Tuesday, March 31, 2009

Quiznos Blinks

In the fast food sub sandwich category, the two biggest players are Subway and Quiznos. Due to a huge head start and relentless franchising, Subway is the dominant company in the marketplace. Their advertising has traditionally focused on differentiating their products from other fast food categories such as burgers and fried chicken.

Subway ads typically emphasize the fresh baked bread and the vegetable fixings piled on their sandwiches. They have positioned themselves as a lighter alternative to other fast food restaurants. Their spokesperson, Jared, has built an entire career around a friendly personality and the fact that he lost a lot of weight by eating Subway food.

Quiznos, on the other hand, has played off the category leader Subway. Quiznos ads have pointed out how much more meat is on their subs, and stressed the oven toasting. “If you want a sub,” they seem to say, “shouldn’t it be our sub and not theirs?”

As a consumer of both chain’s sandwiches, I can attest Quiznos does make a superior sub. What the Quiznos ads forget to mention is that it is also a more expensive sub. The price differential for the premium Quiznos product is $2-$3 more than Subway would charge.

Recently, Subway began a promotion centering around the concept of “the $5 foot long.” It started with selected foot long sandwiches being discounted down to a $5 dollar price. The promotion was so successful (aided by an incredibly catchy ad campaign) that the $5 foot long concept has been extended to all of their sandwiches.




The motivating idea behind the campaign is simple: more food for less money. It is the same animating concept behind McDonalds dollar menu.

Now Quiznos is responding with their own foot long product. The ads for the ciabatta bread sub emphasize the fact that it sells for only $4. In fact, the ad ends by repeating the price three times, albeit with a humorous twist. The new Quiznos ads are clearly a reaction to the Subway campaign. The message is “our sub is cheaper than their sub.”

The ads are funny and memorable. They feature the toasting oven as one of the characters in the ad. The oven’s voice is intended to resemble the HAL 9000 computer in 2001: A space Odyssey.




There are two ways to establish the value proposition in the mind of the consumer. One way is to emphasize the superior features or quality of your brand compared to the competition. The other way is to emphasize a lower price.

With their new ads launching this new product, Quiznos has abandoned the superiority strategy of brand building. They are now trying to sell a cheaper sandwich than Subway. Once you start competing solely on price, it is tough to build your brand up as a premium product.

In the long run, this new direction will hurt Quiznos more than the short term market share gain helps them.

Tuesday, March 24, 2009

Take this TARP...Part II

Goldman Sachs, the big Wall Street investment bank, recently announced that they were going to try and repay their share of the Federal TARP bailout money ahead of schedule. The previously announced plan was to repay the Treasury by the end of this year. They have now said they could pay back the government as early as the end of April.

I can’t help thinking this is partially due to the furor over the AIG bonuses. Watching the AIG financial traders get used as a metaphorical piƱata by the politicians and media has got to be a powerful spur to get out from under the Federal thumb. Who can blame them: would you want to have to answer to Barney Franks?

As in the case of Northern Trust, I think much of the political grandstanding over the AIG bonuses was overwrought and silly. But I also think that the sooner the government gets out of the ownership of financial institutions, the better for the country. So if the posturing and outrage spurs the managers of companies to put their houses in order and regain their independence, in the long run we will be better for it.

It is an ill wind that blows no good.

Monday, March 23, 2009

AIG: Hangin' too good for em! Tax the b***s!

I’m outraged about the AIG bonuses. And right now I’m not talking about how $165 million in retention bonuses was paid out to the traders in the Financial Products unit; the same guys who wrecked the company. I’m still hacked off about that, but right now I’m outraged at the actions of the US Congress in regards to the situation.

In a state of high dudgeon, the House of Representatives passed a special bill last week that imposed a 95% tax on those bonuses. The US is looking at a trillion dollar deficit this year, and Congress is wasting their time going after a small group of traders who are getting retention bonuses when they should not even have been retained. Part of the taxpayer bailout of AIG should have been firing those guys. Instead, they were allowed to stick around until they qualified for bonuses.

The thing is, they were allowed to stick around to the end of the year. They had contracts, and those contracts have to be honored.

Now Congress, after the fact, is trying to get the money back. The US Constitution prohibits something call a Bill of Attainder. A Bill of Attainder is an act of the legislature that targets specific individuals and punishes them without a trial. Confiscatory taxation designed to hit only a small group of people arguably fits that definition.

