Mortgage Delinquencies Accelerated During 2007

Financial System Taking Harder Hit Than Seen Earlier

Mortgages issued in the first part of 2007 are going bad at a pace that far outstrips the 2006 vintage, suggesting that the blow to the financial system from U.S. housing woes will be deeper than many people earlier estimated.

An analysis prepared for The Wall Street Journal by the Federal Deposit Insurance Corp. shows that 0.91% of prime mortgages from 2007 were seriously delinquent after 12 months, meaning they were in foreclosure or at least 90 days past due. The equivalent figure for 2006 prime mortgages was just 0.33% after 12 months. The data reflect delinquencies as of April 30.

Evidence that lax lending standards were leading to higher mortgage delinquencies first emerged in late 2006. The first major casualty of the subprime credit crisis, New Century Financial Corp., imploded in early 2007. Yet the data from the FDIC and others suggest that lenders didn't substantially tighten standards until at least July or August 2007, when credit jitters hit Wall Street and financial stocks began to swoon.

The FDIC's analysis was based on mortgage data provided by LoanPerformance, a unit of FirstAmerican CoreLogic Inc. LoanPerformance says it tracks more than 95% of mortgages that were bundled into securities by financial institutions, not including those securitized by government-sponsored mortgage giants Fannie Mae and Freddie Mac.

Data on other classes of mortgages suggest the same trend. Freddie Mac reported Wednesday that 1.38% of the 2007-vintage loans it purchased were seriously delinquent after 18 months compared with 0.38% of 2006 loans at the same point in their life. Freddie Mac generally purchases loans made to creditworthy borrowers.

Last month, J.P. Morgan Chase & Co. said it expects losses on prime mortgages that weren't securitized and remain on its books to triple from current levels. The increase in bad loans is driven mostly by jumbo mortgages originated in the second half of 2007, a company spokesman said.

Until these bad loans are fully digested, "foreclosures will remain at record highs, the financial system will be under severe stress and the broader economy will sputter," said Mark Zandi, chief economist of Moody's Economy.com. One piece of good news, he said, is that loans originated in the fourth quarter of 2007 and early 2008 appear to be performing better.

Economists and industry officials say several factors may account for the dismal performance of the class of 2007. Home prices were falling sharply in much of the country by 2007, meaning many borrowers who took out loans in that year for nearly the full price of the home now owe more than the home is worth. These borrowers are particularly vulnerable to a weakening economy, and have difficulty selling or refinancing if they lose their job.

Questionable business practices may have played a role, too. Some of the 2007 loans "were knowingly originated as really bad loans," says Chris Mayer, a professor of real estate at Columbia University's business school. Mortgage originators who profited handsomely from the housing boom "realized the game was completely over" and pushed mortgages out the door, says Mr. Mayer.

As credit began to tighten last year, some mortgage brokers and borrowers tried to circumvent tougher restrictions by inflating borrowers' credit scores and appraisal values, says Jay Brinkmann, vice president of research and economics for the Mortgage Bankers Association.

At Washington Mutual Inc., 27.2% of subprime mortgages originated in 2007 were at least 30 days past due at the end of the second quarter, compared with 24.3% of such loans originated in 2006. National City Corp. said recently that 2007 loans are driving delinquencies in its home-equity portfolio.

Some 65% of subprime loans originated in 2007 will end up in default compared with about 45% of those originated in 2006, according to estimates by UBS AG, which looked at loans packaged into securities.

To be sure, lenders did take some steps to cut their losses. The Federal Reserve Board's quarterly survey of bank loan officers indicates that lenders began to tighten underwriting standards in late 2006. And loan volume declined 18.5% last year, according to the trade publication Inside Mortgage Finance.

Still, it's now evident they didn't pull back far enough, at least in the first half of the year. The average credit score of borrowers who took out Alt-A adjustable-rate mortgages edged upwards in 2007, according to UBS, but the portion of such borrowers who fully documented their income and assets dipped. Alt-A is a class between prime and subprime.

The share of borrowers with prime jumbo loans who took out a "piggyback" second mortgage -- which allowed borrowers to finance more than 80% of their home's value without private mortgage insurance -- climbed to a record 33% in 2007, according to the UBS analysis. In other words, many people buying expensive homes were putting little of their own money down.

"The more conservative lenders were scaling back in 2007, but the more aggressive lenders were expanding," says Frederick Cannon, an analyst with Keefe, Bruyette & Woods.

The sharpest pullback in lending didn't begin until the second half of the year, when investor demand for mortgage-backed securities waned. Wells Fargo & Co. reduced the maximum amount borrowers could finance in the fourth quarter of 2007 and again in the first quarter of 2008, according to a recent analyst presentation. J.P. Morgan Chase, meanwhile, tightened lending standards twice by August 2007, but was still making some loans that didn't require full documentation of borrowers' income and assets. Wachovia Corp. made its most drastic changes in loan standards earlier this year.

The changes that lenders did make often took 60 to 90 days to implement because companies need to clean out their pipelines and change their systems, says Michael Zimmerman, senior vice president for investor relations at mortgage insurer MGIC Corp.

