ABN Amro and Barclays: Will bankers ever learn?

It is an interesting coincidence that, as the senior managers of ABN Amro and Barclays continue to discuss their merger, Citibank in the US is preparing to announce substantial job cuts, of 15, 000 jobs. This announcement highlights the pitfall of a big universal bank strategy, of which Citibank was probably the most often quoted example. As long as it was run by Sandy Weil, who over his long Wall Street career, acquired an unique reputation as a merger wizard, capable of spotting value, cutting costs and mitigating internal strife, the concept had a degree of credibility. However, even under Weil, question was being raised whether Citibank has not increased in size and diversity to the point, where it became unmanageable. In the 1980s and 1990s, some banks were TBTF (Too Big Too Fail). These included Citibank, Credit Lyonnais or HSBC. I now looks like those very same banks (with Credit Lyonnais now part of Credit Agricole, the largest French bank by assets) became TBTGSV: Too Big to Generate Shareholder Value.

The point that size is not everything and is not a substitute for a focused strategy should by now become largely uncontroversial. Investors discriminate against big lumbering giants and reward well-run banks. Yet, as the ABN Amro–Barclays idea shows, this reality has not percolated to the Board level of many large banks.

The economic logic of the potential deal is hard to fathom. Barclays has a first rate wholesale operation, built around Barclay Capital and Barclay Global Investors. Those are tightly focused, well-managed and have little synergy with the retail network, which is, at best, of average quality (and I should know, having the misfortune of being their client). No do they really need ABN Amro, a perennial also-run even in the Netherlands (compared say to ING). Hedge funds demand for its break up makes economic sense. And their track record, particularly that of the TCI, is quite good in bringing power-hungry managers to account is worth noting.

ABN Amro is now in play. Let’s hope that the result of market manoeuvres will make more sense than the proposed merger.

Nanotechnology investing: What about risk warning?

The other day, as I was looking through the web at trends at emerging technologies, I came across a research comment written by a Motley Fools contributor, Jack Uldrich. The comment dealt with the acquisition by Arrowhead Research, publicly listed company (NASDAQ: ARWR) specialised in nanotechnology, of another privately held firm, Carbon Nanotechnologies. The acquisition was presented as a “Carbon Coup for Arrowhead,” with the clear implication that Arrowhead was a good way to invest in nanotechnology. Of course, an usual disclaimer about risk was tucked at the bottom of the page, but the comment was included in the”High-growth investing” section of the site and its general tenor was upbeat. Furthermore, it was republished under company news at Yahoo Finance.

Yet, I, for one, would be very careful before investing in Arrowhead. The company had 2006 revenues of 595 000 dollars, which represented a 7% increase over 2005. A quarterly analysis confirms the sluggish growth. It looks like the booked revenues are not from commercial sales but from research projects. Losses on the other hand are growing nicely, from 2.1 million in 2004, to over 9.1 million in 2005 and some 21 million in 2006. The market capitalisation of Arrowhead is 157 million dollars (as of March 23, 2007) which represents a whopping price/sales multiple of 445.

All this suggests that Arrowhead is not ready for the prime time and is an extremely risky investment. And the risk is cumulative: emerging technology, which, for all its hype, is not yet deployed commercially, offered by a small and untested company. Anybody investing in Arrowhead should not only be patient but prepared for disappointment.

I have a relevant personal experience with a similar company, American Superconductor (NASDAQ: AMSC), which is worth recounting. Founded in 1987 by two MIT professors, AMSC has developed a revolutionary technology for a (relatively) high temperature superconductivity (HTS). This technology has a potential to solve a critical problem of inefficiencies in electrical power transmission and generation. The company went public in late 1991 and I bought a stock few months later. Until the late 1990s, the stock moved in a trading range, so I got impatient and sold it at slight loss. This was of course a wrong move. Pushed by the Internet boom, AMSC took off like a rocket in the mid-1999 and reached an all-time high in early 2000 (at 500% of its IPO price) before collapsing. Today (late March 2007), AMSC trades roughly at the level of its IPO price. The company is very active and has been acquiring smaller players. Its 2006 revenues are over 50 million dollars but there is no pattern of explosive growth. And AMSC continues to lose substantial amount of money, 30 million dollars in 2006. It looks like for all its promise and potential, the HTS technology is still not deployed on a large scale

It is possible that Arrowhead’s trajectory will resemble that of Internet start-up rather than that of companies seeking to deploy high-stakes industrial innovations such as AMSC. However, past evidence suggests that this is unlikely to be the case.

