On March 24, 2008 my first post on Why Airline Mergers Don’t Work opened with the following paragraph:

Ever wonder why over the last 30 years Southwest Airlines management (NYSE: LUV) spent only $0.03 on mergers and acquisitions for every $1.00 of shareholder value they created? By comparison Delta management (NYSE: DAL) spent $2.35 for every $1.00 of value they created. And Northwest (NYSE: NWA) spent $1.61 on M&A for every $1.00 of value they created. In Louisiana we have a name for this kind of strategy: Jumping over a dollar to get to a nickel.

A company’s brand name is among its most visible and valuable assets. So one would expect that the greater a brand’s value -- as a percent of its owner’s market cap -- the less its stock would suffer in a crash. Consciously or subconsciously investors are, like the rest of us, more comfortable and familiar with the better brands so they should naturally dump these stocks last on the way down.

The crash of ’08 provides an opportunity to design “natural market experiments” to answer important questions. Among them: did better brands suffer less than lesser brands?

On Tuesday morning May 5, 2009 I was interviewed by Connell McShane on Fox Business News live about my recent article Stress Testing: What’s Your Bank’s AQ? I spent a lot of time positioning the AQ score and describing how the good banks did. Then Connell asked me this question:

Wells Fargo is, forgive me, on the [Fed’s] naughty list … but Wells Fargo is number two on your [Good Bank] list. Is that right?

The Federal Reserve will not be releasing the results of its stress tests of the nation's biggest 19 banks until Thursday, and undoubtedly there is some element of folly in daring to beat the Fed to the punch. After all, according to The New York Times, the tests have been in the works for two months and have involved more than 150 regulators who, in addition to poring through voluminous bank data, have had the benefit of the banks' analyses of how various hypothetical situations will affect their loss rates.

Still, one can't help but wonder if there are other tools at hand that can get the job done properly without taking so long. In fact, I introduced such a tool in my last post – a bank’s asset quality (AQ) index. It enlists an engine of analysis that dwarfs even the Fed's 150 regulators -- namely the equity and debt markets. Quite simply, it compares a bank’s share of market capitalization to its share of revenues -- the interest it earns on producing assets plus fees for banking services. This provides a quick insight into how the share of value investors assign to these institutions compares with the share of revenues they earn on assets, which constitutes a direct measure of their investment quality.

On April 9, 2009 Eric Dash reported in The New York Times on the progress of the federal bank examiners' stress tests. The purpose of those tests is to determine how the nation’s biggest banks would hold up under simulated worst-case conditions. The good news is these banks are in better shape than many think, but:

… the tests, which are expected to be completed by the end of this month, are being conducted out of public view. Federal law prohibits the unauthorized disclosure of the results of any bank examination, including the stress tests. Some investors wonder if the new tests are rigorous enough, given the potential problems lurking inside the banking industry.

Everyone’s trying to figure out which banks are most likely to have hard-to-value assets on their balance sheets. I call these “hard-to-value” rather than “toxic” assets because what ever their value might turn out to be they’re not like a chemical dump.

New proposals appear every day. They range from setting up a “bad bank” to buy the assets, to running “stress tests” to see which banks would most likely fail/survive simulated worst case scenarios. One way to frame this problem is to assess the probability that any given bank holds a significant percent of hard-to-value assets in its portfolio.

Many people believe, and even more hope, that General Motors (GM) has a chance. As William Holstein put it in a recent Business Week article, the company was on the verge of emerging as a leaner, more innovative, and more competitive company by 2010—until the financial crisis hit and paralyzed the economy.

In my last post, GM's Natural Share Level, an analysis of the company’s break-even market share gave it a chance to survive in the short-term if it shrank from 24% to 13% of worldwide sales – nearly half its current size – and slashed its selling and administrative costs by $2 billion per quarter. Management’s February 17, 2009 report to the U.S. Treasury Department made it clear they had no intention of shrinking the business.

After weeks of debate in the press and the U.S. Congress, few concrete recommendations about how to ensure the future of the big three U.S. auto makers have surfaced. Lost in the noise is the following insight about the General Motors Corporation (GM) in a Bloomberg News interview of Jerry York:

As I look at the GM numbers, they’ve actually done 22.3% of the U.S. market year to date. But when you look at their level of fleet sales and the very heavy level of incentive spending to move product, their natural share level is down in the 15 to 17 % range.

