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Space Cadets

By Mark Lacter — Fri, 02 Nov 2012 16:30:00 GMT

Photo courtesy of Space X

Once the Curiosity rover had settled safely on the Gale Crater of Mars, engineers at Pasadena’s Jet Propulsion Laboratory went nuts—hugging, cheering, and letting out huge sighs of relief. “If anybody has been harboring doubts about the status of U.S. leadership in space, well, there’s a one-ton, automobile-size piece of American ingenuity, and it’s sitting on the surface of Mars right now,” presidential science adviser John Holdren said at a news conference. The doubts were understandable. Aerospace, which had been Southern California’s go-to industry since the 1920s, fell on hard times after the Cold War. Companies consolidated and moved out of town. By the mid-1990s local employment had plummeted. What stayed, though, was brainpower: Southern California has among the largest concentrations of aerospace engineers in the world, and that talent is being put to good use, not only for the ambitious Mars mission but for all sorts of space travel.

With the end of the space shuttle program, and with NASA moving toward advanced exploration of the planets (if Congress approves the money), a privately funded space race is taking shape, focusing on the business of routine orbital transport. Getting much of the attention is SpaceX Corporation, the ten-year-old Hawthorne-based company founded by billionaire Elon Musk—arguably the most admired and written-about entrepreneur since Steve Jobs. Musk’s company has already sent a capsule to the International Space Station as part of a $1.6 billion development deal with NASA. (Another mission to the space station had been scheduled for October.) Musk believes that every kind of transportation—be it satellite launches or travel to other planets—can be done more efficiently and at a lower cost if the government is not in charge. (That’s also the philosophy behind his latest brainstorm: some sort of superspeed people mover that can take passengers from L.A. to San Francisco in 30 minutes. At this point, however, space seems a lot more viable.)

One of the competing companies in the race, Orbital Sciences Corporation, based in Dulles, Virginia, is developing a space vehicle for NASA, while a Nevada company, Sierra Nevada Corporation, is working on a “space plane” that’s designed to ferry as many as seven astronauts to low Earth orbit. Closer to home at least 60 businesses are working on various space ventures in California’s Mojave area, which is near enough to L.A. to attract top talent and far enough to operate inexpensively and out of earshot. The most notable of these, Scaled Composites, was started by test flight legend Burt Rutan and is owned by Northrop Grumman Corporation. Besides Musk, billionaires Paul Allen, Richard Branson, and Jeff Bezos each have a space operation. Branson’s company, Virgin Galactic, has booked 600 people for future passage on something called SpaceShipTwo.

All of this is encouraging news for a local economy that remains in stutter-step mode. SpaceX, short for Space Exploration Technologies, alone has added hundreds of workers over the last year, and it’s posting ads for welders, software engineers, composite production engineers, and robotics designers, among other positions. As of August the workforce stood at 1,800, up from around 200 in 2005, and that number is certain to increase. The company has been leasing as much property as it can in and around its massive Hawthorne factory, formerly the place where Northrop manufactured fuselages for the Boeing 747. At last check nearly 1 million square feet were spoken for. Hawthorne city officials, grateful that so much new business has moved into their struggling working-class city, designated last June “SpaceX Month.”

Contextually the company remains fairly small. In nearby El Segundo, Boeing, Northrop, Raytheon, and Aerospace Corporation eclipse SpaceX with a combined 20,000 employees. Throughout Southern California there are roughly 100,000 aerospace and defense positions—160,000 statewide. But when you assess emerging companies, numbers don’t always tell the tale. Musk has a business model that sets SpaceX apart, not unlike the upstarts in Silicon Valley that veered from Hewlett-Packard and Fairchild Semiconductor. While different doesn’t necessarily mean better, Musk has managed to impress some of the industry’s stodgiest analysts. “The SpaceX saga is an appealing story on many levels,” aerospace consultant Loren Thompson wrote at Forbes.com, because “it demonstrates the dynamism of private enterprise.”

erospace settled here because land was cheap, local universities provided research and testing facilities, numerous military installations were close by, and the region was welcoming to new (and sometimes unorthodox) ideas. “Southern California as we know it would not exist without aerospace,” says Peter Westwick, who studies the industry at the Huntington-USC Institute on California and the West. “This was the road to the middle class for California families. The ranch house, the backyard barbecue, the surfing—they were built on the defense industry.” Along the way were ebbs and flows, depending on who controlled Washington and whether the nation was engaged in conflict. Once the Soviet Union collapsed in 1991, tens of thousands of aerospace and defense jobs in the area were eliminated. Thousands of additional jobs could be lost in 2013 if Congress and the White House remain deadlocked on a budget package and are forced to institute across-the-board cuts.

Because planes, satellites, and all the other aerospace gizmos are so complicated and costly, and because the layers of corporate bureaucracy get so entangled, it’s easy to lose track of the billions of procurement dollars. That’s sort of the idea. Conventionally a customer, usually the government, awards a prime contractor, which in turn works with subcontractors, sub-subcontractors, and lower-level suppliers in preparing the bits and pieces for whatever is being manufactured. (It’s a procedure that goes back to at least World War II, when airplane makers couldn’t handle all the orders and had to hand off work to other companies.) The arrangement has been beneficial to everyone: Congressional lawmakers appropriating the money can spread the wealth and maximize the number of companies (and constituents) that have business, while state and local economies can profit from a well-paid workforce.

Where the system breaks down is in the execution. Having thousands of companies responsible for making the needed parts and services often results in cost overruns and delays. This is what happened with the fleet of space shuttles, which originally were supposed to go up several times a month. “That was always the holy grail of space flight,” says Howard McCurdy, a space policy expert at American University. “The space cadets figured that if you could get the cost of space access down to a reasonable level, then you could start putting up large structures—space stations, lunar bases, Mars factories. That would open up everything.” Unfortunately the vehicle’s balky design, which was partly the result of letting in too many subcontractors, allowed only an average of four-and-a-half missions a year over the program’s 30-year run.

Musk wants to turn the process on its head by keeping up to 80 percent of the manufacturing in-house, a strategy that’s known as vertical integration. In addition, he hopes to fully reuse rockets and other expensive items, something that NASA has never been able to accomplish. That would lower the cost of each flight to a fraction of what the government paid during the shuttle days and make it easier to maintain quality control. “Keep it lean, reduce your mass, and then, once you’ve got a successful product, fly it like hell,” says McCurdy. “It contradicts the big-science philosophy that it takes a lot of checks and balances and a lot of people looking over other people’s shoulders.”

