The mighty are falling:

Where to find opportunity in the smoking ruins of global corporate structures

by J. Christoph Amberger

On August 14, the SEC would like to see the CEOs of a select number of companies put their John Hancocks underneath their quarterly statements. As I write my monthly letter to you, that date is still two days into the future. And as you undoubtedly have experienced yourself over the last couple of months, two days can be an eternity.

As of today, however, few companies have filed their statements. That doesn't mean a thing: most Americans file their personal income tax returns on April 15, and not a day earlier. (Even if that means giving Uncle Sam free use of your prospective tax refund dollars for a few additional weeks…)

Accounting departments are working overtime. European companies whose shares are traded in the States are crying foul. (As if they were above suspicion…) CFOs are sweating bullets. Comptrollers are digging out their green eyeshades, glad to once again be able to keep the glare of the “Big Picture Guys” from interfering with the numbers.

Not a numbers guy?

But what's it good for? A sizeable chunk of today’s crop of top-level executives—mainly those the SEC is currently interested in—often lack a detailed grasp of the actual numbers. That doesn't mean they don't know numbers. But the CEOs of the 90s contained a disproportionate segment of finance guys… with but a handful of credits in managerial accounting to their illustrious names. They knew how to cut up a cake and determine progressive valuations for options on cakes yet to be baked. They could parlay a day-old Danish into 67 offshore companies charging each other for sugar, jelly, flour, eggs, as well as transportation, shipment, supply management and supply management software development.

But frequently, the construction and expansion of hermetically sealed symbiotic corporate biospheres has interfered with obtaining a grasp of the basics. This is not something that is going to be eliminated by a CEO’s signature. It is something that has become endemic to many mega-companies… permeating not only accounting but also the entire business structure and strategy.

It’s also not a new or exclusively American symptom.

All in the family

If you have been with Taipan for a few years, you will have accompanied us on our profiteering forays into the then “emerging” markets of Southeast Asia back in the early and mid 1990s. This region of the world used to be infamous for its shady accounting practices… with many top-tier companies being owned and directed by family patriarchs and their tight-knit circle of relatives and retainers.

Much like Enron, WorldCom, and other companies (many of them unquestioned in their business ethics), they created companies out of thin air, often to provide a living for a young male relative, generally to provide services to the mother ship that up to then had been provided by outside vendors. IPOs were undertaken mainly to line the private coffers of the family, with not a second thought about shareholder value.

As globalization progressed throughout the last decade, the practice proliferated, not just in the U.S. and Asia, but in Europe as well. Even medium-size concerns may now have dozens of subsidiaries providing services to their collective center of gravity… from cleaning and maintenance companies, to real estate and finance institutions, to software development and IT companies.

The cost of a cleaning lady emptying baskets of shredded documents at Company A now appears as income to a specially formed Company B that is wholly owned by Company A, which is concurrently writing off a million-dollar investment in Company B for years to come.

There is noting wrong with this, mind you. It makes sense from a business and tax point of view. It also makes it excruciatingly difficult to figure out what the actual earnings of any given company are. And that is nothing a signature will take care of. A year from now, we may indeed see a handful of top-level execs in bright orange jumpsuits working along I-95 to boost the Roadkill Index of their state of incarceration. (More likely, however, their signature on the SEC documents will serve as a hook for civil suits filed by disgruntled investors.)

But unless their companies are completely and entirely restructured, it will make little difference to investors like you and me. After all, had these companies had decent earnings in the first place, you might argue that there would have been little need for structuring and accounting shenanigans.

Change of guard

In the short term, there will be hell to pay. Heads of CEOs have been rolling in the past weeks… and not just the crania of Enron and WorldCom. Just look at the recent dismissals of celebrity CEOs at Deutsche Telekom, Vivendi and Bertelsmann AG, where the aggressive “big picture” CEOs are being replaced by stodgy members of the Old Guard (as in the case of Bertelsmann) or even younger new talent who cut their teeth in some of the less publicized restructuring processes that went on over the last decade.

In many cases, this will mean the closing or merging of dozens of subsidiaries… and the streamlining of businesses by the sale of unproductive and peripheral recent additions.

But this change of tack does not mean the end of globalism. It doesn’t even signify a temporary intermission. It’s simply a shift in the currents.

Riding the waves

To be sure, we’ve seen wild swings in the past few months and weeks. It’s been enough to scare the bejeezus out of Evel Knievel. But the truth is that, despite all the griping and whining, this can be a very exciting, profit-rich time for investors.

Looking at the performance of the U.S. markets for the last 24 months—and
judging from what you read in the mainstream media—you could easily walk away with the impression that nobody is making money these days. (And judging from trading volumes, thousands of investors appear to have given up on the markets altogether, choosing instead to watch from the deceptive safety of the sidelines.)

Which I think is a big mistake. Because—notwithstanding the stomach-churning daily ups and downs of the indices—there has never been a more exciting time to make money. While the worrywarts complain, opportunity abounds. We’ve watched this same scenario time and time again over the years.

The right stuff

From a modern perspective, people in the late 16th century appear to have been morbidly preoccupied with death and mortality. Human skulls, carved in marble, granite and precious woods, provided a permanent “memento mori”—an admonition to “be mindful that you, too, will die.”

One of the achievements of the modern age has been to remove this sober sentiment from everyday life. As Nature became manageable by science and medicine, and Man was established as the sole top predator of man, the focus shifted to living your life within the safe confines of civilization.

But much like the atavistic invasions of Nature into this enclave—by temporary reversions to barbarism or by natural catastrophes—bear markets are capitalism’s way of pointing out that rules and assumptions are human artifacts that may not withstand reality if things take a turn for the worse.

These past weeks—with markets plummeting and rising without apparent reason or purpose other than to destroy wealth and comfort—probably have done more harm to the short-term future of stocks and equities than the previous year and a half. (Adam Lass will have something to say about this in his Market Alert below.) Whatever weak hands were in the market now have been eliminated for good. And all but the hardiest of the newbie investors who entered the markets in the past seven years based on untarnished profits and growth have been sent packing.

And yet, even this violent bloodletting is part of a healthy “natural” cycle. It redefines acceptable thresholds of pain, eliminates excess along with healthy growth… but at the same time creates new long-term opportunities for those with the stamina to carry on, and explosive short-term profit boosters for those adventurous souls with the courage and discipline to go against the sentiment of the mainstream.

Once again, I have called upon my colleagues here at the Taipan Group to provide you with their own detailed analysis as to where we are headed over the next quarter. I hope you will make good use of their insights, and safely maneuver your way through the next sets of rapids the markets have in store for us. (And don’t forget to sign up for our free email service, the Taipan Group’s 247profits e-Dispatch, to get our daily commentary on what’s going on in the global markets.)