By: Ruth Simon
August 7, 2008

Comcast Sets Deal to Buy Daily Candy

Comcast Corp. has struck a deal to acquire Daily Candy, an email fashion and culture newsletter aimed at women. Comcast is paying $125 million for the property, according to people familiar with the matter.

With 2.5 million readers, the email newsletter is of growing interest to advertisers who are migrating to new, Internet-based ways of reaching targeted demographics. The newsletter has an especially large base of affluent woman in urban areas.

Comcast is purchasing Daily Candy from investment firm Pilot Group LLC. Under the arrangement, Daily Candy will become part of Comcast's Interactive Media division, the company said. The unit also houses other Comcast Internet properties, including the Fancast online video site, and movie-information sites Fandango and Movies.com.

Comcast will try to further boost Daily Candy's audience by aggressively promoting it across its other Web properties, Sam Schwartz, Comcast Interactive Media executive vice president, said in an interview.

The company's Comcast.net Web portal, for example, is among the 10 most popular destinations on the Web by some measures. Daily Candy's content, meanwhile, can be used to add material to Comcast properties with a consumer and lifestyle focus.

Daily Candy also will mesh with Comcast's lifestyle-oriented television holdings, such as the E! Entertainment channel, Mr. Schwartz said. The email newsletter was founded by Dany Levy, who sent out the first Daily Candy newsletter in March 2000. She will remain editorial director. Daily Candy publishes 13 daily editions and eight weekly editions.

One of Comcast Interactive Media's strategic objectives is to build primarily ad supported, online businesses and Daily Candy will contribute to that goal, Mr. Schwartz said.

The unit is also tasked with helping Comcast take advantage of emerging trends, such as the growing popularity of Web video.

By: Vishesh Kumar
Wall Street Journal; August 6, 2008

Cisco Profit Climbs 4.4% on Sales Growth

Chief Sees Uncertainty Over Economy Lingering For Next Few Quarters

Cisco Systems Inc. posted a 4.4% increase in profit on sales growth of nearly 10%, bucking worries that the slowing economy would hold down demand for high-tech products.

The company, the world's biggest maker of networking hardware, indicated sales growth is likely to slow in the next two quarters.

John Chambers, Cisco's chief executive, predicted that economic uncertainty will remain for the next few quarters. As a result, the company -- which usually offers a 12-month forecast -- only offered financial guidance for the next two fiscal quarters. Cisco projected revenue growth in the current period in the range of 8%, and fiscal second-quarter growth of about 8.5%.

Mr. Chambers said he isn't changing the company's long-term forecast for growth in the range of 12% to 17%. "Our confidence in our longterm revenue growth remains the same," he said during a conference call with analysts.

Analysts have been waiting for Cisco's numbers for signs that economic woes are spreading. In the past few years, when corporate customers have reduced spending on networking gear, the impact on Cisco has tended to be offset by rising Internet traffic that prompted cable and telephone companies to buy more hardware.

Credit Suisse analyst Paul Silverstein said in a recent report that AT&T Inc. and other telephone companies are trimming their 2008 spending budgets, which he predicts will hurt Cisco. The expected spending cutbacks led Mr. Silverstein to downgrade the networking company's stock from "buy" to "neutral."

Mr. Chambers was among the first high-tech executives to acknowledge a looming slowdown, warning in late 2007 that U.S. spending on networking might be "lumpy" for much of this year. In early July, Mr. Chambers fueled further jitters by suggesting that Cisco may not see an upturn in corporate technology spending until early next year.

To offset some of the pullback, Cisco has broadened its product line beyond an original speciality in switching and routing devices. The company has been among the most aggressive acquirers in the high tech industry, assembling engineers and programmers from start-ups to push further into markets such as social networking, online video and conferencing.

In the latest quarter, Cisco's business in switches and routers posted 5% growth and 8% growth, respectively. The two product categories, which account for nearly 60% of Cisco's overall revenue, have usually grown at percentage growth rates in the mid-teens. Still, the 5% growth for switches is a slight improvement on the 3% growth rate in the fiscal third quarter.

For the quarter ended July 26, the San Jose, Calif., company reported net income of $2.01 billion, or 33 cents a share, compared with $1.93 billion, or 31 cents a share, in the year-earlier quarter.

Revenue rose to $10.4 billion from $9.4 billion. Cisco did particularly well in emerging markets, with revenue growth of 42% compared to 5% in the North American market.

By: Bobby White
Wall Street Journal; August 6, 2008

Siemens Set to Pull Plug On Venture With Fujitsu

In a move that could set the stage for the sale or dismantling of a leading European maker of personal computers, Siemens AG has informed Fujitsu Ltd. that it wants out of their nine-year-old joint venture, people familiar with the matter say.

Fujitsu has a right of first refusal to buy Siemens's 50% stake in Fujitsu Siemens Computers, though it is unclear whether the Japanese technology company is interested in acquiring Siemens's half. Fujitsu President Kuniaki Nozoe said at a news conference Tuesday that mobile phones are a more promising way to boost sales overseas than PCs, raising doubt about the company's commitment to the venture.

