The Investor's Consigliere

Is Hal Varian a Machiavellian Genius, or is He Just Being Polite?

Hal Varian, former economics professor and current chief economist at Google, visited the Berkeley journalism school to discuss the future of the news business.  And by extension, to discuss the job prospects of journalism students. 

On balance Varian was optimistic.  Here he is on Apple's iPad:

"The future of news may lie in harnessing these kinds of devices . . . Users will likely engage with the tablet during peak leisure hours, and you would imagine that's very attractive to publishers."

On digital distribution of news and the opportunities to strip out costs:

Mr. Varian said he has been studying data on news publishing, ad revenue and circulation figures from the Newspaper Association of America, the Pew Research Center and other sources. His conclusion: Digital distribution will be a boon to newspaper publishers if they can also radically redefine their product and means of reaching consumers.

Typically, 53% of newspaper spending goes to traditional printing for distribution -- costs eliminated through digital distribution -- compared with 35% on what the Google exec called the "core" functions of news gathering, editorial and administration.

On what newspapers need to do:

Google wants to help publishers use web technology to grow, Mr. Varian said. "I think papers could better exploit the data they have. They need better contextual targeting and ad-effectiveness measurement."

. . . Instead, publishers should be looking at platforms such as the iPad to lure in readers during non-work hours, when they could presumably spend more time on individual news sites if they wanted to. "The challenge is, how can we make newspaper reading a leisure-time activity again? We know reading the news is valuable to our customers, but they don't spend much time doing it."

"Very attractive to publishers . . . a boon to newspaper publishers . . . Google wants to help publishers . . . the challenge is . . ."  A young journalism student could be forgiven for coming out of the talk with some confidence that, if only these challenges are successfully met, the future of the journalism business looks bright.

I'm not sure I agree.  Morever, I'm not sure Hal Varian agrees either.  First of all, there is a difference between saying the future of publishing is bright and saying the future of the publishing business is bright.  Everyone agrees the future of publishing is bright, if by "publishing" you just mean the amount of news that will be published in the future: that will explode.  The real question, for both journalists and investors, is whether anyone will make any money from all this publishing that everyone knows will happen.  That is, how many full-time journalists will the industry support?  None of Varian's "optimistic" suggestions address this. 

Maybe Varian is just being nice, trying to put the best face on what is at best a very uncertain situation, and at worst a looming disaster for the once-middle class occupation of journalism.  Or maybe, just maybe . . . he's a Machiavellian genius!  Here's the evidence for the latter:

Exhibit A:  Varian has a history.  In February 2008 he participated in an online Q&A with readers of the New York Times Freakonomics blog.  Here is one question, followed by Varian's answer:

Q: How can we explain the fairly entrenched position of Google, even though the differences in search algorithms are now only recognizable at the margins? Is there some hidden network effect that makes it better for all of us to use the same search engine?

A: The traditional forces that support market entrenchment, such as network effects, scale economies, and switching costs, don’t really apply to Google. To explain Google’s success, you have to go back to a much older economics concept: learning by doing. Google has been doing Web search for nearly 10 years, so it’s not surprising that we do it better than our competitors. And we’re working very hard to keep it that way!

That's . . . hard to believe.  I hope to tackle the question of Google's moat more fully in a future post, but for now I'll just say that Google did not get to 70+% market share in search just from "learning by doing."  

Exhibit B:  It's one thing for a media mogul to be overly optimistic; that's in their blood.  But Varian is a microeconomist (and a really good one) who should know better.  He knows full well that the recent decimation in the newspaper industry is not because readers refuse to read papers during their peak leisure hours.  He also knows that it's not enough to say that the costs of digital distribution of news will be much less than paper distribution--you must also look at who will capture that reduction in costs: consumers, employees, or shareholders.   And he similarly knows that any improvements in "contextual targeting and ad-effectiveness measurement" won't necessarily be shared with employees.

Exhibit C:  Varian is a fox in a henhouse.  Back in the Golden Age of Hollywood, the major studios (Warner Brothers, Paramount, Fox, Columbia, and MGM) used to love it when another wide-eyed starlet would get off the bus next to Schwab's drugstore with dreams of becoming a star.  Similarly, back when oil was discovered in Texas "the Majors"--those companies that refined, marketed and transported oil--encouraged the myth of the wildcatter, the independent oilman who could strike it rich at any time.  Why? Because both the studios and the Majors saw improved economics to the extent the supply of their "raw material" increased. 