Not only is this a different business philosophy compared with 20 or 30 years ago, but it has created a different culture. Boeing and Northrop have workforces whose average age is close to 50, a reflection of the stepped-up hiring that took place during the Reagan years. These people have never left, which is why the annual attrition rate is in the 1 percent to 2 percent range (companies generally want more turnover—about 5 percent). “They’re in a sort of hunkering-down mode,” says Jan Vogel, executive director of the South Bay Workforce Investment Board, a career placement service. As an example, Northrop was forced to switch to a larger venue for its annual banquet that recognizes workers who have been with the company at least 25 years. By contrast, the average SpaceX employee is in his (or her) midthirties, and some of the hires are right out of graduate school. At the Quiznos a few steps from the SpaceX facility, several employees told me about the fast pace, endless days, and requisite perks (Ping-Pong tables, free frozen desserts) that you’d find at a Bay Area start-up. “We’ve been drinking the Kool-Aid,” says a 26-year-old engineer who has been at the company several months. “We’re working much longer hours than the other plants, but the Space Station was a nice reminder of what we’re planning to do.”

Craig Cooning, vice president and general manager of Boeing’s Space and Intelligence Systems Unit, scoffs at the claim of longer hours. “I get to work every day at 6:45,” he says. Still, Cooning and his managers have had to adjust to a new way of doing business—specifically the emergence of nongovernment customers who are more demanding about prices and deadlines. In the old days “if you won a major government program, it was like hitting a home run,” he says. “It would go on for a long period of time, and there were usually extensions, and it generated a lot of revenue. On the commercial side it’s more like bunts and hits to first base. They’re on a tight time line, and you’re scrambling a lot faster.” Contractors are faced with conflicting agendas: Commercial customers want to keep down costs, and government customers want to be in control. In just the past year Boeing picked up a $460 million NASA contract to develop engines and spacecraft and also received commercial orders for four telecommunications satellites that will be launched into orbit by SpaceX’s 18-story Falcon 9 rockets.

Clearly the privatization movement is here to stay, but the methods have yet to jell. SpaceX and the other newcomers operate less like traditional companies than expensive science projects. Musk, for instance, splits his time between SpaceX in Hawthorne and his electric car venture, Tesla Motors Incorporated, in Northern California. That’s an impossible regimen to sustain long term—one reason Musk says he might form a holding company to oversee both businesses. And how SpaceX would operate if Musk got hit by a truck tomorrow is anyone’s guess; the company is unusually stingy with information, even by the standards of government contractors. I was surprised at the difficulty in obtaining basic facts, such as the year when the headquarters was moved from El Segundo to Hawthorne (it was 2007).

But the biggest concern is not organization. It’s that once the development phase is over and full-scale operations get under way, something will go wrong. This isn’t like starting up a Web site or fashion label—being rocketed into orbit is the most dangerous type of transport, and the stakes will only intensify once manned flights are introduced. When the two shuttles went down in 1986 and 2003, killing everyone onboard, NASA suspended operations for months until investigators were able to determine the cause of the accidents. I suspect the fears that sooner or later somebody will make a mistake are justified. Yet learning curves are part of any successful industry, including precision-demanding ones like semiconductors and medical instruments. Somehow those businesses have managed to make it through the formative years. With so much money on the line and no real alternative for getting objects and people into space, the question is whether these folks will figure it out as well.

Bad Moon Rising

By Mark Lacter — Wed, 25 Jul 2012 19:39:00 GMT

Illustration by Gluekit

On the surface not much has changed. City Hall looks as imposing as it did when its doors opened in 1928. Cops are still patrolling, firefighters are still responding, trash still gets picked up once a week, and potholes, by and large, still get filled. But make no mistake: L.A. is different, and not in a good way. Desperate to close massive budget deficits for each of the past five years, city officials are hollowing out government before our eyes. They’re mainly doing it on the sly by borrowing money, deferring maintenance and overtime, benefiting from onetime revenue gains, and moving pockets of available cash from department to department. Most of all they’re eliminating thousands of jobs through retirements, transfers, and hiring freezes. Excluding police, L.A.’s workforce has been cut by 21 percent over the past half decade, to around 18,000. Not since Tom Bradley stepped down as mayor in 1993, when the city had 400,000 fewer people, has civilian employment been so low.

This is more than just a few numbers moving in the wrong direction. What’s at stake is nearly every city service that people living and working in Los Angeles take for granted each day. The fire department, for example, has lost so many positions that response times are now longer for fires and medical emergencies. Recreation centers have been forced to eliminate day care and seniors programs while cutting Sunday and holiday hours. The Department of Transportation won’t accept new requests for preferential parking designations because it doesn’t have enough people to manage the extra work. Even good news comes with a catch: L.A. is repaving more streets than ever before, but because a different department is responsible for restriping lanes and painting STOP markings on the road—and because money in that department is short—the work often gets delayed for weeks, creating traffic hazards.

“You see a government that’s struggling to provide basic city services,” says city controller and mayoral candidate Wendy Greuel, who has lost 21 percent of her staff since she took office in July 2009. Greuel is in full campaign mode when describing L.A.’s crumbling infrastructure and degradation of services, but I heard the same lament, both on and off the record, from officials not running for anything. Miguel Santana, who oversees budget matters as the city administrative officer and whose candid comments haven’t always been well received among lawmakers, describes the cuts as a form of crisis management that offers immediate relief but no long-range cure. “In an effort to keep the patient alive, we did things that we normally wouldn’t have done,” he says.

No portion of city government has been spared, including the police department. While the number of sworn officers remains around 10,000, a level that Mayor Antonio Villaraigosa and members of the city council refuse to budge on, funding for police overtime has been all but wiped out. Instead the department has implemented a system that forces officers to bank their extra hours as well as take days off in lieu of cash. Chief Charlie Beck acknowledges that the arrangement “is the equivalent of having between 400 and 700 fewer officers at any given period.” (Commanders have been instructed not to reduce shift sizes on Saturday nights and during other peak periods.) Another problem: The no-cut mandate doesn’t apply to the department’s back-office operations, which range from fingerprint analysis to clerical chores. There’s also a shortage of 911 operators. “We’ve been able to keep our response times at acceptable levels,” Beck tells me, “but they’re not what they would be if we were fully staffed.”

Budget deficits happen in the best of cities and during the best of economic times. Inevitably some years will have too little money coming in from taxes or other revenue and too much going out in salaries, public works projects, and retirement benefits. Modest differences can be resolved. In L.A., however, shortfalls of $200 million or more have become routine—what economists refer to as a “structural deficit.” Consider a home owner who has a monthly mortgage of $3,200 and a monthly income of $3,000. All manner of scrimping will leave him behind each month—and the more he borrows to pay his bills, the higher his debt will be. It’s a hopeless spiral.