FSC, as the joint venture is known, had €6.6 billion ($10.29 billion) in sales in its latest fiscal year. However, it has failed to live up to expectations amid fierce competition from rivals such as Dell Inc. and Hewlett-Packard Co. Siemens Chief Executive Peter Löscher, who joined Siemens last year as part of a management shake-up in the wake of a bribery scandal, hasn't been happy with the performance of the venture.

If Fujitsu didn't want Siemens's stake, other global PC makers could try to buy out both parties. The PC division of International Business Machines Corp. was acquired by Lenovo Group Ltd. in 2005, part of a wave of consolidation in the industry brought on by cutthroat pricing and shrinking margins.

One banker estimated the Fujitsu Siemens venture could be valued at between €2 billion and €3 billion, or between $3.12 billion and $4.65 billion.

A spokesman for Siemens, Europe's largest engineering company by revenue, declined to comment. Representatives for Fujitsu and the PC joint venture couldn't be reached.

Since 2005, Munich-based Siemens has been aggressively selling assets in a bid to raise its profitability. Last week, the company said it would sell two telecom assets, including an 80% stake in its cordless-handset unit. Siemens, which aims to focus on the industrial, energy and health-care segments, recently outlined plans to cut 16,750 jobs world-wide, or about 4% of its work force.

FSC, which also makes mainframes and servers, had a pretax profit of €105 million in its last fiscal year. The agreement between Siemens and Fujitsu calls for their venture to be extended to 2014 if neither side alerts the other this year that it wants to exit.

By: Dana Cimilluca
Wall Street Journal; August 6, 2008

Whole Foods Net Falls 31% in Slow Economy

Natural-Foods Grocer Cuts Back Plans For New Stores and Suspends Dividend

Natural-foods grocer Whole Foods Market Inc., bruised by the sluggish U.S. economy, posted fiscal third-quarter profit that disappointed Wall Street and said it is cutting back on planned store openings and suspending its quarterly dividend to shareholders.

The weak results are the latest bad news for a former Wall Street darling, whose bright, cavernous stores have long been popular with health-conscious shoppers but whose rapid sales growth has cooled in recent years. The lower earnings are also a sign that the sagging economy is causing even consumers in higher income brackets to pare spending.

For years, the Austin, Texas, purveyor of natural and organic groceries saw little impact from economic slowdowns. But now it is acknowledging that it is vulnerable to economic tumult. To some degree, the company's woes mirror those of Starbucks Corp., which is closing stores and shedding jobs amid weaker sales.

"Today's economic environment is the most challenging I have experienced in my 30 years in retail," Chief Executive John Mackey said in a conference call with analysts.

Whole Foods said net income fell 31% to $33.9 million, or 24 cents a share, for the quarter ended July 6, from $49.1 million, or 35 cents a share, a year earlier. Revenue rose 22% to $1.84 billion. Analysts, on average, were expecting earnings of 31 cents a share and revenue of $1.9 billion, according to a Thomson Reuters survey.

Whole Foods reported results after the close of regular market trading. In 4 p.m. Nasdaq composite trading, Whole Foods shares rose $1.46 or 6.8% to $22.92. The shares fell 17% to $19 in after-hours trading.

Whole Foods said it is lowering the number of stores expected to open in fiscal 2009 to about 15, down from its May estimate of 25 to 30. It also said it has cut budgets for capital expenditures unrelated to new stores by 50%.

Whole Foods, co-founded by Mr. Mackey in 1980, now operates more than 270 stores in the U.S., Canada and the U.K.

The company said it is suspending its quarterly cash dividend for shareholders. It paid about $28 million in dividends in the latest quarter.

Same-store sales -- or sales at stores open at least a year, a key measure of a retailer's health -- rose only 3%. That's a sharp decline from the double-digit increases Whole Foods enjoyed just a few years ago, when the retail chain was growing rapidly, attracting shoppers with an array of prepared foods, fresh produce, meats and natural and organic boxed goods.

Whole Foods' stock price has plunged 44% this year on weaker sales growth. The company faces intensifying competition from large food retailers, which have been stocking more natural and organic foods.

Recently, the company has been trying to rejuvenate sales by offering more discounts and emphasizing value in its marketing. It has long tried to shake its image as an expensive place that some customers dub "Whole Paycheck."

"The company long touted its premium food offerings in its marketing, and that branding is now actually hurting them," said Tim Hanson, a senior analyst with the Motley Fool, an online investment community.

By: David Kesmodel
Wall Street Journal; August 6, 2008

A Dated Industry Gets a Modern Makeover

Spanx refashions shapewear, making the products must-haves for a younger, hipper audience.

Like many women, Sara Blakely was unsatisfied with the way her rear end looked in a pair of snug white pants. So one day 10 years ago, she sliced the feet off a pair of pantyhose and wore them under her pants -- giving her the firm rear view she hoped for. But over the course of the evening, the hose rolled up her leg.

Instantly, Ms. Blakely says, she recognized the business opportunity -- shapewear fashioned from hosiery material that would be invisible under contemporary, slim-fitting apparel.

"I knew this could open up so many women's wardrobes," she says. "All women have that clothing in the back of their closet that they don't wear because they don't like the way it looks."