Varian and Google are in the same position.  As far is they are concerned, the more web content the better.  Web content is the raw material of search.  To the extent the supply of this raw material increases, that improves Google's economics.  As far as I can tell, Varian never actually defined what he meant by "publisher."  When you and I think of a "publisher" we think of an important person who influences elections and so forth, and who can pay journalists a real salary.  Google thinks of a publisher as anyone who produces web content.  I am a publisher to Google.  Google wants 310 million publishers in this country.  If some of them happen to be indebted former journalism students, so much the better--they're more productive, like hamsters running on a wheel. 

I don't really think Hal Varian is an evil Machiavellian genius.  But note that he used to be a columnist for the New York Times.  Now he's Google's chief economist.  He's not the New York Times chief economist, mind you.  So he voted with his feet.

Buffett on M&A Valuation: How to Evaluate an Acquisition

I struggled a little to conceptualize in my own head the idea of one company issuing undervalued stock in order to acquire another company.  I understood that a company dilutes its existing shareholders when it issues undervalued stock, but I couldn't exactly quantify it.  In this CNBC interview transcript (starting at page 17) Warren Buffett explains one way to do it in the context of Kraft's acquisition of Cadbury, which he opposed:

1)  Start with the acquirer's "headline" valuation of the deal.  In this case, Kraft stated it was buying Cadbury for 13x EBITDA.

2)  Add to the purchase price whatever restructuring expenses the acquirer will have to pay in order to integrate the acquisition. 

3)  Add to the purchase price whatever deal expenses (legal and investment banking fees, etc.) the acquirer will have to pay to pursue and consummate the transaction.

Before even considering the issue of issuing stock, we can already see that Buffett thinks the "headline" purchase valuation is nonsense. 

4)  Now the stock issuance:  Take the number of shares to be issued by the acquirer as deal currency.

5)  Don't multiply that number by the per-share market value of the shares.  Instead, multiply it by your own estimate of the intrinsic value of the shares.  That product represents the stock portion of the deal.  In this case the result is to increase the purchase price of the acquisition, but when the stock of the acquiring company is overvalued, then the effect is to reduce the purchase price of an acquisition. 

6)  In this case, the headline acquisition multiple of 13x EBITDA became, by Buffett's estimation, a true multiple of 16-17x EBITDA. 

Disclosure:  Long Berkshire Hathaway

James Patterson

Interesting New York Times Magazine profile of author-businessman James Patterson, with some discussion of the modern economics of the book industry.

Peter Brant New York Times Profile

A snarky and gossipy article about Peter Brant in the Sunday Style business section of the Times.  With barely disguised glee, gossip columnist business reporter David Segal chronicles the decline in Brant's personal life.  With the little space he has left over, Segal also writes about Brant's recent business difficulties.  Below I've cut and pasted the business-only passages from the four-page article:

. . . he spent the last decade quietly expanding his newsprint manufacturing empire, borrowing hundreds of millions of dollars and gobbling up mills until his company, White Birch, was the second-largest player in North America.

By 2008, he seemed, like our economy, to be a spectacularly efficient money-making machine . . .

So what we have here is a portrait of love and leverage gone wrong, a reversal of fortune that — like so many stories of our economic cratering — would have been hard to imagine a little more than a year ago . . .

For years, the financial foundation of all these ventures has been the newsprint company, which Mr. Brant’s father co-founded in the 1940s. But these are dismal days for anyone selling paper to the print media. Several White Birch rivals have filed for bankruptcy, and White Birch missed an $18 million interest payment due in late September . . .

Mr. Brant’s creditors — a group of hedge funds — might be running out of patience. Last year, they hired a law firm, Latham & Watkins, and an investment bank, Rothschild, both of which have expertise in bankruptcy. This and other tea leaves have a number of analysts and trade reporters contending that White Birch may be on the verge of a major restructuring or worse.

“Information leaks out here and there, but the company is not very transparent,” says Jim Rowland, an analyst who tracks the newsprint business. “But we’re talking about a private company in an industry staring at an abyss of plummeting demand” . . .

“We think things are getting better,” he says, ignoring a cellphone ringing in his pocket as he discusses White Birch’s future. “This isn’t a situation where there’s a company that’s badly managed. This is a situation where the price of newsprint went from 700 and some odd dollars a ton to $420 a ton pretty quickly.”

