Recently in M&A Category

Congratulations to forensic journalist Neil Chenoweth and his colleagues on their 2008 Walkley Award for Business Journalism: an investigation into the failed stockbrokers Opes Prime.

I interviewed Chenoweth in 2002 for a Masters paper on Rupert Murdoch's negotiation strategies.  During our talk, Chenoweth gave me a couple of "aha!" moments on how to conduct a forensic journalism investigation, Murdoch's use of game theory to understand other parties in a deal, and the murky underworld of cable and satellite television.

Chenoweth writes regularly for the Australian Financial Review, an Antipodean equivalent of the pre-Murdoch Wall Street Journal.  Chenoweth's Virtual Murdoch: Reality Wars on the Information Superhighway (Secker & Warburg, London, 2001), published in the US with new material as Rupert Murdoch (Random House, New York, 2004) chronicles his decade-long investigation into the world's most powerful media mogul.  Read a chapter-by-chapter summary here.  Chenoweth's book Packer's Lunch (Random House, Sydney, 2006), reviewed here, also has substantial research on Sydney's corporate dealmakers in the 1990s and their Swiss bank accounts.

I recently blogged about a presentation the 2008 Communications Policy Research Forum in Sydney on disruptive innovation in the music industry.

You can now download an Adobe PDF version of the PowerPoint slides here.

The refereed paper has been published in the Proceedings of the Communications Policy Research Forum 2008 (pp. 155-175 or PDF file pp. 179-199).  You can also download a local copy of the paper here.

The paper's case study examines why Radiohead and Nine Inch Nails released their new albums as digital downloads.  I suggest a major reason why, and one that was overlooked by Web 2.0 pundits, is that each artist was in the 'label shopping phase' of a new contract and defected after negotiation problems with their major labels.  This fits a pattern in mergers and acquisitions: the major labels lost artists due to integration problems in a merger or acquisition.  Terra Firma Capital Partners has since partially confirmed this hypothesis: the private equity firm endures more post-acquisition integration problems with EMI and is fighting against government regulation of Great Britain's financial services sector.

The paper's data appendices contrast the artists' strategies with signficant events and innovations in music industry contracts, conglomerate mergers and deal structures.  Somehow I missed U2's March 2008 deal with Live Nation: I found out about it in an October 2008 announcement.  Guns n' Roses also finally released Chinese Democracy (MySpace audio stream): a new album that has taken 15 years, a rumoured US$14 million budget and 14 recording studios in New York, Los Angeles, Las Vegas and London.  I may write a paper on it . . .

Recently I posed two questions about Foresight in Organisations: What are are the intervention points?  After five or six years, who are the teachable case studies for successful implementation of the foresight function?

I've only read the Los Angeles Times and New York Times reviews but Charles D. Ellis's The Partnership: The Making of Goldman Sachs (Penguin Press HC, New York, 2008) has some answers to both questions.

Ellis suggests Goldman Sachs has three intervention points to cultivate a foresight function: (1) a human resources function staffed by A+ people who recruit "A+++ people" usually in computational finance, financial engineering and statistical arbitrage; (2) an organisational culture tolerant of the "longer-term view" that is linked to the "[operational] details" necessary for strategic execution; and (3) a creative tension between past excellence and new frontiers.  Intriguingly, the "longer-term view" or "forward view" in Foresight parlance, emerges from people in a supportive culture who are faced with challenge at the boundary of the firm and the external competitive environment.

Two other biographies partially validate Ellis's insights.

Perry Mehrling's biography Fischer Black and the Revolutionary Idea of Finance (New York: John Wiley & Sons, 2005) and his working paper 'Understanding Fischer Black' describe why Goldman Sachs recruited the economist Black: to tap his academic knowledge to design new financial instruments, and use his influence as coauthor of the Black-Scholes equation in finance to impress clients.

Emanuel Derman describes his Goldman Sachs collaboration with Black in My Life As A Quant: Reflections on Physics and Finance (New York: John Wiley & Sons, 2004) and how the firm benefited from the influx of PhD graduates in the 1980s.  Derman was bored at AT&T Bell Labs which had a reactive culture of research management.  He transitioned into Goldman Sachs' fixed income division in 1985 and then moved to equities in 1990 where he thrived for the next decade in a culture that appreciated how conceptual expertise can underpin a firm's competitive advantage in new growth markets.