What should have happened is that at the time of the original bailout, before the Treasury acquired 80% of AIG, all of the employment contracts should have been rendered subject to renegotiation as a precondition to receiving the money. Alas, no one thought of that during the press of events. Too bad, so sad.

Much as it pains my partisan soul, I have to give the Obama administration a pass on this one. By the time Obama was inaugurated in January, the retention bonuses had already been earned.

Instead of grandstanding and hyperventilating about how they are going to get that money back, our elected representatives would more constructively spend their time learning the ins and out of the financial system they are being asked to continue to bail out. Yes the AIG bonuses are outrageous, but in the great scheme of things they are also miniscule.

I would say that Congress has bigger fish to fry, but technically, whales are mammals, not fish.

Tuesday, March 17, 2009

BankTracker: How bad is it at my bank?

I have found a new toy. The BankTracker website has been set up to use publicly available data to rate the health of banks. The site takes information that banks are required to report to the FDIC every quarter, and creates a ratio of troubled assets to capital and reserves.

The troubled assets are defined as loans that have not received a payment in 90 days, loans that are no longer accruing interest (usually this means loans that have not received a payment in 60 days), and the category of other real estate, which means property that the bank has already foreclosed on. The foreclosed property is carried on the books as having a value equal to the outstanding balance of the loan at the time of foreclosure.

The troubled assets are then divided by the combination of Tier 1 capital and loss reserves to come up with a ratio. On the BankTracker website, the ratio is expressed as the percentage of troubled loans to capital. For example, if a bank had $100 million in capital and $10 million in troubled loans, the website reports the ratio as 10. If the website reported the ratio as 130, that would mean that troubled loans were equivalent in value to 130% of the banks capital.

So go ahead and look up your bank and see where they stand. I did, and my bank’s ratio was about 30. Their problem loans add up to about 30% of their capital. Not that bad, although the median for all banks was about 10. Still, my bank has enough capital to ride out the current mess, as long as the number of problem loans doesn’t get worse.

Even banks with ratios over 100 can still survive. If a bank has problem loans in excess of the amount of capital they carry, and cannot recover any of the value of those loans, the bank is technically insolvent. But that doesn’t take into account the recovery value of the assets. Take the other owned real estate (foreclosed properties). If the bank sells those properties for 50 cents on the dollar, they only write off half the value of the property.

For all of the problem loans, they will move from non accruing status to 90 days late, into foreclosure. After foreclosure, they will be other owned real estate. Eventually, the foreclosed houses will sell, and whatever fraction of the loan value the bank recovers will be added to capital.

I don’t know what criteria the FDIC uses to determine their problem bank list. But I would guess that anyone with a problem loan to capital ratio exceeding 150% would be an excellent candidate.

Sunday, March 15, 2009

"...and negotiating for the company will be Bobo the chimp."

The big international insurance company AIG made the news again this weekend. No, they didn’t require another round of taxpayer funded bailout money. The $170 billion pumped in during the last three rounds seemed to have stabilized the patient for the time being.

The news this weekend was that AIG was going to pay out $450 million in “retention bonuses” to employees throughout the organization. These bonuses were apparently written into the employment contracts for executives at the various business units that make up AIG.

The amazing part about this is that $165 million of the retention bonus pool is allocated to the people at AIG’s financial products unit in London. These were the brainiacs who made all the bad deals that sunk AIG into such dire straits that they needed the $170 billion in the first place. Apparently the lawyers at AIG headquarters reviewed the employment contracts and concluded, “yup, we gotta pay ‘em.”

These guys in London inked deals that went bad to the tune of $60 billion in the last three months of 2008 alone. But they held their heads high and refused to quit, so by making it to the end of the year, they qualify for “retention bonuses.”

Who writes these contracts? This is the worst case of “head I win, tails you lose” I’ve seen all year.

According to news reports, the retention plan was set up early in 2008, before the realization set in about how bad the losses on the credit default swaps engineered at the financial products unit were going to be. AIG wanted to keep a number of executives from leaving, so the plan was set up to pay retention payments to senior people.

Call me crazy, but I’m not sure I’d want to keep the people around who wrecked the company and wiped out the shareholders. And the people who wrecked the company are still on the payroll, because they have a contract. For some reason, their business performance didn’t qualify as grounds for termination.

It kind of makes you wonder what you have to do to be fired for poor performance. Do you think being caught on videotape cutting a deal with Satan to sell him the souls of your customers would do it? Or would that qualify you for an additional bonus payment for “out of the box” thinking?