He deflects any talk of an imminent bankruptcy and seems unbowed and upbeat for a man who says he personally has lost $1 billion in the span of two years. In a recent court filing, he said the ailing newsprint market and the recession had slashed his net worth to less than $500 million today from $1.4 billion in 2007 . . .

He left college without a diploma during his senior year and went to work at Brant-Allen Industries, a paper conversion company co-founded by his father, Murray Brant, an immigrant from a small town near the border of Romania and Bulgaria. Murray Brant spoke 13 languages and prompted his son’s interest in art, film and the newsprint business.

In the early ’70s, Mr. Brant and a cousin, Joseph Allen — the son of Murray Brant’s business partner — led the company into the manufacturing side of the business, acquiring a stake in a mill in Rivière-du-Loup, Quebec. Later, the company became partners with The Washington Post and Dow Jones, publisher of The Wall Street Journal, in a mill in Ashland, Va. . . .

ECONOMIC crises have a way of making bold decisions seem, in hindsight, like folly, and the last six years of Mr. Brant’s career in the newsprint business are a case in point. With Wall Street asserting a need for consolidation in Mr. Brant’s industry, the pace of his mill acquisitions picked up sharply in 2004.

That year, his company spent $205 million for a second manufacturer in Quebec (this one formerly owned by Enron). Two years later, it spent $135 million for yet another manufacturer in the same province.

By 2008, he had bought out his partner, Mr. Allen, changed the name of the company to White Birch and put another pile of chips on the table with his largest purchase to date: $305 million for SP Newsprint, a company with operations in Oregon and Georgia.

When this four-year buying spree was over, Mr. Brant controlled roughly 22 percent of North America’s newsprint market, second only to AbitibiBowater, which has 43 percent, according to John Maine, an economist at RISI, which provides information services to the forest products industry.

Unfortunately for Mr. Brant, he bought SP Newsprint just as a downturn in the advertising market was starting to crush print media, already battered by competition from the Internet. Magazines and newspapers shrank page sizes, reduced run rates, eliminated sections and, in more than a few cases, ceased publishing.

Newsprint use dropped 14 percent in 2008 and an additional 24 percent in 2009, according to Mr. Maine. With capacity outstripping demand, prices fell and mills were closed temporarily to reduce capacity. In some cases, the mills kept running but operated at a loss.

Early last year, AbitibiBowater filed for bankruptcy. In late December, a smaller company, Blue Heron, followed suit. White Birch’s own prospects are difficult to divine; as a private company, the particulars are known only to the principals and a handful of debt holders.

There are, however, occasional peeks behind the curtain. In November, Debtwire, a news service, reported that the company had renegotiated terms for that missed $18 million interest payment and was working out a restructuring agreement with holders of its $653 million credit facility.

“It could be that White Birch and the creditors have a prearranged plan,” says Andrew Ragsly, who covers White Birch for Debtwire. “The company could do something out of court where they say, ‘Lenders, you guys can take all the equity and own the company.’ That happens sometimes and a company avoids bankruptcy proceedings, but the result is the same.”

All murmurs to the contrary, Mr. Brant says that he likes his odds and that his relationship with his creditors is very good. “They understand the situation,” he says. “We think things are getting better — we’re seeing advertising come back; prices are going up again" . . .

The tone of the article is "What an idiot this rich guy is," which doesn't allow for much investigation into why Brant made the decisions he did.  But I'm always interested in why rich businesspeople do the things they do, and Brant's business fortunes are closely tied to those of the newspaper industry, historically a BMMT Capital favorite, so I tried to figure out what Brant was thinking.  And by the way, it's a little ironic to read an article about a rich scion of wealth who spends too much money and sees his wealth evaporate--in a newspaper owned by a company owned by . . . well let's just say that people in glass headquarters should not throw stones. 

Anyway, what was Brant thinking?  First of all, some might read the article and conclude that Brant was delusional for buying more newsprint companies when everyone knew that the future of print newspapers was grim.  As it turns out, everybody DID know the future of print newspapers was grim, with one caveat which I'll get to.  The 2003 10-K of newsprint competitor Bowater states clearly that U.S. newsprint demand is in decline and is threatened by the rise of digital media. 

