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What to fear

Week of 1 Sept 08

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One of our faithful readers, Bill LaVallee, wrote in a letter you may have seen in last week's edition: "I would be interested in a discussion of why so many of our formerly U.S. paper companies are now under foreign ownership or financial entities, and the role tax policy may have played in this. Could tax policy changes help to bring back our manufacturing industries?" My thoughts on this are below, and, although they come from a US-centric viewpoint, I think one could find the conclusions similar in most developed countries.

The tax policy is an easy one to answer, a difficult one to fix. Basically, in the US tax code, companies are allowed to hold the profits of foreign subsidiaries offshore and not pay taxes on them until they are repatriated to the US. So, yes, tax policy is an issue in that every dollar earned offshore is not taxable until it lands back here. This makes it very attractive to make things elsewhere. Some companies have been keeping offshore profits offshore for years. However, try fixing this--are you going to reach outside one sovereign country's borders and into another to collect taxes? You'll probably need a rather large navy.

To delve further into Mr. LaVallee's questions, I need to restate a position I have stated here many times before. It is this: you can not measure the health of this industry (or any other industry) by the number of jobs it has or has had in the past. This industry (or any other industry) is not in the business to produce jobs; it is in the business to produce profits for its shareholders. Effort hours per ton of pulp or paper produced have been declining for years, and this is a good thing if one wants to stay competitive and thus in business. Such a condition has existed in all industries (and agriculture and transportation) since the beginning of the industrial revolution: it is called improving efficiency.

Now, when companies lose their way and forget why they are in business, i.e., to make a profit for their shareholders, their stock price declines to a point that private equity companies can come in and take over. That is simply the markets at work. Private equity companies do hold an advantage over public companies in that they are not burdened with Sarbanes-Oxley and other securities regulatory reporting duties that public companies have. They concentrate on emotionlessly making money, a position that often causes a loss in jobs but saves the company from bankruptcy.

Regarding foreign investment. I think it is bad when foreign entities invest in our sovereign debt (a frightening condition here, given our large federal budget deficits). However, when foreign entities anywhere buy assets in another country, I think the advantage goes to the country where the assets actually are. Years ago, when I worked for a company from Finland, my Finnish boss was chiding me, as if I could do anything about it, for the US allowing Japanese investors to buy US assets, particularly large office buildings. I was not worried about it and I was proved right. For in a number of famous cases, the investment went bankrupt. So, let us follow the money for a minute. The Japanese investors brought their money here, paid an inflated price for a building by using their own equity and some debt they took on here. The investment could not meet its debt service and the mortgage holder took it over. The original owner got the equity investment plus the debt proceeds at the time of the original sale. The mortgage holder got the building for the value of the mortgage. All the money, including that from Japan, and the asset stayed here. At the level of sovereign nation to sovereign nation, it was a pretty good deal for the location of the actual assets.

There is another famous case in our own industry. A large multinational from another country bought a large US paper company, for what at the time was consider a fair price. One way or another (equity, debt), they had to bring the money to the US to buy out the original shareholders. A few years later, that large multinational sold out at about half the price they had paid. The loss was theirs, to the benefit of the original shareholders that sold out to them in the original transaction. Again, at the level of sovereign nation to sovereign nation, it was a good deal for the nation holding the actual physical assets--the assets are still here and so is the money.

So, what to fear? If I worked for a large multinational, I would be concerned about their overseas investments, not from the standpoint of job losses, but from the standpoint that something could happen to those assets which endanger the entire company. For what I have not mentioned in the examples above is the risk of nationalization of assets. During the last fifteen or twenty years, many companies in developed nations have been, in my opinion, somewhat carelessly investing in developing countries without duly recognizing the country risk of going there. The country risk breaks into two parts in my mind. The first one is not so bad--the foreign economy in which one invests may not grow at the pace anticipated. Ok, so it takes a bit longer to achieve your objectives--that is embarrassing but not fatal. The second one is the danger of the country where the assets reside either (a) refusing to allow one to repatriate their profits to their home country, or (b) just outright seizing, or nationalizing, the assets on their soil (something similar to this may be happening in the oil industry in Brazil as you read this). My (a) seems counterintuitive to where this column started, e.g., talking about companies holding profits overseas, but the point here being that sometimes you need to bring profits home to do other things.

Thank you, Bill, for giving us our topic for this week.

Regarding safety, have you considered buying alcohol breath analyzers and keeping them in your vehicles? They are ubiquitous on the internet and priced about the same or slightly less than radar detectors. However, such a device just may have life saving capabilities, and as far as encounters with the police go, I would much rather get a speeding ticket than be talking to an officer about a possible DUI (Driving Under the Influence) situation. Spend a couple of hundred bucks and throw one in your glove box today.

Be safe and we will talk next week.


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