The contrast was so different that I pointed Derman's experience out in a private submission to Australia's National Innovation System Review (aka Cutler Innovation Review) in comments about the institutional design and research management culture of Cooperative Research Centre consortia.  Maybe given the subprime fallout CRCs can also learn something from Goldman Sachs and Berkshire Hathaway's Warren Buffett who has now taken a $US5 billion equity stake in Sachs' foresight culture.

I recently spoke at the 2008 Communications Policy Research Forum in Sydney on disruptive innovation in the music industry.  My presentation looked at the reasons for why Radiohead and Nine Inch Nails pursued online release strategies for their respective albums In Rainbows (2007) and The Slip (2008), and evolved from some initial thoughts here. The reasons suggested in media coverage - Web 2.0 experiments, disruptive innovation and freeconomics - were 'true yet partial' explanations.  They overlooked two significant facts: (1) both artists were in the 'label shopping' phase near the end of their contracts; and (2) both artists were frustrated with their respective labels EMI and UMG, who each triggered artist defections due to post-merger integration problems.  The presentation also discusses the role of Disruptive Innovation Markets, the Disruptive Information Revelation principle, and lessons for journalists, new media theorists, policymakers and valuation analysts.  Thanks to the Network Insight Institute team (Mark Armstrong, Cristina Abad and Mark Armstrong) and the two anonymous reviewers for their help.

Has Tim O'Reilly's Web 2.0 meme become a high-tech bubble about to burst?

Origins of the Web 2.0 Boom

O'Reilly's vision of a new Web platform originally fused two developments.

The first development: C, Smalltalk and object oriented programmers devised design patterns in the early 1990s to reuse software code and workaround solutions across projects.  A 1995 catalog catapulted its four authors to software engineering fame.  To capture the rapidly growing number of design patterns programmer Ward Cunningham created the first wiki: the Portland Patterns Repository.

The second development: a re-evaluation of dotcom era business models to encompass new technologies that enhanced the end-user experience including the site interface and information architecture.  Industry buzz around News Corporation's acquisition of MySpace (18th July 2005), Yahoo!'s purchase of Flickr (21st March 2005) and del.ico.us (9th December 2005), and Google's stock-for-stock deal for YouTube (9th October 2006) made O'Reilly's vision the 'default' vision for Web pundits and investors.

The media's buzz cycle soon went into warp speed as Facebook frenzy replaced MySpace mania.  In a move that exemplified the pivotal role of complementors O'Reilly & Associates morphed into the juggernaut O'Reilly Media.  Ajax and Ruby Rails soon replaced Java and C# as the languages for new programmers to learn.  For activists in community-based media, angel investors investing in scalable programming prototypes and international conglomerates seeking to control their industry white-spaces Web 2.0 provided an all-encompassing answer to venture capitalists on how they would change the world.

Two Scenarios: Web 2.0 Boom & Bust

For industry pundits Google's decision in October 2008 not to acquire Digg may signal the Web 2.0 boom has become a bubble.  If true Google's decision could be the mirror of News Corporation and Yahoo!'s acquisitions in 2005.  Slate's Chris Anderson points to several factors: no tech IPOs in the second quarter of 2008, the cyclical nature of the digital consumer market, the exit of Yahoo! as a potential buyer due to internal problems, market noise due to low barriers of entry for startups, and a smaller "window of opportunity in which startups can think of a new neat trick, generate buzz, and cash out."  YouTube's co-founder Jawed Karim adamently believes that Silicon Valley is in a bubble.

Twitter is the latest startup in the duelling scenarios of Web 2.0 boom versus bust. New York Times journalist Adam Lashinsky experiences a similar euphoria to Facebook and YouTube when he visits Twitter's co-founder Jack Dorsey.  Sceptics counter that Facebook and YouTube have not 'monetised' their business models into profitable revenues.  Portfolio's Sam Gustin raises the 'monetisation' problem with Twitter co-founder Biz Stone who believes that service reliability is a priority over the "distraction" of revenue pressures.  In support of Stone's position Anderson observes that cloud computing and open source software are lowering the operational costs and slowing the burn rates of startups.