Second, the caveat: while newsprint demand in the U.S. declined, newsprint demand in Asia skyrocketed.  Here is Wikipedia:  "World demand of newsprint in 2006 totaled about 37.2 million metric tonnes, according to the Montreal-based Pulp & Paper Products Council (PPPC). This was about 1.6% less than in 2000. Between 2000 and 2006, the biggest changes were in Asia—which saw newsprint demand grow by about 20%—and North America, where demand fell by about 25%. Demand in China virtually doubled during the period, to about 3.2 million metric tonnes . . . While demand has been trending down in North America in recent years, the rapid economic expansion of such Asian countries as China and India greatly benefited the print newspaper, and thus their newsprint suppliers. According to the World Association of Newspapers, in 2007 Asia was the home to 74 of the world’s 100 highest-circulation dailies. With millions of Chinese and Indians entering the ranks of those with disposable income, newspapers have gained readers along with other news media."  The New York Times article left this out for some reason.

Third: the subliminal effect of carefully chosen words like "bold decisions" and "he spent the last decade quietly expanding his newsprint manufacturing empire, borrowing hundreds of millions of dollars and gobbling up mills until his company, White Birch, was the second-largest player in North America" is to suggest that Brant's participation in the consolidation of the newsprint industry was some kind of ego-fueled all-in bet on the future of the industry, the business analog of buying all those Warhol paintings.   The evidence from the Abitibi-Bowater merger S-4, filed in March 2007, suggests the opposite: that the consolidation of the industry was the least-bad way to effect the capacity reductions that the industry needed and to improve per-unit competitiveness against new foreign competition.  You can argue that Brant should have been a consolidatee rather than a consolidator, but it's unfair to portray him as "gobbling up" mills to expand his "empire" in order to become the second-largest "player" in the industry.  The better bet is that he felt he had to do it.

Fourth: the strategy kind of worked!  Declining US demand was offset by burgeoning Asia demand, while at the same time industry capacity was removed.  Demand and supply trends combined to produce the following historical newsprint price trend:                          

Year                      Average Newsprint Price per Metric Ton  

2002                                            454

2003                                            481

2004                                            528

2005                                            583

2006                                            636

2007                                            601

2008                                            682

2009 (9 mos)                              588

Now, apparently it's not publicly known how much debt Brant took on to fund his consolidation relative to the earnings power he acquired.  It's very possible he leveraged his balance sheet too much, leaving him little margin of safety if industry conditions changed for the worse.  That would be a bad thing.  But it's also possible that he didn't, and was blindsided by the steep drop in newsprint prices just like everyone else.  Without the numbers it's hard to say, so I don't see how this is automatically a "tale of love and leverage gone wrong," or how Brant's story is somehow emblematic of an era.  You could just as easily write an article that the story of the New York Times Company in the 2000s was a tale of love (of dividends and print newspapers) and leverage (taken on to buy back stock and buy more print newspapers) gone wrong. 

I'm not necessarily a Peter Brant admirer, who after all did steal my wife.  But he doesn't deserve this hypocritical hatchet job.

Funds of Hedge Funds are Ganging Up on Their Managers

in the name of better disclosure.

Scientific Publishing

The media business is very seductive and glamorous, and people and companies get involved in it for all kinds of non-economic reasons.  One of the lessons the Dream Team teaches is that if you're focused strictly on economics, you have to un-seduce yourself and deglamourize where you allocate your time and capital. 

Case in point: scientific publishing.  Not seductive, not glamorous, but in the first six months of 2009 Elsevier, which is the medical and scientific publishing division of Reed Elsevier, earned operating profits of 32%.  And many of the journals Elsevier publishes are very expensive (they may have gotten too expensive, but that's another story). If you can convince people to pay a lot of money for your product, and you get to keep 32% of what they pay you, then you have a good business.

This article by Michael Clarke of the Scholarly Kitchen explains why scientific publishing is such a good business, so good that it has not suffered the upheavals that other forms of publishing have.

The Sack of Dulles, Virginia: How AOL's Moat was Breached and Why Time Warner Should Have Seen it Coming

More on the AOL Time Warner merger, which this book described as "the con of the century."  Ouch.  Hindsight is 20/20, and it's easy to forget that much conventional wisdom celebrated the merger when it was announced.  But if you examine the facts on the ground at the time in the context of certain unbreakable laws of business economics, as they were known to the participants at the time, it's difficult to escape the conclusion that the AOL Time Warner merger was . . . the con of the century.  Specifically, Time Warner's decision to  give half of itself away in exchange for half of AOL was unjustifiable even in those heady days.

