Dan Ramsden's  Instablog

 

Krugman describes these two main parties as the “saltwater” and “freshwater” schools respectively. The “saltwater” party consists of academia along the oceanic coasts – Harvard, MIT, Princeton, Berkeley, and others – and is a descendant of John Maynard Keynes several generations removed. The “freshwater” party includes the inland universities, most notably the University of Chicago, and more or less follows from the foundation of Milton Friedman. Where the “saltwater” school leans in the direction of an activist fiscal policy approach, particularly at times of economic crisis, the “freshwater” party favors the pure and free market, with occasional and good-natured guidance of monetary policy to ease the way. The “saltwater” folks do not trust the free market left to its own devices. The “freshwater” school does not trust government intervention. This is all an oversimplification, but in essence the debate is one of left vs. right.

 

It is clear from Krugman’s overview that the “saltwater” school feels a sense of vindication in the wake of a global economic collapse that, by many accounts, was triggered by a free market gone wrong. The argument is that markets are not necessarily rational, that financial behavior has been irrational throughout the history of capital markets, and that a buffering, protecting, supervising mechanism is necessary to shield us from our own nature. The counter to this case, which Krugman does not really get into (thus betraying his own leaning), is that this protective mechanism is itself managed by human beings, who, like anybody anywhere, may themselves be prone to irrational behavior. If nothing else, Krugman’s article demonstrates the human and non-robotic and not always scientific nature of even those who stand firmly at the pinnacle of logic, mathematics, and objective reasoning: the economists themselves. How then, are we supposed to trust that more fragile group, the politicians?

 

But to take the argument even one step further, and returning to the other side of the coin, it seems that the market itself, free and full of enthusiastic participants as it is, could be described as disproportionately influenced by the so-called “smart money”, “big money”, “large institutional capital”, which has become more concentrated and consolidated in the recent past. Is it then really a question of Keynes vs. Friedman, salt- vs. freshwater, left vs. right, intervention vs. free market? Or is the economic debate more truly one between dominant forces: a public and a private sector respectively represented by strong central authorities? The idea of a “rational free market” is likely to suffer either way. And economics, as a science, is likely to migrate into the realm of literature, as observed.

Disclosure: No positions.

 

But what if we were to take the argument even further? Each part of the traditional media asset portfolio, from spectrum to content creation to infrastructure, can be repurposed and directed towards its most economic use, which use will quite possibly be found outside of the original medium, and perhaps outside of media altogether. In fact, we don’t have to limit this discussion to traditional media, but can probably say the same thing about many new media companies. Take Yahoo!, for instance, which seems to have come to similar realizations and is already in the process of reconfiguring, shedding, repurposing, redirecting, and undertaking all sorts of other techniques that essentially amount to a deconstruction of its perennial web presence.

 

The debate about conglomeration versus “pure-play” equity value is an old one, and every generation goes through a cycle of M&A activity geared at building varied asset portfolios, followed by a wave of divestments designed to refocus the enterprise again on its strength. From a financial perspective, the argument is one of risk reduction through diversification at the company level, versus risk reduction through diversification at the shareholder level, assuming that it is more efficient for an individual stockholder to own a diversified portfolio than for a company to acquire diverse properties.

 

But in the media example at hand, this debate is taken to an even more intense level. The argument is not for the deconglomeration of diversified holdings, but rather the decomposition of pure plays. The case is made for the segmentation of such assets into individual components that may be more efficient in combination elsewhere. A broadcaster, to illustrate the point, is not a conglomerate that consists of broadcast spectrum, a signal tower, and a sales force, but these are indeed components that can repurposed, or multi-purposed, outside of the core broadcast operation. The same can be said about Yahoo!, which isn’t a conglomerate consisting of an email service, a news portal, and an advertising network, just to pick a few of the company’s components, but each of these components can be used in ways and combinations that might enhance the overall value of the enterprise.

 

Should such deconstruction ideas take root, then not only the media industry but the broader economy overall may prove to be a treasure of hidden assets and untapped potential. The equity market that many believe now to be overbought, may unlock enormous upside sooner than we realize.

Disclosure: No positions.

 

According to a recent IPO market summary, there was a total of 21 IPOs in 2008, followed by a comparatively better 36 issues in 2009 to-date. In relative terms, these statistics are roughly on par with the 1978-1979 period, (that “stagflationary” time of double-digit interest rates and around-the-block lines at the gas station), and have not been seen since. Taken in isolation, this IPO issuance data suggests a virtually shut-down market… but that is misleading. In terms of dollar volume, the story is entirely different. The 21 IPOs completed in 2008 represented about $22 billion in proceeds, far above the proportions to which we had become accustomed even as recently as in the current decade. By way of contrast, the 2004-2007 years gave us about 170 +/- IPOs per year, comprising approximately $30-35 billion in proceeds in each of those. The increase in average deal size, from historical norms to the present time, is enormous. First observation.

 

Second observation. After the one step forward of a slight rebound in venture capital investing in the second quarter of 2009, the third quarter was two steps back. VC investment volume was down 38% from one quarter to the next, (and it isn’t as though the initial quarter was anything to write home about, goodness knows). On a year-over-year comparison, the median deal size has declined from $7 million to $5 million, and late-stage investments are now at roughly 40% of the total (compared to 33% one year ago). In summary, venture money is still not flowing well, and that which is flowing is flowing more timidly – in smaller increments – but not because the targets are more risky, in fact quite the contrary.

 

Third observation, which is partly anecdotal. We are hearing from countless borrowers and the investors who back them that the corporate credit market may well be improving for companies with at least $20 million in cash flows, but for borrowers with less than $10-15 million, corporate credit is nearly inexistent. Moreover, terms offered at the low end of the the $20-million-or-more cash flow range are by historical measures expensive, (despite currently low base rates on which such loans are priced). On the other hand at the high end, the bond issuers, and especially those with investment grade ratings, the capital markets are actually quite robust.

 

What we see in all three of these observations, taken from three entirely different market segments, is a concentration of capital flows underway, and this is directed squarely at size as a proxy for quality. Now, quality names and mature issuers have always been attractive… and a flight to quality is always a characteristic of a consolidating marketplace, either recovering from or in anticipation of negative results. What makes the current state different is, firstly, the enormity of the capital concentration and the drastic separation this creates between “haves” and “have-nots”, and, secondly, the era in which this is occurring. With all eyes on the markets and the economy, with so much hope pinned on or taken away by each day’s statistic or market fluctuation, and with critical decisions to be made at every level from the most individual to the most global on the basis of economic prospects, the true nature of such prospects is hugely important to understand.

 

Capital flows, taken in the aggregate, can cover up a much different reality beneath the surface.

Disclosure: No positions.