Today, Ms. Blakely is the founder and owner of Spanx Inc., which manufactures the footless pantyhose that Ms. Blakely dreamed up that day, as well as dozens of other types of shapewear and, most recently, bras. With more than $250 million in retail sales last year, the Spanx name has become synonymous with high-end shapewear. Celebrities like Oprah Winfrey and Gwyneth Paltrow have sung Spanx's praises.

Not Your Grandma's Girdle

While many entrepreneurs tackle new or emerging businesses, hoping to come up with the next great product, Spanx succeeded in reviving a tired industry by casting it in a fresh new light.

Existing companies in some sectors often run their business the way it has been run for years and aren't as able to spot shifting customer preferences, says Mark Rice, professor of entrepreneurship at Babson College in Wellesley, Mass. Entrepreneurial companies often can "bring a fresh perspective to a market and see where it's not working as well as it could," he says.

For Spanx, that meant developing a product line that refashioned shapewear -- a corner of the retail universe that had been sagging for decades, since women stopped regularly wearing pantyhose -- as an essential item for well-heeled, well-dressed women. With slick, colorful packaging and kitschy product names like Hide & Sleek, Spanx shapewear appeals to a younger, more fashion-savvy demographic than a traditional girdle, which instantly conjures an old-lady image.

"Ten years ago, shapewear was considered your grandmother's kind of product," says Mary Krug, a vice president and divisional merchandise manager for Neiman Marcus Stores, a part of Neiman Marcus Group Inc. in Dallas. Spanx "made it cool and hip in what is not a cool and hip category." Today, she says, Spanx is one of Neiman Marcus's highest-grossing intimate-apparel vendors.

Loads of Legwork

Before starting Spanx, Ms. Blakely sold fax machines door-to-door. Armed with an idea for footless pantyhose and a passion for selling, she spent seven straight days at the library, researching related patents. Satisfied that no one had ever patented a product like hers, she began looking up hosiery mills on the Internet. She called mill after mill, but none would talk to her. So Ms. Blakely drove to North Carolina, a center for textile manufacturing. As a saleswoman, she says, "I knew things get done more face-to-face."

One mill owner after another told Ms. Blakely that it "was a stupid idea," she recalls. But one agreed to manufacture the prototype -- after speaking with his daughters, who thought the idea might work.

Ms. Blakely submitted the patent paperwork herself, after buying a book on the subject. She applied online to the trademark the Spanx name, paying about $150.

She designed the package on a friend's computer, focusing on differentiating the product from a sea of beige hosiery cases showing a photograph of a woman's legs. Instead, her packages were bright red, adorned with animated, Spanx-clad women.

As an upstart, she says, "one of the biggest things you can do is differentiate yourself. I wanted the package to make me happy -- make me want to buy it for myself."

The initial investment was about $5,000, Ms. Blakely says. The biggest chunk -- about $4,000 -- went to the production of the prototype and the packaging.

Bathroom Demonstration

Two years after coming up with the original idea, Ms. Blakely was ready to try to get it into stores. She focused on high-end department stores, she says, where women would pay a premium price for an item that would make them look better in their pricey designer clothes.

"If you're spending more on fashion, you're willing to spend more on the foundation," she says. Today, the undergarments range from about $30 for firming underwear to $88 for a full bodysuit shaper.

A Neiman Marcus Group buyer agreed to see her, as long as she paid her own way. So Ms. Blakely booked a flight to Dallas, where the company is based. But when the entrepreneur showed the buyer the product, she wasn't impressed. "You could see on her face that she wasn't making the connection," Ms. Blakely recalls. So she marched into the bathroom, where she offered a before-and-after presentation -- of her own rear end. The buyer agreed to try the product, Ms. Blakely says.

The sale to Neiman Marcus allowed Ms. Blakely to invest in the business, researching more products and expanding to other department stores, including Bloomingdale's, a division of Macy's Inc., and Nordstrom Inc.

For the first year and a half the products were in department stores, Ms. Blakely says, she traveled the country, talking up the product with the sales associates, and flashing before-and-after photos of her rear end. Because hosiery departments didn't get a lot of foot traffic, she positioned herself inside store entrances, lifting her pant leg to reveal her Spanx when shoppers walked by.

As the company grew, Ms Blakely realized that while sales was her strength, day-to-day operations were not -- a big lesson for the entrepreneur. She didn't have a cohesive plan for hiring or for the business in general. So in 2003, she hired a full-time chief executive officer, leaving Ms. Blakely free to do what she did best -- marketing and selling.

"I'm the face of the brand, and we didn't have money to advertise," she says. "I had to be out. Sitting in the office wasn't helping" the business grow.

Today, Spanx offers a slew of shapers. A new lower-priced line is being sold at Target stores. Ms. Blakely declines to reveal Spanx's biggest seller but says that the company's high-waisted shapers "have been our star." But not everything has been a blockbuster. Interest in low-rise footless pantyhose is more limited, Ms. Blakely says.

The most recent addition to the product line: Bra-llelujah, a bra fashioned of hosiery material. "I didn't know anything about bras, but I had to buy them," Ms. Blakely says. "I came in one day and thought: There's got to be a better way."