Los Angeles faces a similar kind of spiral. The recession and sluggish recovery have kept tax receipts way too low, while sharply higher pension and health care obligations, along with the general costs of operating a very complicated city, have kept expenses too high. Some efforts have been made to reduce the biggest culprit—retirement benefits—but what’s needed is a 401(k)-type pension program that won’t make a big dent in the budget. Understandably the unions are balking at such an approach; they expect the city to abide by existing contracts. Except that the city can’t afford to do that. As it is, the deficit in 2012 was about $230 million, and the imbalance is expected to grow—to $342 million in 2013 and $427 million in 2014. And unlike the federal government, where red ink is added to the existing debt, most cities and states must find a way to balance the books.

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Ther municipalities, particularly in California, are also being squeezed, with massive deficits that stem largely from a weak real estate market and unwise decision making prior to the recession. The Northern California city of Vallejo exited from bankruptcy protection late last year; in June another city, Stockton, was forced into a similar Chapter 9 filing, resulting in reduced benefits to retirees and suspended payments to creditors. L.A. is not a probable candidate for bankruptcy—emergency funding is likely to be available in a worst-case scenario, and besides, the political fallout would be unacceptable to anyone in office. But Santana sees Stockton as a cautionary tale. “Right now I have no idea how we’re going to solve the deficit next year. All of our solutions are pretty much exhausted,” he says. “Maybe the public needs to tell us, ‘We don’t want you to do certain things anymore.’ ”

Of course the public will never tell them that. People don’t want to see their services disappear, and surveys have shown a general skepticism about “sky is falling” pronouncements. Instead of confronting the difficult choices that must be made (Should the fire department charge for ambulance services? Is it necessary to have a housing department? Can foundations or even private businesses operate the parks?), the temptation is to blame city officials for not budgeting more efficiently. There’s also the notion that buckets of cash can be quickly generated by uncovering waste, fraud, and abuse as well as by selling off city assets such as parking garages. Greuel has been pushing for these solutions in her campaign, but they’re a lot tougher to implement than it would appear, and remuneration is often marginal. Think about it: If it’s so easy to sell off a few buildings or collect on five-year-old parking tickets, wouldn’t they have done it by now?

L.A.’s budget is in fact devilishly hard to cut. Police and fire take up more than seven out of ten dollars, and there’s not much give in either area. Charter-mandated funding requirements for specific programs and departments, such as libraries, are another nonnegotiable cost. Of L.A.’s $6.9 billion budget, less than $400 million is considered discretionary. That has to cover everything from animal services to transportation, and no amount of trimming in those areas can pare down deficits year after year. The easiest—and some would argue least effective—means of cutting costs is through the wholesale elimination of jobs. That’s different from actually firing an employee, which rarely happens because the public unions apply enormous pressure on the city council (only one employee was let go last year and none so far this year). Rather than layoffs, the workforce is reduced mostly through attrition. As a department head told me, “We couldn’t decide who to eliminate, so we left it up to the city workers to decide.” The willy-nilly approach means some departments lose a disproportionate number of experienced employees. Santana says his staff was reduced so much that a group of retired city accountants came back on a temporary basis. “It’s piecemeal,” says Greuel, “and that’s the problem.”

Accounting sleight of hand is also being used to adjust the numbers. Earlier in the year the Department of Recreation and Parks was instructed to pay for its own energy and trash collection, even though such expenses had been taken out of another part of the budget for decades. These so-called chargebacks total $43.8 million in the upcoming budget and have, in effect, put the department in the red. Park supporters are pushing for a ballot measure that would provide the funding to keep the lights on. “They’re not even getting the best DWP rates,” says Steve Soboroff, who was president of the Recreation and Parks Commission when Richard Riordan was mayor. “The budget doesn’t address the right priorities. It addresses political priorities and union priorities…. Unless there are changes, the city is going to be so unlivable that people are going to have to leave. The city has to start setting priorities that involve quality-of-life issues.”

You won’t get much argument from City Councilman Paul Krekorian, who this year replaced Bernard Parks as chairman of the Budget and Finance Committee. Representing the southeastern portion of the San Fernando Valley, Krekorian is low-key, thoughtful, and from what I hear, more open to divergent views than his predecessor. When I meet him for lunch a few days before his panel begins hearings on the budget plan, he stresses that patchwork solutions only delay the fundamental decisions about what a city should offer its citizenry. “Yes, trash does get picked up,” he says, “but we don’t have the same weed abatement or graffiti abatement or bulky-item pickup or tree trimming or any of those things. People have noticed a difference.”

With much of the old system in tatters, scattered efforts have been made at reinvention and reform. One idea is performance-based budgeting, in which departments receive funding based on what they truly need—measured by a battery of standards—as opposed to what they routinely received in the past. Basic stuff, to be sure, but it gets to the heart of the challenge: determining where cuts can be handled with the least pain. Santana acknowledges the benefits of less bloat, just as government critics have preached for years.

Change, however, does not come easily for entrenched bureaucracies. On May 21, the L.A. City Council voted unanimously to approve a $7.2 billion budget for the upcoming fiscal year. Getting past the deficit involved nearly $70 million in spending cuts, $10 million from higher parking fines, $76 million in additional revenue that still has to be approved by state and federal officials, and the elimination of more than 400 vacant positions. The 209 layoffs that the mayor proposed will not happen, at least this year. Budget officials scraped together enough money to keep those folks working. In other words, L.A.’s new budget looks a lot like the budgets of recent years—a hodgepodge of short-term solutions that fails to confront a city government that’s being dangerously downsized. Over the next four years, according to the city’s budget office, expenses are projected to grow 4.7 percent while revenue is projected to grow 2.3 percent. You can’t fudge those numbers forever, and that’s the point: Everybody says the right things about wanting to save Los Angeles, and yet no one has a clue about how to do it.

It’s a Mall World

By Mark Lacter — Fri, 25 May 2012 17:14:00 GMT

Photograph by Damon Casarez

Century City’s shopping center, a high-end mélange that features Coach, Bloomingdale’s, Brooks Brothers, and Tiffany, is one of the most profitable malls in the nation, with each square foot of retail space generating nearly $1,000 in sales last year—almost double that of Fashion Square in Sherman Oaks. But there’s a problem: Century City is too small to accommodate the number of retailers wanting to get in. That means the loss of potential sales, jobs, customers, and local tax revenue as well as a loss of rental income for the owner of the property, Westfield Group. So later this year, having secured approvals from the City of Los Angeles and support from the area’s persnickety home owner associations, Westfield will begin work on a $500 million remake of the Century City mall by adding a second floor and more than doubling the number of shops. When completed in 2017, the project will have taken more than a decade from the time it was conceived.

