Remembrance and Corporate Evolution

Blain’s Morning Porridge, Nov 11^th 2021:  Remembrance and Corporate Evolution

“Having now been in the trenches for five months, I had passed my prime. For the first three weeks, an officer was of little use in the front line… Between three weeks and four weeks he was at his best, then his usefulness gradually declined as neurasthenia developed.”

This morning: How much safer is the state of global diplomacy today than in 1914? And, how the demise of GE illustrates the inevitabilities of corporate evolution, and the threat of mispriced capital.

Global Unity

Today is the 103^rd anniversary of the end of World War 1, and its strange to be sitting at a desk in the bright sunshine of Dubai. On Armistice Day last year I walked under leaden grey skies to an old military hospital cemetery at Netley for the 11 am silence. Standing by the grave of a Highlander of the Black Watch buried beside an Australian cavalryman, I listened as a lone piper serenaded the glorious dead with “Flowers of the Forest”, a Scots lament for the fallen. The cemetery is a beautiful peaceful place where the wounded brought back from France for treatment are buried. Scattered among the Sons of the Empire graves were many Belgians and Germans; enemies then, but all united now.

What we dimly remember about the first World War is the utter pointlessness of it all, and the sheer futility of the conflict. How nations were caught up in a flurry of ultimatums and communiques that triggered an unstoppable cascade of events tumbling them into war in August 1914. The consensus is war had become inevitable because of the convoluted network of alliances, and national pride.

Could we ever be so foolish again? Isn’t it strange how the world still revolves around the same diplomatic language?

While we await the final communique from the COP26 conference in Glasgow, it’s encouraging the world can get together to face the biggest perceived crisis – climate change. (After the hurly burly’s done I will write a piece for the Friday Porridge on the Climate Conference.) The big issue is who pays – and that’s unclear. It was most clearly illustrated by India’s demand yesterday for $1 trillion of international money this decade to finance the costs of its transition to carbon neutrality over the next 50 years!

But, perhaps the world is a better place.

The most encouraging sign might be the Americans and Chinese agreement that cooperation is the best way forward. Y’day, the two nations agreed to work together on climate change, (Surprise US-China Deal on Climate Change Breaks Superpower Standoff),  opening the way for a thawing of relations between them. It’s an encouraging macro signal.

Less good is the rising tension on Europe’s eastern borders. The manufactured refugee crisis between Belarus and Poland is straight out the Kremlin’s Destabilisation 101 course. The lack of consensus on immigration and Right-wingers emphasising the Refugee crisis is likely to prove the greatest threat to European Unity in coming years. The temptation for countries to play their own rules is just too great – thus putting unity under pressure, just when it will be most required.

Meanwhile – GE: A lesson from History

I’ve written intermittently about GE and GECC (General Electric Capital Corp) over the years. The news it paid over $7.2 bln in investment banking fees since 2000 does not surprise me. (Even I got a tiny little share: making the trip up to the lair of their Corporate Treasury many times in search of bond mandates at the turn of the last century.)

Its quietus was administered earlier this week when Larry Culp, CEO announced it will split into 3 firms: aerospace, healthcare and power. The mighty conglomerate is effectively finished. It is unlikely to ever grace the list of most valuable US firms. It’s an abject lesson in the Ozymandias Principal of Corporate Evolution: “Look upon my works ye mighty, and despair.”

What went so wrong? There is nothing fundamentally wrong with the theory of conglomerates – big powerful players across multiple sectors should diversify earnings and funding sources, improving returns and liquidity. However, a conglomerate composed of small insignificant firms – is unlikely to fare so well. It becomes a target rather than the targetor!

What characterised GE was strong leadership and an aura of corporate arrogance founded upon its ability to raise any sum at any time from the markets. With the apparently unlimited backing of Wall Street, there was nothing GE could not do. It reached its zenith in the era of CEO superstar Jack Welch when it was a dominant force wherever it chose to place its markers.

GECC, its own internal bank, was the target of every banker. Who would not want to lend to the pristine AAA GECC? We cut fees to the bone and offered them the finest bond terms. I remember it was Geoff Werner, their corporate treasurer, who famously dismissed a disappointing bond issue with a snide comment at a Euromoney conference; who cares about the issue – “the market has no memory.” And he was right, for a while, till he was wrong.

Hubris is a terrible thing. What changed its future was its access to finance and relationship to the market. It all began to unravel in 2007 as liquidity became the crisis. Suddenly the market for short-term debt to fund long term assets dried up and it was GECC that was caught swimming naked as bank risk perceptions changed. Suddenly GECC lost unlimited access as bankers started to ask questions. The businesses remained what they were – but it was the financing structure behind them that was exposed as obsolete and no longer “fit-for-purpose”.

What GE demonstrates is the envitability of corporate evolution. Companies are formed, they grow, they become successful, they become less inventive and innovative, they spawn internal bureaucracies, they become too big to comprehend and manage effectively, they stagnate, the face crisis, they wither and die.

Although it’s a slightly imperfect simile, companies are like stars – some are slow burning White Dwarves that will unspectacularly last for centuries, carefully and slowly converting capital to profits. Others are spectacular Blue Giants, burning brightly through enormous amounts of capital and filling the business sky with light and noise, before going supernova. In between are all the normal stars that will burn bright for eons, but eventually fade after competition or merger brings them down.

At the moment, I would characterise the business galaxy as vulnerable because of the amount of mispriced capital that is driving corporates to burn too bright..  (Mispriced because interest rates have been artificially kept low for a decade.) It fuels two effects: First, the notion its ok for new firms to consume vast amounts of capital in pursuit of growth, and second, it creates the notion capital is effectively free and unlimited. Things will change – when the cost of capital changes, it will expose the naked swimmers.

We can see these effects very clearly across corporates – where the number of vaguely profitable unicorns (which includes many exciting firms) have lost sight of returns. Some will adapt – many will burst. It also fuels speculation – and for all the bullsh*t sprouted by cryptocurrencies barkers about how boomers can’t understand them, Crypto is simply a product of too much cheap capital looking for something, anything to buy.. (More on the crypto market next week – I hope!)

Five Things to Read This Morning

FT – Wall Street Banks reap $7.2 bln in GE Fees

FT – Biden’s White House scrambles to tame inflation

WSJ – Elon Musk Sells Around $5 bln in Tesla Stock

WSJ – Stocks Close Lower, Bond Yields Rise as Inflation Reaches 31 Year High

Bloomberg – It’s Official – The Inflation Numbers are a Hot Sticky Mess

Out of time, and back to my multiple day jobs!

Bill Blain

Strategist – Shard Capital