Congress adjudicate that question politically going to resolve the issue? Stock prices are showing that the market can tell the difference, let it do its work. Try to fool the markets with political flim-flam again, and the eventual butcher's bill will be even worse.

If there were any decency in Congress, there would be resignations from chairmanships or office over this, but there won't be. There is no shame. The best we can hope for is that the hole isn't being dug deeper. The longer the bill reported, the less time for debate and public examination, you can bet the more payoffs and favors will be in it.

No bailout bill.

Update: It's just as bad as I feared. The Senate version of the bailout is now over 450 pages. They are busy tacking on all sort of little jingly bits to buy support. A $3.8 billion unfunded mental health insurance mandate; since clearly those responsible for this mess need their heads examined. I support AMT reform (nay, repeal!) but this is not the place to do it. Ditto R&D tax credits. A piece of pork for everyone, wonder who's to pay. Check the mirror when you're shaving / putting on makeup in the morning.

Update 2: more on the pork from Bloomberg.