You might recognize Westfield by the red-scripted logo that’s displayed atop each of its properties. But it’s also known as a preeminent fixer-upper of shopping centers, a big, messy process that requires huge amounts of capital, a coterie of lawyers and lobbyists, and most important, time. Westfield, you see, has a way of wearing everybody else down. “You know going in that they’ll get most everything they want,” says the head of a West L.A. neighborhood group, and it’s true. With Century City, the company agreed to construct an area for bicycle storage lockers and showers, and to lop off 10 stories from a planned 49-story hotel-condo tower. Those changes, however, still leave most of the blueprint intact. Even Grove developer Rick Caruso couldn’t keep pace, backing out of a 51-acre retail project that would have been located next to Arcadia’s Santa Anita Park—and near Westfield’s Santa Anita mall. Caruso and Westfield engaged in litigation and two contentious ballot measures. After a falling-out with his partner, Caruso finally said, Enough.

Westfield co-chief executive Peter Lowy joked during a speech last fall that of the 170 people in attendance, 30 or 40 were from Westfield and “the other 100 or so are from law firms—I think downtown—that we do business with.” For those looking to challenge the Australian-based company, it’s not so funny. Westfield is a real estate colossus, with 118 centers worldwide and assets valued at nearly $33 billion, not including works in progress like the retail portion of New York’s World Trade Center. Its local portfolio—much larger than that of the nation’s two top mall owners, Simon Property Group (Del Amo Fashion Center) and General Growth Properties (Glendale Galleria, Northridge Fashion Center)—covers 10.7 million square feet, which is roughly the equivalent of 34 L.A. Memorial Coliseums.

Of course mall owners must ultimately rely on their tenants to do well, and that’s where things become tricky. For the moment, customers are back, especially in the more affluent sections of town. Sales at Westfield’s ten Los Angeles locations have increased 7 percent over the past 12 months, to where they were at the end of 2007. But consumers aren’t behaving as they did before the recession. An obvious example is the preference for fashion-forward clothing on the cheap, which reflects a fundamental shift in the way people do their shopping. That explains why many boutiques are struggling, while low-cost chains like L.A.-based Forever 21 have become powerhouses. The use of comparison-pricing phone apps in particular places an emphasis on discounting, and retailers have tried to respond by offering markdowns, sometimes on an hourly basis.

The other change is in the makeup of shopping malls. Before the economy collapsed, U.S.-based retailers like the Gap or Victoria’s Secret had a business model that relied on opening new stores every year. After exhausting all potential locations, they would then spin off different concepts, like Baby Gap or Banana Republic, and open additional stores. But the downturn and the weak recovery have thrown off that approach (too many stores, not enough customers), forcing retailers to significantly downsize. This could have been a disaster for mall owners, except that something else was going on: Chain stores in other parts of the world were discovering the United States as a new market. All of a sudden Sweden’s H&M, Japan’s Uniqlo, and Spain’s Zara began filling the empty spaces. At the end of 2011, the vacancy rate for L.A.-area malls was 3 percent, down from 4.8 percent in early 2009.

Lowy loves talking about this stuff. He’s quite familiar with L.A., having lived here since 1990 as head of Westfield’s U.S. operations (he and his wife own a seven-bedroom, nine-bathroom home in Beverly Hills). Sitting in a conference room at Westfield’s headquarters in West L.A., Lowy notes that the company has spent $1.2 billion during the past five years overhauling, expanding, and redoing L.A. properties. The most ambitious of the rehabs so far is Culver City, which Westfield purchased in 1998 when it was called Fox Hills Mall. Plagued for years by gang-related incidents, the place became run-down and empty—a “forgotten mall,” as one real estate broker put it. Completed in 2009 and renamed Westfield Culver City, the complex is 45 percent larger than it was during the Fox Hills days—with the additions of a Target and a Best Buy—and last year sales totaled $116 million, an 11 percent increase from 2010. The difference is striking, not just in the number of shoppers but in the towering movie ads, glass-and-steel exterior, and eye-catching storefronts. Violent crime is also down.

One floor below Lowy’s office is a large room jammed with renderings and blueprints of future mall renovations throughout the United States. Scattered along the wall are samples of flooring; off to another side are chairs and garbage cans being considered for the food courts. Cost-consciousness is a priority; the company recently announced plans to reduce its debt load by selling eight of its properties, including Eastland Mall in West Covina. The company also emphasizes aesthetics, particularly in affluent locations. When the Century City food court was being gussied up in 2007 (real flatware was one of the improvements), somebody noticed that diners sitting on the outdoor terrace would be staring at air-conditioning units on the roof of an adjacent building. The solution was to install bannerlike movie advertisements to shield the view—and generate extra revenue. “What Westfield tries to do is create communities,” says Lewis Feldman, a partner in the Los Angeles law firm Goodwin Procter who has worked on Westfield projects. “That’s one of the things an online experience will not give you. People still want to go to the movies, and they still want to eat. There’s a social aspect to it.”

estfield started as an Australian success story: Two partners, Frank Lowy and John Saunders, opened a delicatessen in 1955 opposite the railway station in Blacktown, a Sydney suburb, that they figured would attract Europeans immigrating to Australia after World War II. Later, as tracts began filling up in the outlying western communities, the pair switched to land development. By 1960, Westfield was a publicly held company, leading to the construction of dozens of centers throughout the country. The United States, with its growing suburban population and consumer mind-set, would be the next major target.

Among early locations that Frank Lowy had his eye on was a stretch along Pico Boulevard in West Los Angeles—at the time occupied by a freestanding May Company, a Vons supermarket, and a minimall. The land for what would become the Westside Pavilion was purchased in 1983 for $8 million, but the coup was in persuading Nordstrom executives to open a store in the enclosed three-story complex (the retailer had been reluctant to expand outside of its base in Washington state). Residents were concerned about congestion, and Zev Yaroslavsky, then an L.A. city council member, called it “without doubt the worst case of commercial overdevelopment in my district.” Apparently nobody told the shoppers, who showed up in huge numbers.

