Showing posts with label US. Show all posts
Showing posts with label US. Show all posts

Tuesday, July 24, 2012

Stratagem-INTERNATIONAL-TECHNOLOGY: BUBBLE IN THE MAKING

Question is: Will such a situation occur? The ecosystem does lack antibodies. Since early last year, investment banks have shifted gears, and money to grab a pie of the Internet machines, has started flowing-in thick. Just six months after paying a record $550 million to settle a Federal fraud case, in January 2011, Goldman Sachs (along with Russia’s Digital Sky Technologies) invested $450 million in Facebook (with a promise to help raise another $1.5 billion), valuing the social networking site at $50 billion (valued more than the world’s second largest automaker GM – $47.91 billion – and 200% more than the world’s largest aircraft manufacturer Airbus-EADS – $16.96 billion). Groupon, a deal-of-the-day website, turned down a $6 billion takeover bid by Google in January 2011, and is now planning an IPO, which will make it a $25 billion entity. Surprisingly, Twitter, which still hasn’t broken-even (it officially launched its first revenue model in March 2010, called “Promoted tweets” revenue model, four years after its launch), carries a price tag of $10 billion. Over the last five months, other VCs have also raised huge sums to invest in tech start-ups. Accel Partners, is about to raise $2 billion for investments in Facebook’s China and US operations. Others like Bessemer Venture Partners, Greylock Partners, Sequoia Capital, Andreessen Horowitz & Kleiner Perkins Caufield & Byers have collectively raised more than $4.5 billion since September 2010.

Speaking to B&E from New York, Greg Blonder, Former Chief Technical Advisor at AT&T, while explaining the rationale behind these deals says, “These valuations are too high for any single company. They are preferring PE funding for now because private stock sales retain much of the valuation bump. Furthermore, big banks need a conduit of private sales to feed their large clients who are otherwise dissatisfied with conventional investments. It’s simple economics – supply, demand and greed.” Even Prof. Steve Blank of Haas School of Business, in his 2011 paper titled, New rules for the new bubble, discusses the danger of over-valuations in the Internet market. He writes, “The signs of a new bubble have been appearing over the last year. It is being driven by market forces on a scale never seen before in the history of commerce.” There is some reassuring science too. One like this – in 1999, 308 tech companies came out with IPOs, while 2010 saw only 20 such instances. Accepted. But the game has just got riskier. Can you imagine someone valuing a cash-guzzling Twitter for $10 billion a decade back? According to Dealogic, a total of 5,100 inorganic deals were executed in this sphere last year – the highest since 2000. Moreover, the average deal size at $46 million is also higher than the average deal size in 2000 ($40 million). An analysis of the S&P 500 composite index (which include 75 tech stocks) based on Tobin-q for a cyclically adjusted P/E values also reveals that stocks are today overvalued by 40%. As of April 14, 2011, the P/E ratio of the technology sector stood at 17.61 – lower than the current P/E ratio estimates of Facebook (50) and Twitter (28).

Now that we know that there are chances of a bubble, what is it that can be done to control it? The key lies in a Fed intervention, which can control hyper sentiments in the market by sharply increasing Fed funds rate. But such a move might lead to all PE firms, VCs and angel investors from turning their head away from funding ideas germinating in university classrooms and company boardrooms. Some even debate that using a economy-wide hosepipe to control a growing fire in a particular sector isn’t very smart. Actually, it is, for this fire, though largely unseen by most now, threatens the world. Agreed. Every start-up is not Facebook. But investors around the world do not deserve bankruptcy because of one Harvard dorm-trick!



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Wednesday, July 18, 2012

Does R&D Really Pay?

When Apple came up with Mac, IBM was investing 100 times more in R&D than Apple... when Xerox was spending billions at its PARC research centre, others were becoming market leaders in laser printers and mouse, which Xerox invented... and now, when western CEOs are shying away from billion dollar R&D investments, Indian CEOs have began to pour in more and more... and that’s for a reason for sure!

Research & Die! That’s exactly what we said in 2006 (see 4Ps B&M issue dated September 14, 2006) when we argued that those prodigious commentaries on R&D’s capacious contributions to top & bottomlines, and those golden treatises on the voluminous powers of R&D were equivalent to one huge and most impressive looking word: Balderdash!

It all started at the start of this century when Dr. Scott J. Wallsten of Stanford wrote a paper titled ‘The R&D Boondoggle’, where he very strongly commented that internationally, leading firms have started investing lesser and lesser in R&D. And the reason, he deliberated, was that in general R&D spenders had received considerably lesser benefits than all others around them... Since then, time and again, researches have kept proving how even in the industries where R&D was supposed to provide the biggest benefits, it has gone on and accumulated losses that are statistically significant and not ignorable. What can be better examples than Sun Microsystems and Xerox, two prolific R&D investors? After investing over $2 billion in R&D every year for a decade and wiping out a large share of investors’ money, while the former finally got sold to Oracle, Xerox, which kept investing in R&D through its PARC research centre, failed to make money on its patents; even the laser printer and mouse, two of Xerox inventions, are now cash cows in the hands of competitors.

Unarguably, the devastation that the spectacularly researched Resilience Report (2005) of Booz Allen Hamilton, which surveyed the top 1,000 R&D spenders across the world (who constitute around 90% of the global corporate R&D spending) over six years, caused on the world of R&D remains unequalled till date. The report undertook the most massive correlation analysis between R&D and performance. We note here two statements from the report that have attained significance at least in contemporary history. The report statistically proved that “lavish R&D budgets don’t guarantee performance.” In fact, statistically again, the report turned the R&D world around with the statement that there existed “no correlation” between R&D spend and any performance factor (sales, profitability, shareholder return...). “No Correlation!”

