Industries Primed For A Fall

We all know about the auto industry and the mess that they are in right now. I expect that in the near future, GM and Ford may have to merge to stay alive. Given how ‘cheap’ their stocks are right now, the temptation is to jump in and buy. However, in the Practical Risk Manager’s view, the risks still outweigh the reward. Firstly, there is no other automaker desiring to take over the bloated pension deficit, existing high-cost structure, and antiquated assembly plants that GM and Ford have.

The other automakers have their own problems. With increasing cost of raw materials such as steel and plastics, car manufacturers are running on fumes. If there were an investor willing to take over GM or Ford, it would be to extract the value within each firm and sell the auto operations at a steep discount. File this under “there is a valid reason why their stock prices are so low.”

GM has hidden value in its Onstar satellite communication division and its non-North American auto operations. A bold move for GM would be to (1) follow Halliburton’s move and relocate its HQ offshore, (2) sell off or shutter its North American operations (this would put a cap on its retirement fund obligations), (3) Expand the Onstar satellite communication division’s capabilities to compete with Sirius and XM Satellite, and (4) be an importer of ultra-small cars from its international operations into North America.

I wonder if any senior executives from from GM / Ford are reading this…

Another industry that will see more failures is the Airline Industry. While they have taken dramatic steps to cut costs and increase revenue – a position proposed by the Practical Risk Manager several months ago – there are still the issues of ever-increasing fuel costs and continuing trend of reduced demand for air travel. Given that consumers are traveling less and increasing the use of alternative transport means, airlines will have to have to begin offering something that they did away with a long time ago: good customer service.

Airlines need to offer something tangible without tremendous added cost. The bold move would be to raise the profile of the cabin attendants to that of air hosts / hostesses. The international carriers do this very well. In fact, most Asian airlines have one of the most rigorous training for their flight hosts / hostesses. This is clearly evident by the Skytrax’s list of six airlines worldwide that are rated 5-stars, its top rating. All six airlines are Asian: Asiana Airlines, Cathay Pacific Airways, Kingfisher Airlines (India), Malaysia Airlines, Qatar Airways, Singapore Airlines.

Where are the major American carriers? They are clustered together in the mediocre 3-star category. The U.S. airline industry seems to think that good customer service means offering free beverages, food, and onboard entertainment. Good customer service does not mean just what happens on the plane; it starts with the reservation and goes all the way to deplaning.

Currently, the airline industry has so many built-in inefficiencies that actually prevent them from providing good customer service. This is a clear risk factor in the Practical Risk Manger’s view; a clear financial and reputational risk factors.

What more can the airline industry do? Here is a sample of bold moves (I have more) that the industry can take to reverse the traveler’s view of the airline’s poor customer service:

Provide free curbside baggage loaders. The redesigned baggage loaders is capable of holding up to 5 large check-in bags and 3 carry-on bags, is electric driven, lies flat on the ground for easy loading / unloading and rises to move. Customer could use this to load their bags at curbside and guide the electrically driven loader to check-in.

I think that even with bold moves, there are certain airlines that cannot make it if the fuel prices stay high into 2009, which is highly probable. To wit, I stand by my previous assertion that American Airlines will not make it. This is even more probable since they have not taken strategic actions to reduce their reliance on their fleet of MD80s. I would file American Airlines as an investment that I wouldn’t touch with a ten-foot pole.

Regards,
Ed Kim
Practical Risk Manager

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Are We Near The Bottom Yet?

The short answer is still “Not yet.” The news continues to be grim without any signs of letting up. In fact, the major media appeared to have all climbed on to the Bear market bandwagon. As any prudent investor knows, one can make money in a Bull market as well as a Bear market. The converse of this is equally true.

My readers have been aware, several months ago, the risk factors that are manifesting themselves in current events. Hopefully, the readers have made some good and wise investments based on the risk factors, as I have presented previously. Continuing on this theme of taking prudent risks, here are additional ‘futurescape’ of the global economic condition, in my opinion, based on the publicly available data.

Will Large Banks Fail?
While it is highly improbable that many large money center banks will fail, there are certain candidates that are closer to the precipice than others. The risk manager, using a standard six-sigma approach, would note that we are currently in a ‘tail’ event economy - an economic event that typically has 0.3% or less of occurring. This means that an unthinkable can and may occur, including at least one “too-big-to-fail” bank failing. It is not a matter of “IF,” it is a matter of “When” and Which.”

In my view, the front-runners, vying neck to neck, for this dubious distinction are: Citigroup, Lehman, UBS, Merrill Lynch, and Morgan Stanley. I wonder if Ladbrokes would open betting lines on this action. If so, I would take UBS as being the candidate to fail. This is based on three factors, in addition to the general malaise affecting all banks: (a) it is still losing its high net worth clients, (b) is downsizing its investment banking division, in attempt to cut costs, and (c) the unwillingness of its senior management to admit its mistakes. With its sterling reputation tarnished, clients leaving, revenue sources drying up, it would be very difficult for it to remain independent for too long.