The industry hit its stride around this time, with 16,000 malls built between 1980 and 1990. Then there was the savings-and-loan meltdown, a recession, and consolidation within the industry. “In 1993, you had 20 major owners of malls; in 2005, you had 5,” says Peter Lowy, who is Frank’s son. Lowy and his brother took charge of day-to-day operations in 2011: “We bought some, they bought some, companies merged.” As part of the deal making, Westfield unloaded the Westside Pavilion in 1996 while it acquired stakes in Century City and Valencia Town Center. And unlike its competitors, the company started to brand its holdings, as in Westfield West Covina and San Diego’s Westfield Horton Plaza. The idea, first introduced in Australia, was for shoppers to connect with the standard features of a Westfield property. “Every marketing expert told us it was stupid, that we come from Australia and we don’t know what we’re doing,” Lowy says. But branding its malls creates an identity that goes well beyond a single property.

Lowy himself is a familiar name at City Hall and within L.A.’s business and civic communities (he served as chairman of the University of Judaism and has been on the board of numerous nonprofits). Politics is also part of the picture: Lowy has given tens of thousands of dollars in campaign contributions to local elected officials, though he insists, rather implausibly, that such giving “doesn’t help at all to get any approvals.” One area where the family fortune—estimated by Forbes at $4.4 billion—has caused problems is a long-running investigation by Australian and American officials over possible tax evasion. In 2008, a U.S. Senate subcommittee report uncovered information suggesting that the Lowys used an offshore bank to set up a foundation in Liechtenstein and then funneled money back to the family through a separate corporation. During a subcommittee hearing, Lowy refused to comment on the investigation, and he wouldn’t discuss the case with me, either.

The thing to know about Westfield, beyond all the money, is the single-mindedness. Lowy believes that urban areas offer the best potential for development and that the best urban areas are both densely populated and located near transportation hubs. Busier is better. This is not a new concept in other parts of the world, but in sprawling and congested Southern California, busier isn’t that inviting a prospect, especially for the people who have to live with it. When the company first proposed the Village, a 1.4-million-square-foot mixed-use project in Woodland Hills, residents were furious. They had been putting up with congestion from Westfield’s two nearby malls—Westfield Topanga and the Promenade—and were now faced with still more stores, anchored by a Costco that would attract shoppers from other parts of the San Fernando Valley.

It took seven years of hearings and environmental impact statements before the L.A. city council finally signed off on the deal in February. As it had with Century City, Westfield made a few accommodations, including a redesign that will feature bike paths and greenery. The Costco will have a brighter facade than a typical big-box store, and its gas station will be redesigned to hide the pumps from street view. “I know there were…a lot of issues,” said City Councilman Dennis Zine during a council hearing, “but at the end of the day this will bring a tremendous amount of opportunity.” Well, it’s not quite the end: Despite council approval, the Woodland Hills Homeowners Organization has gone to court over the project, accusing the company of violating statutes concerning car use and the environment. At Westfield it’s always something. But with lawyers, money, and all the time in the world, the outcome is rarely in doubt.

Station Break

By Mark Lacter — Wed, 11 Apr 2012 23:38:00 GMT

Illustration by John Ritter

In the world of public television it was nothing short of the nuclear option. After years of squabbling over how much money L.A. station KCET should pay PBS for the full complement of network programming, both sides declared an impasse, and on January 1, 2011, KCET pulled the plug on a 40-year affiliation. No more Masterpiece, Frontline, or PBS NewsHour; no more Sesame Street or Nova. All PBS shows would now be aired on Orange County’s KOCE. “The time has come to acknowledge that this relationship no longer works,” Gordon Bava, KCET’s chairman, said in a letter to PBS chief executive Paula Kerger.

The PBS honchos never thought it would come to this. Yes, there had been acrimony over membership dues, corporate grants, and network schedules, but most everyone assumed that KCET would grudgingly stay the course. Considering that nearly 80 percent of the programming came from PBS, what choice did it have? And yet once the announcement was made, station managers all over the country began keeping tabs. It became a grand experiment to see whether a major public station could actually break away from PBS’s clutches. Dan Schmidt, head of Chicago’s WTTW, told his trustees that “if KCET is able to thrive without PBS, this will be a paradigm shift for [public television], which will change our business model forever.”

But KCET isn’t thriving—it’s merely hanging on. Though the station is desperate to note that ratings have been increasing since the initial plunge in viewership, the numbers remain low. As of last fall an average of only 10,000 people were watching KCET at some point during the day, according to Nielsen; a year earlier, with PBS, the figure was 20,000. (KABC, the most watched station, had an average of 165,000 viewers.) Prime time isn’t quite as bad, due in part to the popular British dramedy Doc Martin, with viewership off 27 percent.

“It’s been a liberating year, to say the least,” says Al Jerome, chief executive of what is now the nation’s largest independent public television station. After weathering months of “what were you thinking” tirades from viewers, Jerome and his staff managed to cobble together a presentable lineup of dramas, movies, international news programs (most notably, Al Jazeera English News), travel and cooking shows, and favorites like California’s Gold and SoCal Connected. Jerome, who joined KCET in 1996 and speaks with a salesman’s polish, compares the post-PBS world to a Costco membership store after the private-label Kirkland products have been removed. “We have lots of shelf space,” he says.

Station executives like to call the new KCET a start-up, and to some extent it is. The 4.5-acre campus, which is located at the eastern end of Hollywood and has been home to studios since the early days of the movie industry, was bought last year by the Church of Scientology. This month KCET is scheduled to move into two floors of a 14-story Burbank office tower near NBC’s studio complex. The net proceeds of that sale—about $29 million—along with a $1 million grant from the Ahmanson Foundation, will help fund the transition. Long term, the idea is to lessen the reliance on the outsourced lineup of PBS-type shows and concentrate instead on more locally oriented fare. (Even the new slogan, “Rethink TV,” is a placeholder for the future.)

What Jerome envisions is a three-hour news block, followed by a daily edition of the public affairs series SoCal Connected, followed by Huell Howser’s travel series and a mix of mostly arts programming and dramas. Several of these already have been on the air, including Open Call, a concert series hosted by mezzo-soprano Suzanna Guzman and featuring area orchestras in performance, and L.A. Tonight with Roy Firestone, which has the former ESPN sportscaster doing Charlie Rose-type interviews. Another new offering, Classic Cool Theater, is among the programs being developed under a deal with Encino production company Eyetronics Media & Studios.

So where will the money come from? The shows were funded only for several episodes—just to generate buzz—and it’s been tough to attract backing for extended runs. Meanwhile U.S. Bank’s sponsorship of SoCal Connected expired in October and has yet to be renewed (production has been suspended until more funding comes through). In some ways this is the hand-to-mouth conundrum that KCET has always faced—except now there’s no PBS to lean on and a number of larger contributors are antsy.