By: Simona Covel

Eli Lilly Signs R&D Pact With Covance

In a move aimed at delivering new medicines to market more quickly and cheaply, Eli Lilly & Co. struck a $1.6 billion deal with drug-development service company Covance Inc., which will buy one of Lilly's research-and-development facilities for $50 million as part of the agreement.

Lilly hopes Covance's expertise in conducting drug trials will shave months off the Indianapolis drug maker's early-stage product-development timeline, which could help it make faster decisions about whether to kill a compound or prioritize its development. A "significant" portion of Lilly's pre-clinical safety testing work -- which involves animals, not humans -- will be done by Covance from now on, according to Andrew Dahlem, chief operating officer of Lilly's R&D division.

The companies, which have had a long-standing relationship, announced the agreement Wednesday. Lilly Chief Executive John Lechleiter said the new 10-year contract with Covance means the Princeton, N.J., company "will continue to work with us...in a process of reducing our cycle times, particularly early-stage cycle times, measurably."

The hand-off to Covance of a 600,000-square-foot R&D facility in Greenfield, Ind., which was operating at only about half its capacity, will allow Lilly to reduce its fixed costs as well.

In similar agreements also announced Wednesday, Lilly is also transferring U.S. clinical-trial monitoring work to Quintiles, a pharmaceutical-services company, and data management to i3, a clinical-research organization.

Contract research businesses such as Covance conduct many clinical trials and focus on improving efficiency at every step of the process. They can accelerate execution of early-stage testing by 20% to 30% -- or about two to four months -- and can speed enrollment in human clinical trials by 6-12 months, according to Chuck Farkas, head of consulting firm Bain & Co.'s North American Healthcare Practice, which has conducted extensive research on drug-development cycle times.

Lilly's decision to move beyond simply contracting with Covance "sets the stage" for other companies to do so as well, says Eric Coldwell, a health-care business analyst at Robert W. Baird & Co.

This deal and the growing amount of outsourcing in the industry may also indicate more broadly that major drug makers are scrutinizing their "large, disjointed and bureaucratic operations" and "rethinking what their internal infrastructure and expense structures look like," Mr. Coldwell says.

He adds that in the long run, it may mean that pharmaceutical companies become more focused on being "the financier that aggregates data and markets data" rather than the entity that internally develops drugs.

Drug makers have been trying desperately to develop innovative medicines at a time when many companies are facing looming patent expirations on blockbuster drugs and struggling with their drug pipelines. Another issue facing major drug companies is the pricing of their drugs. Many drug companies have been investigated for inflating average sales price in an illegal practice known false average sales price or drg false claims. Lilly experienced a setback in June when the Food and Drug Administration decided it needed three more months before making a decision about the company's blood thinner prasugrel, which Lilly is hoping will be a big seller.

About 600 Lilly employees will be affected by the Greenfield facility's sale, according to Mr. Lechleiter. Some will go to Covance to continue working on drug trials while others may take alternative positions at Lilly.

By: Shirley Wang
Wall Street Journal; August 7, 2008

AOL Remains Sticking Point for Time Warner

Ad Revenue Stalls; Publishing Unit Is Drag on Earnings

Seven months into the job, Time Warner Inc. Chief Executive Jeff Bewkes's biggest move to reinvent the company has been a spinoff of the cable business. But now he faces a much bigger problem: AOL.

Time Warner reported a 26% decline in second-quarter net income Wednesday, as its Time Inc. publishing unit burned a hole in earnings, countering strength in its television networks and movie studio. The biggest drag on profit, however, was AOL, where advertising unexpectedly stalled.

AOL's bumpy transition from a subscriber-based model to an advertising model has dented Time Warner's performance in recent quarters, putting pressure on the company to consider ways to unload it.

Time Warner announced Wednesday it had completed the work necessary to separate AOL's Internet-access business from its core advertising business in 2009, paving the way, Mr. Bewkes said, "to do something strategic with either of these businesses today."

Time Warner is in talks with both Yahoo Inc. and Microsoft Corp. about a possible deal that could value its core advertising and portal business at about $10 billion. It has also had informal contact with possible buyers for its smaller, Internet access business, including Earthlink Inc.

Mr. Bewkes is under pressure to revive Time Warner's long-stagnant stock price with some bold moves. In April, he unveiled long-awaited plans to spin off Time Warner Cable Inc., focusing the company more acutely on its content businesses. He also cut costs by folding the New Line movie studio into Warner Bros. Now the spotlight is fixed firmly on solving AOL.

For the quarter ended June 30, Time Warner reported net income of $792 million, or 22 cents a share, down from $1.07 billion, or 28 cents a share, in the year-earlier period. Revenue rose 5% to $11.6 billion. Last year's earnings were boosted by the sale of a book business and by tax benefits.

Mr. Bewkes said both AOL and Time Inc. have fallen behind his expectations, weighed down by the advertising slowdown.

Faced with sharp revenue declines in the first quarter, executives had predicted that AOL's ad growth would show some improvement. But AOL reported slim gains, which failed to make up for deep declines in subscribers, stirring concerns about the success of the unit's shift in strategy.