Only two things could have possibly justified Time Warner's decision.  The first is that there were enough merger-related synergies, either marginal revenues that only a merger could bring about and/or marginal cost cuts that only a merger could enable.  The AOL Time Warner crew trumpeted total potential EBITDA synergies of $1 billion, which no one should have believed.  AOL's total EBITDA at the time was $1.8 billion; it was more than a stretch to believe that number could nearly double just by joining the Time Warner family.  If you want to read more, check out "The Curse of the Mogul." 

The second thing is that AOL was actually worth what Time Warner gave up for it.  What was the ex ante probability that that was true? 

    a) Time Warner was technically acquired at a 71% premium to its market price--if you invert the math you can also say that Time Warner bought AOL at a 42% discount to its market price. 

    b) AOL's stock closed at $73.75 on the eve of the merger announcement.  With about 2.61 billion diluted shares outstanding, that means it had a merger-day market cap of $192.5 billion.

   c)  AOL's EBITDA for the FY ended 6/30/2000 was about $1.8 billion.  Give the company the benefit of the doubt and assume that EBITDA is a useful proxy for the cash generating ability of the business--it works out to 26% margins on FY 2000 revenue of $6.886 billion.  That's a good business. 

   d)  $192.5 billion divided by $1.8 billion equals 107.  AOL was trading for 107 times that year's cash flow when it merged.  Time Warner paid a 42% discount, so it paid a multiple of 62 times that years' cash flow for AOL. 

Under what circumstances is it justified to pay 62 times cash flows for a business?  Only when the future cash flows of that business are so high as to justify it.  Did Time Warner have reason to believe this when it decided to give half of itself away?  Consider the following:

   i)  Just on general capitalist principle, it's extremely rare that a large public company ever grows into a cash flow multiple of 62 times.  There is a chart on page 107 of my edition of "Stocks for the Long Run" that shows the "warranted P/E ratio" of each of the legendary Nifty Fifty stocks of 1972, those companies widely considered the best companies in the world.  "Warranted P/E ratio" is defined as: that P/E ratio that would have produced a total return from 1972-1997 equal to the 1972-1999 returns of the S&P as a whole.  In other words, "warranted P/E ratio" answers the question "How much should an investor have paid, as a multiple of that year's earnings, for a stock, given its subsequent earnings growth?"  Of the entire Nifty 50, only three had a warranted P/E ratio above 62 times.  One sold water flavored with sugar, caffeine, and some other stuff listed in a bank vault in Atlanta.  One sold little sticks of tobacco that happened to be addictive.  And the third sold pharmaceutical drugs.  Everyone else came up short.  It's extremely rare for a public company to grow into a cash flow multiple of 62 times.

  ii)  Just on general human nature principle, it's extremely rare that when someone comes to you and offers to sell his company to you for the "bargain price" of 62 times cash flow, that you are in fact getting a bargain.  "Why come to me?  What have I done to deserve such generosity?" is the better response.

 iii)  The only way to be one of the extremely rare companies that can grow into a 62x multiple is to have a really really good moat in a growing industry, and the former is more important than the latter.  That AOL was in a fast-growing industry was true.  That it had a really really good moat was less true.

Let's examine the state of AOL's moat as of January 2000.  Think back to the supply chain that allowed a layperson like me to access this new thing called the internet:

1)  First I turn on my computer.  More than likely this computer was a PC running Microsoft Windows.

2)  I click on the "dial in to AOL" button, which triggers my modem to dial a telephone number and make that noise we all remember.

3)  On my screen appears "Welcome to AOL" and "You've Got Mail!" and off I go.  There are many many web pages owned by AOL, and I spend my entire session on them, looking at AOL-sold advertisements in the process.

Who did I pay along the way?  I paid something to Microsoft when I bought my PC, for access to its operating system.  I paid something every month for the use of the phone line that my modem used.  Then I paid AOL a monthly subscription for its very user-friendly way of accessing the internet, and for its very fun and informative and user-friendly web pages it directed me to.  As a bonus, a bunch of advertisers paid AOL to show their ads on its virtual real estate that I viewed.  These advertisers paid a lot of money to AOL because the internet was new and exciting, and because AOL had all these customers seemingly locked in.  It was a "walled garden," and in fact the AOL Time Warner merger even drew scrutiny from antitrust authorities and experts like Lawrence Lessig because they thought that with the addition of all the Time Warner online content the new company would be even more of a walled garden, favoring its own sites over non-AOL and non-Time Warner sites.