“I’d be disingenuous if I told you we weren’t disappointed,” says Fred Ali, chief executive of the Weingart Foundation, an L.A.-based nonprofit that paid for a communications center at the old headquarters containing $8 million worth of broadcast equipment—much of which will be kept by the Scientologists as part of the sale. The foundation has no plans to finance additional equipment for the new offices. In 2011, its first year of independence, KCET reported $22.3 million in revenue from contributions and grants, down from $37.6 million in 2010. While $12 million was saved in programming costs (no more worries about PBS dues), the station faces crushing financial obligations at a time when corporations continue to penny-pinch. “KCET is at a disadvantage because no one really knows what to make of them,” says Ali.

Then there’s competition from KOCE, formerly a second-tier affiliate that won the public television lottery by becoming PBS’s main outlet when KCET broke away. “I never would have dreamed that we’d be in this situation,” Mel Rogers, the station’s president, says at his office in Costa Mesa. In just three months the 38-person staff had to rebrand the station (now called PBS SoCal), rebuild the master control facilities, and arrange for placement on all cable and satellite systems in Southern California. More than a year later the benefits of being a top-tier affiliate are apparent: The second season of the hugely popular serial Downton Abbey premiered with a rating of 2.0 (that’s the percentage of all television households in the market tuned in), way ahead of KCET’s 0.5 rating for the same period. “Maybe they got it in their head that their brand was stronger than the PBS brand,” says Rogers.

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KCET first went on the air in 1964 as an affiliate of PBS’s predecessor, National Educational Television, and has enjoyed a wide range of successes. The 13-part series Cosmos, hosted by Carl Sagan, explored the origins of the universe and remains one of the most popular programs ever to air on public television. The nightly news show Life & Times had several iterations from 1992 to 2007, and A Place of Our Own (with its Spanish-language companion show, Los Niños en Su Casa) ambitiously focused on a largely overlooked audience: day care providers. But the station has been notorious for its slow-mo corporate culture and top-heavy management; proposals would take years to develop and frequently ended up going nowhere. (Station executives say that a senior-level restructuring has streamlined the operation.) My own experience goes back more than a decade, when I was editor of the Los Angeles Business Journal and met with station executives week after week about a proposed show on local business. Everyone agreed it was a good idea, but the money never materialized. When I recently reminded Jerome of the program, he said, “It’s still a good idea.”

Coming up with serviceable concepts has never been the problem. What hamstrung KCET over the years was the lack of production dollars and access to the PBS lineup, which has been dominated by three East Coast stations—WNET in New York, WGBH in Boston, and WETA in Washington, D.C. With longtime favorites such as Great Performances, American Experience, and Nature, the Big Three effectively blocked any path to national exposure, and with it an extra revenue stream. (Affiliates whose shows run on PBS typically receive a production or license fee.) Yet it’s easy to see why PBS has stuck with those warhorses: They’re the shows that the aging public TV audience—viewers average in their early 60s compared with 50 on the commercial networks—care the most about.

KCET’s showdown with PBS wasn’t about creative disagreements but money, specifically $50 million worth of grants for producing A Place of Our Own. In PBS’s crazy-quilt way of doing things, the more funding that a station is awarded for a specific program, the higher the membership dues. Over four years KCET’s bill went from $4.9 million a year to $7 million. “They know these dues are punitive—they just don’t change them,” says Jerome. PBS head Paula Kerger wasn’t made available for an interview, but a spokeswoman said that the “lost dues would have to be recovered from other stations, which would place an unfair financial burden on the rest of the system.” The spokeswoman also said that the station had been given “unprecedented flexibility and assistance” in making payments. KCET’s bellyaching, in other words, was not justified.

The thing is, KCET really did get ripped off, but in ways that go beyond membership dues or East Coast bias. The ultimate culprits were three other PBS affiliates in the L.A. area. Those stations—KOCE, KVCR in San Bernardino, and KLCS, which is owned by the L.A. Unified School District—had been operating as secondary affiliates, which meant they could air 25 percent of the PBS schedule as long as they waited eight days after shows were first broadcast. In return the stations were charged a fraction of what KCET had to pay. So KCET was shelling out more money and losing viewers in the process—not exactly a great deal.

Jerome approached the PBS board about turning KCET into a secondary affiliate (with much lower dues) and making one of the others the primary L.A. outlet, but the request was turned down. Then he suggested forming a consortium with the four stations and splitting the network schedule. That, too, was denied, despite a study finding that the arrangement could save money by consolidating operations. The two sides kept talking past each other—Jerome says that PBS is just a “precedent-averse organization,” noting that at one point Kerger said to him, “They’re all going to be lining up and asking for the deal that Al got.”

The folks at KOCE were not in on any of this; Rogers discovered that KCET had bailed out when several reporters called his office for comment. (The two stations, battling each other for viewers and dollars, have long had a chilly relationship.) Predictably prime time ratings skyrocketed, but now the station is stuck with higher membership dues—they’ve jumped from $1 million to $3 million—and increases in other programming costs. Rogers says he wants to expand, “except we don’t have a pile of money to throw at it. So we have to grow incrementally, and it’s terribly frustrating.” Among the challenges: establishing relationships with potential underwriters in L.A., improving sluggish daytime ratings, and stepping up local programming throughout the region.

Here’s the most unlikely development: Total public TV viewership in the L.A. area is up 6.8 percent since the KCET changeover. That’s better than the national numbers for roughly the same period—and significantly better than how several struggling markets are doing. The increase reflects television’s newfound reality: Viewers expect as much variety as possible, even on public TV. They want places to watch both Downton Abbey and Doc Martin. Whether the KCET experiment can be replicated elsewhere is anyone’s guess. Whether the station’s ratings can get back to the old PBS days is another unknown. Jerome, for all his upbeat patter, realizes that he’s on shaky ground. “Necessity is making us do the right thing,” he says. “We don’t want to be naive about it, but we’ve got to have a little bit of faith that if we build it, they will come.”

Rich People

By Mark Lacter — Fri, 03 Feb 2012 18:05:00 GMT

Photograph courtesy Jessica Craig-Martin/Trunk Archive

Here’s a piece of hopeful news about the economy: Porsche sales are back up. Through the first ten months of last year, 2,284 of them were newly registered in the L.A. area, an increase of 21 percent over the same period in 2010 and 55 percent over 2009, when the recession was coming to an end. “People held onto their money for a while, but at a certain point they figure they need to live their lives,” says Victor Ghassemi, senior sales manager at Porsche of Downtown L.A. “They still want the car.”