I wish I could get my hands on one of those contracts and see what it really says.

Saturday, March 14, 2009

Orchestra Tuning (Off-topic Post)

I went to a concert by our local symphony orchestra this evening. Before they began playing the first piece on the program, the musicians did what they do at all symphonies, all over the world. They tuned up their instruments.

Is there any more wonderfully expectant sound in the world than a symphony tuning up? It is a sound latent with all the potential that the future holds.

It is the sound of predawn lightening of darkness, just before the sun breaks over the horizon. It is the sound of the first cup of coffee in the morning, before the day's business begins. It is the sound of the mad scramble to get dressed and ready for an evening out, just before you step out the door.

Often times, I enjoy those moments of anticipation when the orchestra tunes up as much as some parts of the actual program. Judging by the videos that others have posted on YouTube, I'm not the only one.

Tuesday, March 10, 2009

We Bring Good Things to Light?

GE stock has fallen precipitously in value over the last year. It was trading at a little over $6 per share last week, having come down from a high of $40+ in 2007. This is the same GE that builds both jet engines and refrigerators, light bulbs and MRI scanners. GE even owns NBC and Universal Studios. They are a leader in globalization, noted for having a deep management bench and the ability to develop talent. GE is one of the few American companies with AAA bond rating. The bluest of the blue chips.

And yet, panic selling drove the price down 45% in one month. This, despite the fact that the company was profitable last year. What gives?

The problem is that GE has xx in assets, but has yy in liabilities. If GE has problems paying back those liabilities, that spells real trouble for the stockholders. In corporate finance, the owners of the liabilities (bondholders) always get paid before the owners of the equity (stockholders). The reason the stock price has fallen so far is that the judgement of the market is that GE’s liabilities won’t be paid back.

You may think “What’s the problem? They’ve got a lot more assets than liabilities.” Well, maybe yes, and maybe no.

GE is really two companies. There is General Electric, which is the collection of industrial businesses that makes all the stuff. They have twice as many assets as liabilities. Then there is GE Capital. GE Capital provided half of GE’s profits for 2007. The problems are in GE Capital portfolio. In the 2007 annual report, GE Capital had $646 billion in assets, and $587 billion in liabilities. If the assets are worth only 10% less than what GE said they were worth a year ago, that would be enough of a fall in value to wipe out GE Capital’s equity, forcing the company to put more cash into the business.

GE Capital uses the AAA rating to borrow money cheaply. They then use that money to make loans. A lot of the loans are equipment leases. You want to lease a jet engine or MRI scanner, GE Capital will help you do that. But they make a lot of other types of loans as well. For a financing company, the money borrowed is a liability, and the loans made are the assets.

The market is concerned about writedowns hidden in the loan portfolio. Another way of saying that is that the assets are worth a lot less than what GE has been saying, and GE will have to ‘fess up soon.

I decided to go looking through the annual report to see if I could spot any potential problems. In corporate annual reports, the pesky details that can cause trouble are usually buried in the notes that follow the financial statements at the back of the report. Opening up the report almost at random, I found Note 12: GECS Financing Receivables.

Inside Note 12 was a line item for a division called GE Money, listing Non-US Residential Mortgages: $73.759 billion. So GE owns a mortgage company that is holding almost $74 billion in mortgages. I’m guessing that most of the mortgages are in the UK.

Attached to the line items was a reference to subnote (A). In little, tiny print, subnote (A) included the following statement: “approximately 26% of this portfolio comprised loans with introductory, below market rates that are scheduled to adjust at future dates; with high loan-to-value ratios at inception; whose terms permitted interest-only payments; or whose terms resulted in negative amortization.”

Yikes. Let me translate that for you: “GE holds over $19 billion dollars of toxic subprime mortgages in a collapsing real estate market.” After those UK homeowners stop paying, GE will foreclose, and then sell the houses for half. My back of the envelope calculation is that GE will have to write down that sliver of their portfolio by about $10 billion dollars. The total reserve for losses in their Financing Receivables is only $4.3 billion.

GE recently eliminated 70% of their dividend. This contributed mightily to the free fall in the stock price, but it will free up $9 billion a year in cash to apply to other uses, like writing off foreclosed mortgages. I have a feeling that they are going to need the cash.

The 2008 annual report is due any day now. I can’t wait to read it.

Monday, March 9, 2009

Another Step Closer to the Edge

I have encountered more evidence of the incipient collapse of our civilization. Barbie Totally Stylin’ Tattoos. Yes, our friends at Mattel have come up with a doll that little girls can “customize” by covering the toy in designs using the included “tattoo gun.”