That was how I and many others accessed the new thing called the Internet circa January 2000.  AOL had two moats: it was a toll bridge that charged consumers about $20/month for its user-friendly way of getting on the internet.  And it was a toll bridge that charged advertisers for the privilege of selling stuff to its 23 million subscribers.

Now I have a confession to make.  I've been fibbing a little.  That was not how I accessed this new thing called the internet circa 2000, which, it's important to note, wasn't so new by then.  It was how my mother accessed the internet circa 2000.  I, on the other hand, was a senior in college by then.  Here is how I accessed the internet.  See if it sounds familiar:

1)  First I turned on my computer.  This computer was a PC running Windows, an operating system I paid Microsoft for up front when I bought my computer.   I also paid Microsoft up front for the operating system when I bought a new computer in 2007.  And I'll probably pay them a little when I buy my next computer.  Something tells me you will too.  As this guy might say:  "That's not a moat . . . THAT's a moat."

2)  I didn't need AOL at all to help me access the internet, nor did I need a phone line.  My college had wired my dorm with ethernet, so I just plugged my computer into the ethernet jack.  I didn't click an AOL button either because by that time my Windows operating system had a button that allowed me to open a browser called Internet Explorer.  The browser allowed me to get right on the internet with no problem and no AOL.  And it was free to use--actually it was bundled into the upfront cost of my operating system, but I didn't pay much attention to that at the time.  Microsoft fought something called a "Browser War" for the right to bundle its browser with its operating system.  It won that war: by the time of the AOL Time Warner merger it had a browser market share of 80% and growing, up from approximately zero in 1996. 

3)  When I finally reached the internet, I had very little interest in AOL's websites or email.  I had my own email address by then, and by then there were maybe a billion web sites that were not owned by AOL or Time Warner.  I cared about investing, so I spent a lot of time on Yahoo! Finance.  I cared about my college, so I spent a lot of time on my college's web site.  I cared about fitness, so I spent a lot of time on the web sites of a few gurus who knew how to build web sites from their basements using something called HTML.  I cared a lot about sex, so . . . never mind.  The point is, by the year 2000 you could spend the entire day surfing the internet without ever encountering one AOL web site.  And the growth of non-AOL web sites was expotential.  So exponential, in fact, that a bunch of people were already trying to figure out how to help organize it all.  One team, two Stanford graduate students named Larry and Sergei, had just six months before managed to attract $25 million of venture capital.  And advertisers were paying attention.  With every passing month AOL's advertising real estate diminished as a percentage of the total advertising real estate available.  As far as I was concerned, AOL's moat was non-existent.

Again, hindsight is always 20/20, but Time Warner really had no excuse for assuming AOL's moat would continue:

1)  As a general rule, technology that's easy for college students to use eventually becomes easy for their mothers to use.

2) Time Warner could have and should have known that non-AOL and non-Time Warner advertising real estate was growing exponentially, which would inevitably diminish the value of its own real estate.

3)  Most importantly, and most inexcusably, the seeds of AOL's eventual moat destruction were being sown . . . within Time Warner itself!  Time Warner Cable was hard at work upgrading its systems to allow always-on broadband connectivity to the internet.  It had a new service called Road Runner that was dedicated to providing faster and more reliable online access, a superior product to telephone modems. 

Then as now, a very bad deal.

 

Clay Shirky

Clary Shirky is a new media guru.  In this essay he presents his argument for the fundamental difference between old media and new media:

Scarcity means valuable things become more valuable, a conceptually easy change to integrate. Surplus, on the other hand, means previously valuable things stop being valuable, which freaks people out.

To make a historical analogy with the last major increase in the written word, you could earn a living in 1500 simply by knowing how to read and write. The spread of those abilities in the subsequent century had the curious property of making literacy both more essential and less professional; literacy became critical at the same time as the scribes lost their jobs.