Yet monetisation remains a primary concern for Sand Hill Road entrepreneurs and other venture capitalists.  They differ in their decision-making criteria to Web 2.0 pundits and high-tech futurists: for angel investors and first round VC funding the entrepreneurs will demand a solid management team, the execution ability to control an industry whitespace, and viable sources of future revenue growth.  This is the realm of financial ratios and mark-to-market valuation rather than normative beliefs and ideals which probably influenced the acquiring firm's decisions and valuation models in 2005-06.

Furthermore, if a Web 2.0 bust scenario is in play, the 'contrarian' sceptics will look to Charles Mackay, Charles P. Kindleberger, Joseph Stiglitz and other chroniclers of past bubbles, contagion and manias for guidance.  With different frames and time horizons the Web 2.0 pundits, high-tech futurists and venture capitalists will continue to talk past each other, creating still more Twitter microblogging, blog posts and media coverage.

Several preliminary conclusions can be drawn from the Web 2.0 boom/bust debate.  In a powerful case of futures thinking O'Reilly's original Web 2.0 definition envisioned the conceptual frontier which enabled the social network or user-generated site of your choice to come into being.  The successful Web 2.0 startups in Silicon Valley have a distinctive strategy comparable to their dotcom era counterparts in Los Angeles and New York's Silicon Alley.  Web 2.0 advocates who justify their stance with MySpace, YouTube and del.icio.us are still vulnerable to hindsight and survivorship biases. There's a middle ground here to integrate the deep conceptual insights of high-tech futurists with the quantitative precision of valuation models.

It's possible that the high-visibility Web 2.0 acquisitions in 2005-06 were due to a consolidation wave and strategic moves/counter-moves by their acquirers in a larger competitive game.  There are two precedents for this view.  Industry deregulation sparked a mergers and acquisitions boom in Europe's telecommunications sector in the late 1990s comparable to the mid-1980s leveraged buyout wave in the United States.  Several factors including pension fund managers, day trading culture and the 1999 repeal of the US Glass-Steagall Act combined to accelerate the 1995-2000 dotcom bubble.  Thus, analysts who want to understand the boom/bust dynamics need to combine elements and factors from Web 2.0 pundits, high tech futurists and venture capitalists.

If the Web 2.0 boom has become a bubble then all is not lost.  Future entrepreneurs can take their cue from Newsweek journalist Daniel Gross and his book Pop! Why Bubbles Are Great for the Economy (Collins, New York, 2007): the wreckage from near-future busts may become the foundation of future bubbles.  Web 3.0 debates are already in play and will soon be eclipsed by Ray Kurzweil's Transhumanist agenda for Web 23.0.

Bryan Burrough is legendary in M&A circles for co-writing Barbarians at the Gate (Harper & Row, New York, 1990) with John Helyar, the cautionary tale of RJR Nabisco's leveraged buyout and the winner's curse faced by deal-maker Henry Kravis.

Burrough's latest investigation for Vanity Fair contends that short sellers used CNBC and other media outlets to spread rumours that destabilised Bear Stearns and sparked a liquidity run on the investment bank's capital.  Burrough's thesis has sparked debate that overshadows his investigation's strengths: a strong narrative and character portraits, new details of the negotiations with JPMorgan Chase and the Federal Reserve, and a cause-effect arc that shifts from CNBC's internal editorial debate to the effects its coverage has on the marketplace and the subjective perceptions of individual investors and senior decision-makers.

In the absence of a 'secret team' or a 'smoking gun' how could Burrough's thesis be tested?

Theoretically, Burrough's hypothesis fits with: (1) a broad pattern over two decades of how media outlets respond to media vectors, systemic crises and geostrategic surprises; (2) the causal loop dynamics and leverage points in systems modelling; (3) the impact that effective agitative propaganda can have in psychological operations; and (4) the complex dynamics and 'strange loops' in rumour markets (behavioural finance) and rumour panics (sociology), notably 'information cascade' effects on 'rational herds'.