Advertising growth, which decelerated in the previous four quarters, stalled at 1.5%, dragged down by a 14% slump in display ads. The unit posted a 36% decline in operating income.

Mr. Bewkes said AOL was still struggling with integrating recent acquisitions made in pursuit of its new strategy. But he added that "there continue to be encouraging signs about the underlying health of the business," and the company predicted that ad sales would improve in the second half of the year.

Time Warner has held discussions about selling AOL before, but a deal has always proved elusive, in part because of disagreements over valuation. Mr. Bewkes wants to conclude current talks on the core advertising business, however, before turning to the Internet access business.

A bright spot in earnings was the cable-TV networks business, which largely bucked the ad downturn. The division, home to CNN and HBO, reported an 11% rise in advertising and 18% increase in operating income. The Warner Bros. movie studio also had a strong quarter, boosted by DVD sales of "I Am Legend" and "The Bucket List."

Time Warner shares, which have fallen 10% this year, slipped 5 cents, or 0.3%, to $14.83 in 4 p.m. New York Stock Exchange composite trading.

By: Merissa Marr
Wall Street Journal; August 7, 2008

GM Presses Ad Agencies on Costs

As Suffering Detroit Looks for Savings, Local Media Are Feeling the Pinch, Too

In its latest attempt to save money, General Motors has asked its advertising agencies to slash their fees by as much as 20% this year and next, according to several people familiar with the matter.

The owner of Cadillac and Chevrolet works with dozens of agencies around the country, including Publicis Groupe's Leo Burnett and Interpublic Group's McCann Erickson and Campbell-Ewald.

Several ad executives familiar with GM say the cuts could translate into more than $20 million in total savings for General Motors, but likely will mean layoffs for the agencies involved.

GM also has pulled out of September's Emmy broadcast on Walt Disney's ABC; it has advertised on the star-studded program for about a decade.

GM's push shows how Detroit's pain -- caused by a sharp drop in U.S. car sales due to soaring gas prices -- is creating ripples in other sectors. The fallout is expected to be particularly harsh for companies reliant on car makers' massive marketing dollars.

It's not just ad agencies being whacked by the belt-tightening.

Auto makers account for more than 12% of all ad spending in the country -- more than any other single industry. Media companies such as CBS, Viacom and News Corp. have all taken significant hits.

"The collapse in U.S. automobile consumer demand will materially damage the advertising growth rates of traditional media owners," said Michael Nathanson, a senior analyst at Bernstein Research, in a report to investors this week.

Bernstein predicts U.S. auto advertising will fall to $15 billion in 2008 from $18 billion last year -- a noticeable drop from $24 billion in 2004.

Ford Motor's U.S. ad spending for the first five months plunged 37%, while ad outlays by Chrysler in the period sank 31%, according to the latest data from ad-tracker TNS Media Intelligence. TNS figures don't include search advertising.

GM declined to give details on its request that agencies lower their rates, but a spokeswoman says the car maker has "asked our agency partners to work with us to eliminate low-value work and find creative solutions to go to market more efficiently."

Chrysler wouldn't comment on the TNS numbers, but a spokeswoman says the company is shifting marketing dollars to the Internet and to mobile, two areas not included in the TNS data.

A spokeswoman for Ford says the company doesn't comment on TNS data, but notes that Ford said in July that it cut $200 million from its marketing budget in the second quarter.

The media sectors most vulnerable to the pullback in automotive advertising include local television stations, local newspapers and local radio. Local TV stations get about 28% of their ad dollars from the automotive sector, and it accounts for 18% of ad spending in local papers, Mr. Nathanson says.

They are working overtime to find new sources of ad revenue. Tribune's WPMT FOX43, which broadcasts in central Pennsylvania, says it saw the cuts coming and offered its sales force more financial incentives to tap other ad-spending categories. Telecom company ads and a bit of political ad spending have helped. Still, automotive has represented 35% of the station's business in the past. "Automotive is huge," says John Riggle, the general manager. "Are we struggling without it? Yes."

Others stations are scrambling for other sources of revenue, too. "This is the worst I have seen it in my career," says Wayne Simons, vice president and general manager of Fort Myers Broadcasting's WINK-TV in Fort Myers, Fla. Mr. Simons, who has been in the business for 41 years, says the only group spending more on ads these days is lawyers. "They are advertising like crazy, saying that they can help you with foreclosures," he adds.

Auto accounts were once the most profitable pieces of advertising business, but auto giants, like other marketers, have squeezed their agencies enormously over the past few years. FCB, now part of Interpublic's DraftFCB, in 2000 had profit margins in the 20% range for its work on Chrysler. Now, profit margins on auto accounts are typically between 8% and 12%, according to ad executives.

Though ad executives say car accounts remain a vital and profitable piece of business -- in part because the agencies, after years of such work, have created effective economies of scale -- Detroit's retrenchment is another blow for Madison Avenue.

By: Suzanne Vranica
Wall Street Journal; August 7, 2008

Newspaper Inserts Trending Down

Advertisers Not Using As Many Print Inserts

Newspaper Industry experts cite several reasons for a recent slowdown in the retail insert marketplace, among them declining news paper circulations, rising paper and ship ping costs, as well as advertisers' desire to reach younger, text-savvy consumers. Several printers and at least one media company, however, have introduced data-intensive programs designed to convince retailers of the power of print.