The same thing is happening with publishing; in the 20th century, the mere fact of owning the apparatus to make something public, whether a printing press or a TV tower, made you a person of considerable importance. Today, though, publishing, in its sense of making things public, is becoming similarly de-professionalized; YouTube is now in the position of having to stop 8 year olds from becoming global publishers of video. The mere fact of being able to publish to a global audience is the new literacy, formerly valuable, now so widely available that you can't make any money with the basic capability any more.

If I read him right, Shirky sees the fundamantal capital-intensivity of old media as the main reason it was so profitable.  Only a few people could afford a TV tower or a printing press, therefore printing presses and TV towers were relatively scarce, and valuable.  I agree, but I'm not sure that's the whole story.  It doesn't fully explain the Golden Age of monopoly newspapers, for instance, or the fact that there are only five major Hollywood studios.  In future posts I hope to look into this further.

AOL/Time Warner Post-Mortem

In the New York Times.  Ten years later, the main players look back.  So do I, and here is what I conclude:

1)  Steve Case is not allowed to say this but merging with Time Warner was a great move for AOL shareholders.  In hindsight those shareholders should have sold their AOL shares at the pre-merger top but Case had a fiduciary duty to whoever would have bought them.  Case did the next best thing: he took a super-inflated currency and on behalf of his shareholders used to to but something pretty substantial.  Had AOL stayed independent, it would be worth zero today.

2)  On the other side of the deal, those who exchanged something substantial for AOL's super-inflated currency . . . do not belong on the BMMT Dream Team. 

3)  I've never heard so many flaky and fake-mystical justifications for the massive reallocation of other people's capital: 

"Unleash immense possibilities for economic growth, human understanding, and creative expression"

"vision of of how to combine AOL with a more traditional company in creating what at the time was going to be perceived as a company of the future."

"philosophically people were beginning to understand that the digital world was a transformational universe."

I guess it was not good enough to simply say "This merger will increase the per-share intrinsic value of the company."

4)  I adore Ted Turner; he's one of my favorite entrepreneurs and philanthropists and I love Ted's Montana Grill and everything.  But when it comes to cold-eyed calculation of the investment merits of a deal, I must say his former arch-enemy (and current Dream Team Member) Rupert Murdoch has him beat.  

5)  A little armchair psychoanalysis: Each member of BMMT Capital Partners (with the possible exception of the Thomson family, which I know less about) has deliberately set himself up outside the New York-based Establishment.  One of them lives in Omaha and hates to leave.  Another one lives the lone cowboy/lone sailor life in Colorado and Maine.  The third is a proud conservative among liberals.  I speculate that this set-up is not unrelated to their ability not to get caught up in the kind of mass hysteria that led to the Time Warner-AOL merger. 

Update:  I forgot the most important part, the part about moats.  Much of the futurology that went on surrounding the merger was right-on.  Here is the FT:  "The future they have glimpsed is one in which consumers and employers live in a permanently connected world.  Broadband communication networks would pipe all manner of information and entertainment to television sets, personal computers and other appliances not yet imagined.  Ubiquitous wireless gadgets would make it possible to work, communicate and be entertained from anywhere . . ."  Not a bad prediction.  But it's one thing to predict the future in business, and its another thing to predict the incidence of that future on the relevant participants.  In other words, who gets to make money from this future we're all envisioning?  Who is going to have a moat?  That was the main missing ingredient--no one ever asked "Does our merger partner have a moat?  Will it be able to make money from the future?"

Fox News

I'm starting a new category, which I'm going to call "BMMT Capital Partners: the Economics of New Media Investing." 

1)  My New Year's resolution is to spend more time thinking about great investments than great investors.  I feel like I'm running out of things to say about what makes a great investor in terms of psychology and how he sets up his fund and the incentives he faces, etc.  I'm now at the point where I simply think "a great investor is someone who makes great investments."  Therefore I think my job is really to find and study great investments and then work backwards to the people who make them.

2)  Part of knowing what makes a great investment is knowing what the market tends to misprice.  It's not enough simply to understand what makes a great business, because often what makes a great business great is well-known to the market and therefore not mispriced.  To get from a great business to a great investment you have to figure out what about it is mispriced.

3)  I believe what the market tends to misprice is the long-term earnings power of a company two to five years out from the time of investment, especially for younger companies, companies in changing industries, and/or companies entering new business lines.  The market was pretty good at pricing Coca-Cola's Q3 2009 earnings back June 2009.  It was less good at pricing its 1991-2000 earnings back in 1988, when Buffett made his big bet (see future post) after correctly forecasting a fundamental change in the economics of Coke's business.