This is likely a 'correlation-not-cause' error although it does suggest a dark possibility for strategic intervention in financial markets: could this illustrative/theoretical knowledge be codified to create an institutional capability, deployed operantly, and which uses investor fears of bubbles, crashes, manias and various risk types as a pretext for misdirection?  Behavioural finance views on groups and panics, and George Soros' currency speculation against the Bank of England's pound on Black Wednesday suggest the potential and trigger conditions may lie in the global currency/forex markets (using stochastic models like Markov Chain Monte Carlo for dynamic leverage in hedge funds) and money markets (using tactical asset allocation).  If possible, this capability could also create second- and third-order effects for regulators, the global financial system and macroeconomic structures, and volatility in interconnected markets, which may actually be more dynamic and resilient than this initial sketch indicates.

To meet quantitative standards and validate Burrough's hypothesis a significant forensic and data analytics capability with error estimates would also be required.  'Strong' proof may not be possible: Burrough's hypothesis is probably an unsolvable 'mystery' rather than a solvable 'puzzle' (a distinction by intelligence expert Gregory Treverton that The New Yorker's Malcolm Gladwell later popularised).

Ironically, several CNBC analysts have already decided: they used parts of Burrough's hypothesis to explain the subsequent short-selling driven volatility of Fannie Mae and Freddie Mac's stock prices in mid-July 2008.

Bloomberg Markets' Lisa Kassenaar and Elizabeth Hester profile Jamie Dimon the CEO who spearheaded JP Morgan Chase's acquisition of investment bank Bear Stearns.

∙ Dimon compares the managerial bias for action and velocity of a pre-deal team to the 101st Airborne Division of the US Army --- reminiscent of John Boyd's influence on business strategists with his 'observe-orient-decide-act' loop used in air combat.  This bias and velocity is crucial for: (1) strategic execution and rollout of high-growth strategy; (2) anticipatory responses to hedging and catastrophic risk; and (3) negotiation in surprise events such as the Bear Stearns collapse.

∙ Dimon focuses on costs in structuring a deal, leveraging strengths and triaging this with risk management and growth strategies that are quickly scalable.  Dimon claims this is why JP Morgan Chase did not venture into the securitisation markets for collateralised debt obligations, subprime mortgages and exotic options.  Instead, his 'fortress balance sheet' is 'defined by efficiency, stable sources of revenue and risk management that protects assets'.  Equally, the risk dimension of 'risk-return' is central to banking, securitisation and the leverage of future cashflows.

∙ Kassenaar & Hester's interviewees suggest Dimon has an 'information filter' that oscillates between 'details' and 'the big picture' to keep track of deals.  In particular, Dimon uses one sheet of paper with 'things I owe people' and 'things people owe me' rather than a Blackberry.

∙ Dimon's career management insights: (1) take time off after termination to create a new space; (2) make a financial commitment via an equity stake as a signal to others in your 90-day period to transition-in.

The Village Voice's Tony Ortega reveals how uber-media mogul Harvey Weinstein organises his priorities, in-progress projects and key stakeholders:

(1) a "Calls you owe" and "Need to call" daily telephone list
(2) a one-line summary of contactees and their needs
(3) a coterie of personal assistants to handle those sensitive emails

The first two are sparse and remind me of David Allen's productivity/workflow heuristics Getting Things Done.

Ortega cites an email to Weinstein by former Weinstein Company employee Lori Sale as a model of succinct communication management:

(1) a one-line summary of the background context for negotiations
(2) the deadline for a decision to be made
(3) the spread of negotiation offers made --- with financial details and impact
(4) any counterparty offers and response relevant to (2) and (3)
(5) contact protocol and email signature

M&A communication streamlines (1) - (3) while game theory, negotiation and risk management provide frameworks and methodologies for (4).

Ortega's garbological adventures to discover Weinstein's strategies for management (communication, priority & stakeholders) are on par with HBO's Entourage television series on deal-making in Digital Hollywood and Nikki Finke's blog Deadline Hollywood Daily.