This brings to me to a final point about user-based rating systems such Motley Fool”s CAPS. Such systems do not pay sufficient attention to risk factors, thus overlooking a key aspect of financial investing: the tight coupling between risk and return. Such coupling is absolutely essential for emerging technologies but it also matters for mainstream stocks.

John Backus and the IBM labs version of the war for talent

Media reported earlier the week the death of John Backus, ex-IBM researcher, who in the late 1950s, developed the first high-level programming language, Fortran, and thus transformed what was previously a tedious, largely mechanical task into a challenging intellectual pursuit. Despite fame and honours bestowed on him, Backus remained a level-headed man, who claimed that he invented Fortran out of “being lazy.”

Backus is one of several distinguished IBM researchers, who transformed not only the science of computing but also basic physics (with four researchers sharing two Nobel Prises and mathematics. Its historical scientific achievements are on a par with better known Bell Labs

By pure coincidence, I attended a week ago in Brussels, a lecture given by another illustrious IBM lab alumnus, Benoit Mandelbrot, who invented fractal geometry, while at IBM. Professor Mandelbrot, who now is in his 80s but remains professionally active and as feisty as ever, digressed for few minutes from fractals and their applications in finance and other domains, to discuss the evolution of basic research. Not surprisingly, he expressed concern about the loss of quality. His point was that as government withdraws from funding of research, the latter becomes more academic. By that he meant not a choice of topics detached from practical realities or conceptual relevance but the selection of researchers, based on criteria of academic credentials. According to him, such criteria are too narrow. IBM Labs, at their day, made sure that researchers they selected had various qualities, including practical bent. He specifically mentioned one of Nobel Prizes in physics, co-inventor of scanning tunnelling microscope, who would probably never been hired by a top university.

From what I read, it looks like Backus was a similar case. His academic record was solid but not outstanding. At the time he was hired by IBM, he had a MA, rather a Ph.D in mathematics (from Columbia, where he also studied medicine and radio engineering) and was chosen on an intuition about his future rather than the evidence of his grades and research papers.

As “war for talent” rages and new generation corporate giants, HP, Microsoft or Google, set up their research units, lessons of IBM labs approach, as presented by Mandelbrot, deserve careful considerations. So far, new labs appeared to have made little contribution. One reason for this may be that they are missing the vital tier of researchers, between developers and academics

TEFAF market: High art going digital?

Last week I had an unique opportunity to visit one of the most prestigious fine art markets, The European Fine Art Foundation (TEFAF), which has been held in Maastricht in early March for the last thirty years. This is a big and classy business. It showcases works of art, primarily painting and sculptures but also furniture, jewellery, table art, manuscripts and rare books, spanning the entire history of art, from antiquity to contemporary. All together, some five thousand artefacts are exhibited by some 215 merchants, with a total pre-sale value over 1 billion euros. Both merchants and artefacts are individually selected and vetted by twenty four committees, comprising 142 experts.

Visiting TEFAF makes immediately apparent the scale and scope of the art business. Financial institutions are all over the place: providing insurance cover, bringing their high net worth clients (and I really mean high: upward of 10 million euros) and entertaining them, their advisers and merchants in well-stocked booths. The private Maastricht airport is quite busy with some clients flying in their private Boeings.

The visit of TEFAF is highly enjoyable, even if one cannot afford to buy anything (and the entry price is stiff, over 50 euros). The quality of artefacts is amazing and everything is done to make the visit pleasurable: tulips everywhere, free water fountains, easy chairs and a variety of foods, from classy to casual.

My visit was more than just an aesthetic experience. I went to Maastricht at the invitation of my good friend, Jean Penicaut, owner and CEO of small business specialising in high-value digitization of paintings, Lumiere Technology (LT). Lumiere had developed a very high resolution camera – 240 million pixels (professional quality cameras offer 10 million). Combined with a special lighting system, LT camera offers not only the highest possible resolution for quality printing but also a set of analytical tools to analyse the paintings, allowing in particular the analysis of successive layers and corrections as well as a detailed investigation of colour and paint. The company is well-known for its pioneering analysis of Monal Lisa.

LT was not part of the official exhibition. However, TEFAF also offers a number of booths used by financial institutions and selected service providers. Jean was lucky twice, to get a booth in the first place and to be located next to the bar, which guaranteed high traffic.