This might seem inconsequential to the rest of us who can’t afford a $205,000 Porsche 911, but it’s really not. When someone cuts a check for one of these cars, the economy is strengthened in several ways. Most directly the dealership is enriched, which means that the sales staff can keep working, which means that the

nearby sandwich shop can stay in business, which means that dozens of distributors and wholesalers won’t be losing a customer. The purchase of a six-figure automobile signals something else: that the wealthy are starting to spend money again. Not nearly as much as they were spending before the downturn—Porsche sales in L.A. remain 30 percent below 2006—but enough to be noticed.

For months rich people have been demonized by Occupy L.A. protesters and other Occupy movements around the country. At the risk of oversimplifying, U.S. households that have incomes of $350,000 to $400,000 a year—the minimum requirement for entry into the infamous 1 percent club—are being blamed for the financial miseries of the other 99 percent. The problem with such sniping is that, first of all, it’s ridiculous (Bill Gates and Warren Buffett are hardly cut from the same cloth as Bernard Madoff and Frank McCourt), and more important, it ignores how reliant—for better or worse—the 99 percent is on the 1 percent. California households making more than $200,000 a year contributed almost two-thirds of the state’s total tax bill in 2008 (the last year data is available). Without those dollars, state government would be effectively wiped out. There is no other place to find that kind of money.

The arrangement, though, has become complicated. The highest rung of the income ladder is a rickety place, with investors bringing in huge amounts when times are good and then losing substantial amounts when times are bad. As of 2009, according to the Internal Revenue Service, U.S. households making more than $500,000 a year accounted for 14 percent of the nation’s income, which is half the level of 2007. One reason for the disproportionate drop is that most of us 99 percenters didn’t have the opportunity to pursue the kind of high-risk investments that went kablooie in 2008 (hedge funds that year tumbled almost 20 percent). Everybody lost money—California’s median family income fell 5 percent between 2007 and 2009—but what’s been left out of the narrative is that the gap between the rich and the nonrich, while still massive, has actually narrowed a bit since before the meltdown.

L.A., of course, is among the nation’s most affluent locales. Roughly 41,000 households in the county reported more than $400,000 in adjusted gross income in 2009, according to the Franchise Tax Board. Perhaps more astounding is that postrecession, 20,000 households have a net worth of at least $10 million. This represents the 1 percent—serious money, Beverly Hills-Brentwood-Malibu kind of money. Yet it’s considerably less money than before. Financial managers and others I spoke to say that as a rule, portfolios at the highest end shrank anywhere from 10 percent to 20 percent. Ballparking, that translates into losses of $40 billion to $80 billion (though some of that money has been made back). “This was a very personal loss,” says Tim Lappen, a partner at the Los Angeles law firm of Jeffer Mangels Butler & Mitchell, who has years of experience working with wealthy families. “Personal net worth is personal self-worth, especially when they’ve dedicated their lives to building an empire. Then suddenly there’s a train wreck.”

The bad times weren’t so bad for Los Angeles-based multimillionaire Mark Kress, who sold jewelry in partnership with Joan Rivers on QVC and started a company that manufactures hair care products to cover bald spots. Nevertheless, Kress, whose net worth is somewhere in the eight figures, says he’s pared down debts and isn’t as status conscious as he used to be. “I’ve become aware of how hazardous life can be, money can be—how easy it is to lose a business,” he says. Since nobody outside his income bracket is likely to feel much sympathy, Kress commiserates with other rich people through the Los Angeles chapter of an organization called Tiger 21. “When the economy is going crazy, you get swept up in it,” he says, describing the days preceding the downturn. “There was a great deal of recklessness and assumptions that prices are only going one way. Everyone thinks they’re a genius.” What about now? “It’s changed their assumptions about life and their future.”

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The economist John Kenneth Galbraith had it right when he said, “Of all the classes, the wealthy are the most noticed and the least studied.” What’s worth remembering about the upper crust is that it used to be a small and stable group, with most of its money coming from oil and family trusts (inherited wealth composed a large portion of that). As noted by Wall Street Journal reporter Robert Frank in his book, The High-Beta Rich, only 276 people in the United States made more than $1 million in 1955. We’re talking about a genteel, class-conscious sort of wealth (depicted in movies like Sabrina and The Palm Beach Story). Federal taxes at the high end were astronomical—around 90 percent between the 1940s and early ’60s—and powerful labor unions, along with a growing entrepreneurial class, created the post-World War II economy that became dominated by the middle class, not the well-to-do. And it stayed that way for the next 30 years.

By the time Ronald Reagan came into office, several important developments had taken place. The top marginal tax rates were lowered from 70 percent to 50 percent, and in 1982, Congress passed legislation that deregulated the savings and loan industry. Further regulatory loosening over the next several years allowed banks, insurance companies, and brokerage houses to consolidate their operations into massive financial companies. The result was an explosion of investment possibilities, allowing the financial services industry to profit handsomely in what’s become known as the “financialization of wealth.”

Customers gradually moved from the usual collection of stocks, mutual funds, real estate, and commodities into more exotic bets, such as mortgage-backed securities, credit default swaps, and collateralized debt obligations. “Pre-2008, wealthy investors were fine to say to us, ‘Here’s a pool of money. I’ll sign a mandate, and you can manage it as you see fit,’ ” says Michael Walsh, managing director of the L.A. offices of J.P. Morgan’s Private Bank. In 2008, 10 million U.S. households were in the millionaire bracket, double the figure for 1990.

Los Angeles became one of the country’s two or three biggest financial centers, and by the 1990s, state officials began noticing a jump in the amount of personal income taxes being paid by the richest households. The money came from Silicon Valley entrepreneurs, Hollywood producers, newly arrived immigrants, and aging business owners who were selling their companies for vast amounts and then retiring, often to Southern California. In essence, they supplemented state sales tax revenue, which had been the dominant source of government funding but could not keep up with California’s spending needs. Then, as today, California income tax rates are more progressive than federal rates—that is, the wealthy shell out a disproportionate share. The upshot is that a large percentage of low- and middle-income households pay little or no state income tax.