Mothers will be so proud of the creative work of their daughters. It just brings a tear to your eye.

What’s next? “Baby’s First Body Piercing” kits?

Thursday, March 5, 2009

Not Long Before the End

The final collapse of Western civilization may be near. There are signs and portents, for those who know how to interpret the omens.

Take, for example, the case of Latreasa Goodman. This is a woman in Florida who went to McDonalds and ordered the 10-piece Chicken McNuggets with fries and a drink. After paying for the items she was informed that they were out of McNuggets. The manager refused to give her a refund, instead offering any other item off the menu. Our gal Latreasa did not want any other item, she wanted her McNuggets, or she wanted her money back.

Faced with this impasse, she had at least three choices on how to handle the situation:
A) Take her fries and drink, losing her $3.49, and drive off, never go back to that McDonalds.
B) Choose another item to go with her fries and drink, drive off, and never go back to that McDonalds.
C) Call 911.

Ms. Goodman picked option C. Three times. The first time she called, the 911 operator actually agreed to dispatch a police officer to the scene, but the police apparently did not show up fast enough to suit Ms. Goodman. Hence calls two and three.

When the police finally showed up, they cited Ms. Goodman for abuse of the 911 emergency system. Her riposte is classic: "This is an emergency. If I would have known they didn't have McNuggets, I wouldn't have given my money, and now she wants to give me a McDouble, but I don't want one. This is an emergency."

I love the way she repeated that it was an emergency, just in case they didn’t understand the first time she said it.

The astonishing thing to me is the sense of entitlement possessed by this woman. The cops spent more money in gas driving out to where she was than the value of the dispute, but she obviously didn’t care about anything else other than getting what she wanted.

One lone nut job does not a trend make, I know, but to me this woman epitomizes the trend toward total reliance upon government for the solutions to all problems. God forbid she solve the problem peacefully on her own.

You can listen to recordings of the 911 calls, and see a previous mug shot of Ms. Goodman here.

Monday, March 2, 2009

Northern Trust: "Take this TARP and Shove It..."

Two weekends ago Northern Trust sponsored a PGA tournament in LA. As part of their sponsorship, they flew hundreds of their clients and employees out to California for the event. Northern Trust’s guests were put up in fancy hotels, and treated to several parties, with big name entertainment such as the bands Chicago, Earth Wind, and Fire, and Sheryl Crow.

When news of this sponsorship broke, Congressman Barney Frank fired off an outraged letter, demanding that Northern Trust pay the Treasury back the amount that they spent on this event. His position was that since the bank had not refused Federal TARP money last year, it "demonstrates extraordinary levels of irresponsibility and arrogance" for the bank to spend money marketing to it’s clients in a way that Barney Frank disapproved of.

Last week Northern Trust defended itself by pointing out that it was profitable, and that it was funding a marketing plan out of those profits, not out of the TARP bailout money. They also pointed out that the Federal money was actually a loan, and that they had made the interest payments back to the Treasury on time.

Now the other shoe has dropped. This weekend Northern Trust announced that it would be returning the $1.6 billion given to it by the Treasury as soon as possible. In essence, they have told the Federal government “You can take your unsolicited bailout money, and your unsolicited advice on how we should run our business, and put them both where the sun don’t shine!”

Northern Trust does most of its business with institutions and high net worth individuals (AKA rich folks). Thy put the trust in trust funds. The execs at NT must have figured that if they went with the sackcloth and ashes marketing advocated by the new Puritans in Congress and the media, they stood to lose a lot of business. As long as they had the Federal money on their books, they were going to continue being attacked for following a strategy that has made them one of the banks that don’t need a bailout. So to preserve their successful business model, they decided to return the money.

One question pops up for me. Just how much money do you have to have in a bank to get treated like a Northern Trust client? I keep what I consider a fair chunk of money on deposit at my bank, and I don’t get freebies like getting flown out to a California golf tournament, and being put up at the Ritz Carleton. My bank won’t even give me a coupon for the get away weekend at the local Red Roof Inn.

Or how about the Sheryl Crow concert? Shoot, I’d be happy with a Sheryl Crow CD! No, the only freebie I’ve gotten from my bank was a pad of Post-it notes, and I had to distract the banker to get those (“Look, it’s Hailey’s comet!” Point with the left hand, snatch with the right).

When I grow up, I want to be a Northern Trust client.