To reconfirm if the trend sighted by the research still prevails, when we at B&E, with the statistical and research support of the IIPM Think Tank, carried out a similar correlation test on the top 20 R&D spenders in 2010 among the Fortune 500 companies (US) including the likes of Microsoft, Intel, Apple and IBM, the results came out to be even more shocking. The results indicate that over the past 5 years CAGR growth in R&D expenditure as a percentage of revenue has resulted in a decrease in revenue as well as profit and market capitalisation of these companies as they bear a negative correlation of 0.50, 0.64 and 0.36 respectively (see table below). Justifying the fact in a more intriguing manner Steve Ballmer, CEO, Microsoft, once said, “The lifeblood of our business is that R&D spend. There’s nothing that flows through a pipe or down a wire or anything else. We have to continuously create new innovation that lets people do something they didn’t think they could do the day before.” Microsoft under Ballmer has seen its m-cap destroyed from $580 billion at the start of this century to $230 billion right now (as on January 20, 2011). Despite his public statements, a fire-fighting Ballmer has reduced the company’s R&D billings as a percentage of revenue by 0.92% from 14.87% in 2006 to 13.95% in 2010. On similar lines, HP too brought down its R&D spend as a percentage of revenue by 1.57% between 2006 and 2010. Microsoft and HP managed to uplift their turnover by 41% to $62.4 billion and 37.5% to $126 billion respectively during the period R&D spend was reduced.

On the other hand, despite doubling up its R&D expenses from 4.11% of revenue to 9.53%, revenue per R&D dollar spent by Boeing has fallen dramatically to $10.50 in 2010 from $24.30 in 2006. The situation is no different for companies like Merck and Cheveron, which opted the R&D root to add to their top-lines over the past 5 years. In fact Merck, after investing more than $5 billion annually in R&D, with approximately 10,000 people, and with thousands of patents filed every year, has been able to introduce less than half a dozen new products in as many years. And their heart stopping story of Vioxx is a fable!

These results leave no doubt as to which way CEOs need to go when it’s about spending on R&D and the rate of acceptance of the fact is certainly improving at a smart rate. Be it MIT’s ‘Corporate R&D Scorecard’ – which proved how the top 150 corporate R&D spenders were investing significantly lesser and lesser in R&D – or the recently published (Winter 2010) Booz and Company report titled “The Global Innovation 1000” for 2010 – which indicated how the top 1000 R&D spenders of the world have cut down on their allocations on the front by 3.5%, to $503 billion in 2009 – they all stand tall vowing for the changing mindset. For that matter, over 55% of the global CEOs, who participated in 2010 NYSE Euronext CEO Report gave a huge thumbs down to any increase in R&D spending.


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MEXICO’S ECONOMIC REBOUND

So far, so good. The Mexican Policy Makers now need to get back to The Drawing Board if they want to Convert The Recent Rebound in Economic Activity into a long-term Sustainable Recovery. 

Further, much of the boost to the economic numbers comes from the Mexican government, which stepped up its assistance to the economy during 2010. Government consumption expenditures increased by 5.7% during Q2 2010 compared to a meager increase of 0.6% during Q2 2009. No doubt, the rebound has some teeth if Mexico’s export sector (exports of goods and services grew by 28.8% y-o-y during H1 2010) is examined, but this positive performance too is negated by a 25.9% increase in the imports during the same period.

So, is there a way out for this crime-prone nation that also has a history of bad economic decision making (Economic Deterioration in the 1970s, 1982 Debt Crisis, 1995 Tequila Crisis, to name a few)? While Banco de México didn’t respond to the queries sent by B&E (till the time this magazine went to print), Eugenio J. Aleman, the US based Senior Economist at Wells Fargo Securities tells B&E, “The Mexican economy requires serious reforms that must include constitutional changes to allow FDI in the all-important petroleum sector. However, we believe there is no political will to do this today. Maybe a change in the political landscape in the coming years will create the opportunity to move in this direction.”

No doubt, the government’s responses to the recent global financial crisis have helped the country weather the 2009 recession, but then Mexico’s key challenge now will be to reform its tax system to replace the declining share of oil revenues (which constitutes about 40% of total revenues) with tax revenues as the oil production in the country has fallen from over 2 million barrels per day in 2005 to below 1 million barrels per day. With Mexico’s tax revenues representing only 10% of GDP (Mexico has one of the lowest tax collection rates in Latin America), policymakers will now find it hard to meet the economy’s growing needs.

Further, Mexico’s over dependence on US, which makes it vulnerable to the economic threats, also needs to be done away with. Although Mexican policymakers have done their bit over the last 20 years through trade liberalisation, privatisation efforts, and a floating exchange rate regime, these policies have not been enough to protect Mexico from fluctuations in the US. What’s more? Mexico shipped about 80% of its total exports (about 26% of its GDP in 2009) to US last year. Thus, a change in US demand can have a severe impact on Mexico’s economic health.

No doubt, the Mexican economy is rebounding, but there is nothing much for policy makers to actually celebrate. And if they really want to do so, they definitely need to get back to the drawing board to craft structurally logical polices that ensure a steep rise in the gross fixed investments and tax revenues apart from some serious reforms which includes allowing FDI in all-important petroleum sector. Else, the war on drugs may soon become their secondary focus!


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