“We see a decline in inserts year-over-year, of between 12% to 20% industry wide,” reports a marketing director at Quebecor World Market ing Solutions Group.

Printers point to a decrease in pages as the cause. “Retailers are increasing insert page counts for key events like Christmas, Thanksgiving, Mother's Day and Father's Day while decreasing pages for other, less key, events,”. Costly gate-folds are also used less often. Newspapers in general are no longer delivering Return on Investment for Advertisers.

“The newspaper home sub scriber has always been one of the retailer's most valued consumers, and advertisers are beginning to walk away from newspaper and insert advertising efforts,” reports a top sales officer at Valassis Communications Livonia Michigan.

There are a few positive signs remaining for Hypermarket Meijer is taking in 10 times the number of paper coupons that it did last year, accord ing to Valassis. “Cash register returns drive circular and preprint behavior.

Targeted marketing, a direct marketing strategy, using demographics, minority demographics are all being applied to retail inserts more often to drive relevance.

Tribune Company, which publishes 10 daily newspapers, has started rolling out a program called PrePrint Optimization. It pairs client customer data with subscriber data to target where and how advertisers can effectively reach consumers.

“We know we're in the age of account ability and that this was a key component missing from newspaper advertising,” says an advertising director for major accounts at The Chicago Tribune, of the Tribune Newspaper's data-oriented market segmentation advertis ing programs. Linking Tribune newspaper household demographic data bases with their own customer databases, advertisers can insure they are get ting the best return on investment from print insert efforts.

PrePrint Optimiza tion is too new for results. Tribune Company said retail advertising revenues were down 26% for the second quarter; preprint revenues dipped 19%.

Sometimes analytics show the best medium for an advertiser to be one of Tribune's non-subscriber publica tions or its shared mail program. By ensur ing that advertisements are more targeted, Tribune hopes to increase the relevance of ads for consumers and advertisers.

“Advertisers test different methods to reach consumers to see what works best,”says a sales manager for Direct Delivery+ at Tribune Media Net, Tribune Company's national sales arm. While no “silver bullet” may exist, “by no means are we sitting back on our laurels, we have to get aggressive to counter internet marketing and the power of Google."

Retail insert printers Quebecor World, Vertis and Valassis have each introduced strategies for print advertising by crunch ing available data. The goal is to assist retailers to effectively reach their audi ence through such vehicles as shared mail, targeted direct mail, in-store on-demand coupons and other print solutions.

Advertising Opportunities are there for retailers to reach consumers via print, offered a SVP of sales at Vertis. “Free-standing inserts are one way to convey a print message. It needs to be part of the total media mix.

By its cross-selling initiatives, Valassis shifted $7.3 million in newspaper preprint business to shared mail in the first half of 2008, giving advertisers a way to reach non newspaper-reading households (not reported is the breach of privacy used to identify and list non-newspaper households.

This month, Quebecor World will launch Store.driver, a new direct-mail piece — designed to drive people into retail stores — that can be printed in-line with a map, paper gift card and fragrance strip.

All of these untested, new print advertising programs appear as desperate efforts by the print and newspaper community to combat the shirt of advertising dollars migrating to online marketing programs.

The Sirius-XM Merger: Now What?

Liars Figure & Figures Lie! Why did the FCC Approve the XM Sirius Merger?

As the former XM Satellite Radio and Sirius Satellite Radio finally have been allowed to merge and now confront the fact that deal was the least of their problems. Very little is known about how they will handle the integration; the only thing the companies have said is that they expect $400 million in cost cuts. Several bigger business issues await the companies, who once argued that if they couldn’t merge together, they would collapse separately. Here are some of the challenges confronting the combining companies.
A weak auto industry: Sirius has 18.5 million subscribers and expects to add 3 million more next year from auto makers including General Motors, according to Sirius XM CEO Mel Karmazin. That would generate $350 million in revenue, Karmazin predicted. But auto sales have been slowing, hit by rising fuel prices, constrained credit and a slower-growing economy. Sirius’s second-quarter financial results provided insight into how that already has affected the satellite radio business: it added 246,221 subscribers from auto makers, well below the 325,000 expected by some analysts. Detroit’s Big Three are in dire enough financial straits that they will appeal to Congress to increase to $50 billion a $25 billion loan facility signed into law last year. A Citigroup report this week spoke of a silver lining in that news, arguing that the better-capitalized the auto makers are, the better off Sirius XM is. Still, that may be something of a stretch.

Subscriptions are slowing: In the second quarter, Sirius added a net 279,820 subscribers–less than half the 561,500 subscribers of the year-earlier period. Morgan Joseph analyst David Kestenbaum warns of slowdowns in subscriber growth both from sales to auto makers and through retail outlets, and glumly predicted of both distribution channels, “We believe the [auto maker] troubles are short-term while retail’s demise is permanent.” Many new cars also have iPod jacks, another threat to Sirius-XM’s business.
Debt refinancing: XM refinanced more than $1 billion of debt before the deal closed, but Sirius has another $1 billion to take care of within the next 16 months. Not only is the credit crunch going to make that more difficult than it would be in normal times, but the capital markets haven’t been very welcoming to the satellite radio operators. Sirius sold $550 million in convertible securities to investors in late July for what Stifel Nicolaus analysts called “a desperately low price.”