4)  Those investors (whether they are stockpickers, PE investors, venture capital investors, or operating within businesses) who develop an edge in this area can make a lot of money.  You could have made a little money correctly predicting Coke's Q3 09 earnings a few months in advance, but you would have made a lot of money correctly predicting Coke's 1991-2000 earnings power back in the fall of 1988.

5)  What most determines the long-term earnings power of a company two to five years out AND is undervalued by the market is the quality and durability of its moat.  When Buffett bought Coke in 1988 he did not have any unique insights about the general growth of the soft drink industry in the coming two decades--his estimate was probably as good as the market's.  Where he did have an insight was in forecasting correctly the percentage of the future growth of the soft drink industry that would be captured by Coke rather than its competitors, which was a function of its moat.  He also had an insight in correctly forecasting the percentage of that future growth that would be captured by Coke's shareholders rather than its employees, suppliers, construction contractors, distribution partners, etc.  That too was a function of its moat.

6)  Those investors who can correctly forecast the quality and durability of a company's moat two to five years ahead of time can make a lot of money. 

So I want to study moats and how to forecast them.  I've decided to focus my efforts on moats in the media industry, for several reasons:

a) It's a fun industry.

b) It's undergoing a lot of change.

c) Many investors have made a lot of money investing in media in the past few decades.  Many investors have lost a lot of money investing in media in the past few years.  So you'll get a lot of mileage out of studying media if your goal is to judge investors.

What does the name "BMMT Capital Partners" mean?  I imagine assembling a Dream Team of the greatest media investors of the modern era, those who've made money in the last decades and who have managed to keep it or even grow it in the upheavals of the past few years, and asking them to form an investment partnership to invest in new media companies in the next decade.  They can make investments in existing companies, private equity, venture capital, whatever.  The goal is to forecast the future of moats, which is where the real money is.  My Dream Team is:

Buffett, Warren

Malone, John

Murdoch, Rupert

Thomson Family.

So please stay tuned.  In this category I plan to look at the media industry and its moats, and underlying everything will be the question "What would the Dream Team do?"

First up: check out this article about the rise of Fox News.  Forget about the politics and focus on the fact that the channel went from nothing in 1996 to current run-rate operating profit of $700 million, which if you capitalize at 10x comprises about a fifth of the equity value of its parent company News Corporation, and which is more than the combined earnings of CNN, MSNBC, and the evening newscasts of NBC, ABC, and CBS.  Rupert Murdoch's allocation of corporate capital to start Fox News has to rank among the best media investments of the past two decades, especially considering how poor the competition is.  Compare it to, say, the New York Times Company's decision to buy the Boston Globe, or to buy back its shares in the early years of the decade, and you'll see what I mean.  Now the New York Times can only write slightly snarky articles about media companies that make money, rather than being one itself. 

What was Dream Team Member Murdoch thinking when he made that bet back in the mid-1990s?  How to reverse engineer that great investment?  Here are my thoughts on what he did right:

1)  Murdoch is famous for ranting about how liberal the news media is.  I don't care about politics but in economics terms he happens to be right: In deciding to start a news operation with a conservative slant Murdoch was entering a field with almost no competition from traditional media conglomerates.  About half the company votes republican and in aggregate they spend the same money on cars, clothes, detergent, etc. as democrats do.  Advertisers don't care about politics either, they care about eyeballs and wallets.  So the decision to create a channel to connect advertisers to an underserved population of eyeballs and wallets was a great contrarian move.

2) Murdoch correctly forecast that cable channels would have the most durable and lucrative economics of all the various platforms for delivering news.  He did not start a newspaper with a conservative slant, or a magazine.  He did not start a broadcasting network with a conservative slant.  He did not start a website with a conservative slant.  He started a cable channel.  Another great move.  Interestingly, around this same time fellow Dream Team Member John Malone was reallocating his fortune away from cable systems and towards cable channels.

3)  Murdoch did the right thing by putting Roger Ailes in charge.  Ailes was the perfect person to execute Murdoch's strategy.

4)  Murdoch was patient.  Fox News did not make much money until 2003, but Murdoch had the ability and the willingness to continue to invest in it until it hit the tipping point of size and popularity that cable channels need to extract high carrying fees from cable systems.