Personalized medicine – diagnosis and treatment based on sequencing DNA -- burst into the headlines on September 18, 2008 with the revelation by Google (GOOG) co-founder Sergey Brin that he carries the rare Parkinson’s disease marker LLRK2:

… I learned something very important to me -- I carry the G2019S mutation and when my mother checked her account, she saw she carries it too. The exact implications of this are not entirely clear. … Nonetheless it is clear that I have a markedly higher chance of developing Parkinson's in my lifetime than the average person.

Stretching all the way back to 1841 when Charles Mackay -- the Scottish poet and journalist -- first published Extraordinary Popular Delusions and the Madness of Crowds there is evidence that crowds move markets. Which is the first of three maxims necessary to win with a headwind:

1. Crowds move markets.

“Law & Order” is the most successful TV franchise of all time and one of my favorite shows. If I rewrote the opening voice-over from that series to capture the essence of Competing for Customers and Capital it would read like this:

In the private enterprise system, investors are informed by two separate yet equally important groups -- customer markets where revenue is generated and capital markets where value is created: this is only one of the stories they have to tell.

Two-thirds of the market value of US companies is based on intangibles. Yet, the source of all this intangible market value is considered to be “a mere detail” in some stock pricing models. For example, intangible market value is not given even a passing mention in McKinsey & Co.’s widely read is Valuation (4th ed.) by Tim Koller, Marc Goedhart and David Vessels. And the internal costs of developing intangible assets are summarily dismissed by the rules of financial accounting:

Development costs for intangible assets can be capitalized only under the most stringent conditions (page 580).

The previous post in this series was Air Express Carriers: Mr. Smith Goes to Holland. In it I compared actual market shares with optimal ones for a combined FedEx (NYSE: FDX) and TNT [AEX: TNT] in a peer group that included the Swiss carrier Kuhne+Nagel [SWX: KNIN]; United Parcel Service (NYSE: UPS); and DHL [XET: DPW].

Here are the surprising conclusions from the analysis in that post:

COULD IT BE?
The previous post in this series was Air Carrier Wars: Managing Market Share for Optimal Earnings. In it I compared actual market shares with optimal ones for each of the five leading air express carriers: Kuhne+Nagel [SWX: KNIN]; TNT [AEX: TNT]; FedEx (NYSE: FDX); United Parcel Service (NYSE: UPS); and DHL [XET: DPW].

• DPW turned in the worst performance of the group. Its maximum earnings market share (31.8%) was a full 13 points less than its actual share (44.8%) of revenues.
• UPS turned in a much better relative performance with a maximum earnings share of 18.6% compared with actual share of 22.9%.
• FDX, TNT and KNIN all posted actual shares of revenue that were significantly less than their maximum earnings shares.

These findings begged two questions:

In Straight From the Gut Jack Welch said “If you’re not #1 or #2, fix it, sell it or close it.” His quote captured the spirit behind the development of the Profit Impact of Marketing Strategy [PIMS] studies by the Marketing Science Institute under the direction of Professor Robert D. Buzzell in the early 1970s. These two works have led nearly every CEO since then to believe that more market share means more profit.

A LITTLE HISTORY

Why is market share of revenues a strategic benchmark while market share of value is not even measured? There are several possibilities. Make a mental check of the following reasons that apply to your answer to this question:

_____ Market value is a financial metric
_____ Market share is a marketing metric
_____ Market value is too volatile
_____ Stock markets are efficient
_____ I haven't thought of it before
_____ All of the above.

In its 10-K filing (page 33) Amazon.com (NASDAQGS: AMZN) reported spending $1,174 million on outbound shipping in 2007. That amounted to 7.9% of revenues. The good news is Mr. Bezos also earned $740 million on those outbound shipments, a lot of it from the Amazon Prime Club annual membership dues.

A LITTLE BACKGROUND

Paul Goldberger’s article Situation Terminal in the April 21, 2008 issue of The New Yorker magazine reminds us that “Airports are essentially machines for processing people, airplanes, automobiles, cargo and baggage.” He also notes the most recent example of the huge impact passenger baggage handling has on airport operations:

… Terminal 5, an eight-billion-dollar structure that was supposed to transform Heathrow from a congested tangle into a place that would thrill passengers with the joy of air travel, all but shut down on its opening day, when a computerized baggage system malfunctioned (p. 132).

Nicola Clark reported in her article in the December 12, 2007, issue of the International Herald Tribune that the IATA predicts 2007 worldwide airline profits will be around $5.8 billion. Reuniting passengers with their mishandled baggage cost those same airlines $3.8 billion in 2006. And that number is bound to be greater in 2008. It probably will even exceed worldwide profits. This makes mishandled baggage a major problem for airlines.

UPDATE