New talent is expensive: Karmazin lured Chris “Mad Dog” Russo for a new show with a contract reportedly valued at $3 million a year for five years. Shock jock Howard Stern, the crown jewel of the Sirius broadcasting empire, signed a contract in 2004 reportedly valued at as much as $500 million over five years and received as much as $306 million in 2006 if you count bonuses and other perks, according to Forbes. Programming costs for both XM and Sirius total $475.4 million, or 23% of revenue. At the same time, Sirius shares are trading at record lows, and much of Stern’s compensation is in stock. Unless Sirius wants to pay cash or boosts its stock price, it may have trouble luring more talent.

By: Heidi N. Moore
Wall Street Journal; August 28, 2008

Trading Scandal's Legacy, Five Years On

'Stale-Price' Deals Cost Small Investors, But Led to Reforms

Five years ago next week, the mutual-fund world was rocked by the biggest scandal in the industry's 80-year history.

Fund companies had given certain customers trading privileges that weren't open to everyone; those special interests -- most notably some hedge funds -- engaged in rapid trading that netted quick profits at the expense of the average shareholder.

Headlines called it a "market-timing scandal," a misnomer since there is nothing illegal about trying to time the market. The problem wasn't so much the quick-fire trades as it was the special privileges that let traders play games the ordinary shareholder couldn't engage in.

The scandals centered on something called "stale-price arbitrage" in international funds. Knowing that European markets closed hours before the domestic exchanges, speculators would look for days when the broad market had risen sharply. Just before 4 p.m. in New York, the speculator would buy shares in funds with big international exposure, knowing that the foreign markets were already closed for the night; the bet was that the big day in America would trigger an equally big response abroad the next day.

Had the foreign markets already been open, market prices would have adjusted to that optimism. With the foreign markets closed, the prices were stale, creating a chance for the speculator to grab a quick profit.

The ordinary shareholder was paying the trading costs for the money moving in and out; former New York Attorney General and Gov. Eliot Spitzer said funds wouldn't put the new cash from the arbitrageur to work for days, thereby diluting any gains the fund made from the foreign exposure.

At a time when many fund investors had just lived through their first bear market and had seen their technology-laden and momentum-driven issues crushed, the public wanted the scandals to be worse than they were. They wanted the problems to explain their losses, so that they could hold someone's feet to the fire and maybe recapture their shortfall through lawsuits.

Pitching Pennies

Fast-forward five years.

The case that dramatically increased the public profile of Mr. Spitzer is now coming to its ultimate conclusion with a whimper, which has some people questioning its real significance.

Shareholders in scandal-tainted funds are starting to receive compensation for their losses. The Securities and Exchange Commission just sent checks worth a total of $40 million to 600,000 Putnam investors. An additional $18 million was distributed to some 325,000 Janus shareholders.

That is an average of roughly $66 per affected Putnam account, and about $55 per Janus shareholder. Only really big shareholders will get anything even close to those totals. The small shareholder with an IRA will be lucky to get enough payback to buy a pizza.

Over the next six months, an additional $110 million will go to Putnam shareholders, and Janus investors will see $80 million-plus in distributions. The fund firms -- and there are many others who paid fines for similar allegations -- admitted no wrongdoing but agreed to the repayment deals. In virtually every case, payouts are ready to go to shareholders in funds where rapid trading was allowed.

Compared with what investors lost to the bear market -- or what they have lost since from the mortgage crisis and credit crunch -- the settlements are minute. No one is turning the checks away, but they aren't big enough to make investors feel vindicated.

Truth be told, regulators and fund firms, along with the people hired to determine how to divvy up the fines fund companies paid, are guessing at the dollar impact of the actions.

Here is a safe bet: When the fund scandals first became public, shareholders who had been disappointed by the Putnam and Janus funds couldn't head for the exits fast enough. Chances are that scandal-tainted funds lost more money because of the run for the door than to the actual bad acts of rapid trading.

Wouldn't Happen Again?

The problems behind the scandal were easily fixed. Between prospectus changes, the addition of compliance officers, "fair-value pricing," and other behind-the-scenes moves, industry watchers say the same problem couldn't happen again today. There may be new scandals, but they will focus on some other as-yet-unaddressed loophole. Moreover, they won't involve unequal treatment, as fund companies are much more in tune with treating all shareholders alike.

In the end, industry supporters will use the small-dollar repayments to shareholders to say that the scandals were overblown. They weren't, because they showed a weakness in the system -- and in management's character -- that needed to be addressed and fixed before it was exploited further.

Clearly, investors should be more focused on performance than on back-room shenanigans, but the real legacy of the small-dollar/big-headline scandal of 2003 is that it probably saved the industry from getting into much worse, bigger problems by now.

By: Chuck Jaffe
Wall Street Journal; August 26, 2008