Banks will need to continue raising capital as more assets are reclassified to tier-2 and tier-3. The only problem is that most potential investors have already been burned and are sitting on substantial paper losses. That means that banks will have to juice up the preferred rate of return and provide a recast trigger should the stock prices drop below a threshold. Furthermore, the banks will have to go to lesser known investors and SWFs (think Brazil, South Korea, India, Taiwan, and Russia).

Regards,
Ed Kim
Practical Risk Manager

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Risks Of Sound Risk Management – Part 1

It has been slight over a month since I last wrote my 99th article. As I pondered the subject of my 100th article, I agonized over the topic that would grace the 100th writing, as I thought that the number symbolized something special. During my pondering, I realized that there is nothing significant in the number itself. Although we tend to hear the centennial being a major milestone – such as the 100th episode of a long running TV show, the first 100 days of the Presidency, etc. – its significance has largely lost its meaning in the today’s “do it now” society where a story that occurred more than a week ago is no longer news but trivia.

This is also true in the realm of business where “what have you done for me lately?” attitude is prevalent. In this environment of corporate upheaval, continual job cuts, economic uncertainty, and senior management lost in a myopic miasma of “try everything to stem losses” school of management, the risk managers are especially in dangerous waters as they have to try to bring reason and sanity to the this corporate environment.

As a risk manager, I have always practiced the following rules:

1. Never compromise my integrity. This means that that while the allure of the brass ring is tempting, a risk manager’s responsibility is directed to ensuring that the organization is abiding by all requirements as set forth by law, regulations, and its own policies and procedures. Staying your course in not compromising one’s integrity does not win you any favors with those who cut corners and operate openly in the interpretive gray areas. However, the risk manager is charged with the sacrosanct responsibility of being the beacon of rationality in face of blind greed.

2. Don’t sugar coat the truth. In the corporate world, the managers are in their position for a reason. They should be mature enough to accept the facts and consequences of the facts without the need for circumlocution. However, good business practice is to recommend choice of action plans to the manager. This way, the risk factors are properly “actioned” and potential losses minimized or even mitigated.

3. Watch out for unscrupulous managers. This is difficult to do, as most of these managers will not be transparent in their mendacity. However, if they arrived at their station by trickery or deception, then these unscrupulous individuals, who fear being caught by a diligent risk manager, will make the risk manager’s job difficult. Knowing this, tread cautiously as these people may have supporters in upper management.

4. Incompetence is throughout, so don’t be too efficient. Now, this seems counterintuitive and possibly a contortion of logic. However, this is a vital point that most risk managers fail to keep in mind, including yours truly. By incompetence, I mean those individuals whose job functions are antitheses to organizational profitability but perform them very well, to the detriment of the organization. The saddest aspects of incompetence come when an entire unit is happily doing work that other unit/units will have to undo.

When joining an organization, one is given a grand overview of the organization’s principals. This is especially true when joining a Fortune 50 company or an elite financial institution. However, a risk manager needs to realize that there are people of incompetence in all organization, even in the best organization. And the incompetence exists at the top. Take the case of Charles Prince of Citigroup when he uttered the now infamous statement: “As long as the music is playing, you’ve got to get up and dance,” In the immortal words of Dr. Seuss, Mr. Prince “said what he meant and meant what he said.” He honestly believed in his statement and stuck with it, even in the face of blatant fact to the contrary.

So, what is a risk manager to do? Firstly, don’t be a hero. A risk manager or a team of risk managers cannot fix such a process. Those who try are labeled Don Quixote or even worse. At best, the risk manager’s effectiveness is questioned. Now, this was very difficult for me to turn a blind eye to a group that cost millions in operational cost to the firm and it cost me my job. While I do not regret my actions, as I followed my first rule of never compromising my integrity, I caution other risk managers to seriously weigh their personal financial risks and rewards before acting against established incompetence.

5. Add value using dollars and sense (practical sense). Corporations toss around “value-added” a lot in their stated principals. This is also true in their risk management units. However, most people do not truly understand what “value-added” means or even how to enact it. Presenting a month-old risk report to senior management is not “value-added.” Rather, it is value lost, as numerous highly paid managers are forced to attend an hour-long meeting to comply with Basel II accord. Any action taken post event is not valued-added.

The value addition comes from two main practices: (a) concrete and practical preventative action plans that the business can implement and (b) identifying process improvements that reallocates existing workforce to a more effective (and profitable) use within the organization.

I will follow up later on these points; after all, I do want a rapt audience. So, enjoy the weekend and look forward to more insights and risk analyses.

Regards,
Ed Kim
Practical Risk Manager

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