Jean told me that reactions to LT’s technology were highly polarised. Traditional experts saw it as either a threat or an upstart attempt to question their expertise. However, few galleries and experts saw it as a complementary tool for analysis of high-quality paintings. Such analysis would create objective, quantifiable and comparative data and could serve as a basis not only for certificates of authenticity but potentially for a system of ratings of the technical quality of paintings.

I am a firm believer in Andrew Grove’s law: if the technology exists it will eventually be used. And, knowing Jean’s energy, it is likely to be sooner rather than later. I am looking forward to a fruitful union between high tech and high art.

Global warming: the risk of being a sceptic

It appears after all that global warming is man-made. However, its main cause is not the accumulation of carbon oxide but the heat generated by the intense controversies over the scientific reality of global warming and the viability of statistical and mathematical models developed to explain its causes and forecast its future evolution. This statement may be excessive but so is the tenor of the debate. The topic has always been highly contentious and was object of spirited debate among various academics and researchers. However, in the last few months, the intensity rose noticeably as the result of increased the political and media visibility of the issue. Catastrophic events such as Asian tsunami or Catherina hurricane were perceived as tangible signs of global warming. For their part, governments sympathetic to the hypothesis of man-made global warming sponsored exhaustive, data-laden studies, which sought make the case airtight and overwhelm the opposition. Thus, there was the Stern study, published last August and proclaimed by Tony Blair, whose government commissioned the study, to be the most important piece of policy work, ever carried out by the UK government. Most recently and more spectacularly, a French government, under a direct patronage of Jacques Chirac, organised in early February in Paris, a “Citizens of the Earth” conference for Global Ecological Governance, bringing together several hundred scientists and senior officials from national government and international organisations. During that meeting, the Fourth report of the French Intergovernmental Panel on Climate Change (IPPC, or GIEC in French) was published, which sought to demonstrate through exhaustive empirical studies and sophisticated forecasting models that man-made global warming is incontrovertible.

The result of all this is the emergence of conventional wisdom (“pensée unique” in French) about the global warming that makes a reasoned discussion and contradictory debate quite difficult, even among supposedly open-minded intellectuals. I realised the strength of the conventional wisdom last Tuesday in Paris during a meeting of group of economists, brought together by the CEO of leading retail services company, Laser. For the most part, members of group, which meets once a month, are eminent academics, sceptical about the merits of neo-classical theory but respectful of the tradition of Political Economy, which includes Adam Smith, Karl Marx and John Maynard Keynes. Our topic of discussion this time was the climate change, in particular Stern report. Many participants thought this report marked a radical break with past practices and a recognition by an eminent member of the global elite that business as usual not is no longer working for global warming. As I have written few months a blog on the report, I circulated it to the members and made two points (a) Stern recommendations do not represent a radical break with the past, his main point being that a speedy action could be relatively painless in terms of economic growth and therefore acceptable to policy makers (b) as much as I respect the work of Stern In the ensuing discussion, I sensed a sense of unease about what was perceived as a minimisation of global warming both a threat to the survival of humanity and as a policy lever, which would create an economic upheaval on a scale of industrial or information revolution. One participant called my position provocative; another praised the quality of GIEC work, and still another wondered whether I appreciated the magnitude of political groundswell (as evidenced by popular success of refuse recycling). No voices were raised and the discussion remained very polite, if animated but I felt among my colleagues a degree of surprise that a well-informed person would not share the conventional wisdom. And the conclusion of the meeting was that we should propose “something,” preferably international and incentive- rather tax-based, to tackle global warming, particularly in the emerging superpowers, India and China. I am very curious about such proposals and looking forward to our next meeting when they will be presented.

For all my frustration about being misunderstood by my colleagues, I should consider myself lucky. According to the UK media, it would appear that in the UK those who dare to express doubts are threatened with bodily harm, even death.

Yet, risk of ostracism notwithstanding, I do remain sceptical particularly about the weather forecasting models. I spent considerable amount of time looking at financial forecasting models, whether for the macroeconomic or financial parameters (GDP growth and inflation, interest and exchange rates and market trends). Those models attracted the best brains of thousands of researchers and powerful computers, using highly sophisticated methods. And yet, their track record is far from stellar or consistent and their forecasting time horizon is usually confined to few months.

Yet, climate is an infinitely more complex phenomenon (or a set of phenomena) than financial markets. The idea that a model based on current scientific methods and data can reliably forecast weather evolution fifty years with any degree of chronological and geographical is far-fetched, to say the least. If GIEC scientists really believe in their models, I suggest that they spend some time with financial “quants” in investment banks. This will make them either more modest and realistic, or, conversely, very rich, thus generating sizeable resources to combat global warning.