While there’s nothing wrong with soaking the rich, lawmakers sidestepped an obvious flaw in the system: When the economy goes south, such as during a recession, high-end personal income taxes plummet as well. Revenue from Californians in the $200,000-plus category totaled $25.1 billion in 2000—right before the dot-com downturn—and then fell to $13.8 billion in 2002. By 2007, at the height of the economic bubble, it soared to $33 billion. The next year it collapsed. The state could have controlled such unpredictability by putting aside enough money during the flush years to cover expenditures during the lean ones—commonly referred to as a “rainy day fund.” Former governor Arnold Schwarzenegger tried to expand the fund as the economy grew worse, but he had only limited success. The budget deficit, in turn, got bigger and bigger, and state officials were stuck having to make drastic cuts. The long-term solution, overhauling the tax system so that most everyone has a little skin in the game, is impossible because of the fractured political system. For the moment Governor Jerry Brown is focusing on interim steps, such as a November ballot measure that would raise the state sales tax by half a percentage point, to 7.75 percent, and boost the income taxes of wealthy households over the next five years. In other words, Brown wants to bankroll the economy by depending largely on the 1 percent—the very system that helped get us into this mess.

To some extent the 1 percent is cooperating, like when Neiman Marcus was able to unload ten pewter-colored Ferraris, at $395,000 each, only 50 minutes after they went on sale last fall. But spending patterns are not what they used to be. An L.A. money manager says that one of his clients decided last year to buy a used Ferrari because he would be saving $50,000 (he wound up paying more than $250,000 anyway). Transactions in L.A.’s ultra-high-end housing market—typically $10 million and up—have been stubbornly down because property owners are not motivated to sell (“I can’t tell you the number of wealthy clients who have said, ‘I just want to pay off the mortgages,’ ” says Brett Bartman, senior vice president/financial adviser at RBC Wealth Management in Beverly Hills). Such hesitancy to spend is likely to be around for a while—at least two or three years would be my guess.

More worrisome over the long term is a hesitancy to invest. A business owner told me that after losing millions of dollars in retirement savings, she now keeps everything in a savings account earning nearly zero interest. J.P. Morgan’s Walsh mentioned clients who were buying bars of gold and having them stored under the Thames River in London (they periodically fly there to check the serial numbers). The conservative reflex is understandable, and yet the key to earning money on your money is taking risks—the greater the risk, the higher the return. Before the economic meltdown, losses were seldom a concern because everyone was doing so well. Today it’s about being risk averse—and yet if the wealthy don’t grow their assets in significant amounts, they won’t generate the income to pay the capital gains taxes needed to fund the schools. They also won’t be buying the stuff that keeps so many folks employed. Like it or not, this is the connective reality of our economic system, and no amount of protesting is going to change it.

Keeping Score

By Mark Lacter — Tue, 06 Dec 2011 00:47:00 GMT

Photograph by Sam Comen

The video game company Activision Blizzard put on quite a party in Playa Vista in September for fans of its action-adventure title Call of Duty. Along with live paintball skirmishes, simulated battle scenes, and appearances by military personnel were row after row of computers armed with the game’s latest iteration, Modern Warfare 3. Roughly 8,500 Call of Duty aficionados attended the two-day event—staged inside the mammoth hangar where Howard Hughes built the Spruce Goose—but what really stood out were the millions of additional fans who watched via a live-streamed broadcast. Activision, which is based in Santa Monica, claims that only the royal wedding of Prince William and Catherine Middleton had a larger streaming audience. “It’s America personified in a video game,” one fan posted in a chat room. “Violence, patriotism, consumerism, and zombies.”

The eight-year-old Call of Duty franchise is a phenomenon all right, with sales in 2010 of $1.2 billion (7 million people play every day for an average of 54 minutes). Activision loves its blockbusters—there’s the online fantasy World of Warcraft (operated by the company’s Blizzard unit); Guitar Hero, where players use a guitar-shaped controller to mimic rock musicians; and Tony Hawk, the skateboard game that’s now in its 14th version. This fall saw the introduction of Skylanders, a collection of action figures whose character traits are connected to an onscreen adventure game through a wireless device. Kids can play on a TV, computer, tablet, or cell phone, swapping one figure for another.

Over the years Activision’s strength has been creating games for home consoles like the Microsoft Xbox and Sony’s PlayStation. But the industry’s growth is coming more from online social sites, notably Facebook. This is the world of casual games, which take less time to play, aren’t as competitive, have a largely female audience, and lack the incessant violence connected with something like Call of Duty. When you’re playing FarmVille, the struggle to raise virtual crops and livestock is about as heated as the action gets. Sims Social, a repurposed version of the console game from Electronic Arts, lets players create avatars that mix and mingle in a made-up community. “Gaming has broadened to much bigger audiences,” says Dave Martin, senior vice president of media at Ignited, an El Segundo-based marketing firm. “When I plant a new crop and the plant dies, all my friends are going to know about it.”

We’re talking silly games, nothing like Activision’s guy-oriented titles that provide snazzy graphics and a realistic player experience. Those remain Activision’s bread and butter, although the company has been under pressure—from Wall Street and else-where—to enter the casual ring. As of October Activision chief executive Bobby Kotick still wasn’t ready. “If we can’t put a creative foot forward, it’s not interesting to us,” he told me at the company’s headquarters, which is tucked in an office complex on Ocean Park Avenue. In assessing Facebook, Kotick says he’s been “trying to figure out what we could do that’s different from what’s being done. So now that they’ve gotten a large enough audience and we’ve done enough analysis of the opportunity, we can commit capital.” He adds, however, “We don’t have huge expectations.”

Kotick, who is 48, heads an efficient and reliable consumer goods business, the kind investors love. The company’s market value of $14 billion is nearly double that of Electronic Arts, one of its primary competitors, and Activision’s stock has increased 40-fold since 1994. One reason for this success is an aversion to risk: The company concentrates on a limit-ed number of titles with the potential to become long-term moneymakers. The strategy, which Kotick describes as “narrow and deep,” is similar to how film studios focus on megahits like Pirates of the Caribbean. Kotick clearly has a thing for Hollywood: He speaks at length about wanting to infuse video games with better stories and characters. (He also appears briefly but convincingly as the owner of the Oakland A’s in Moneyball, his first movie role.) “What I’m good at,” says Kotick, looking very much the studio boss with slicked-back hair, an open-neck white dress shirt, and a blue blazer, “is making sure we have the best resources, the best talent, the best marketing, and the best access to distribution.”

Actually the video game business has been structured a lot like the movies. Much of the business is controlled by Activision, Electronic Arts, and a handful of other large publishers (they’re comparable to the studios), while hundreds of small development houses (production companies) are owned by the publishers or have contractual arrangements with them. The developers, who include writers, artists, and programmers, create the titles, which the publishers distribute and market. As players demand better graphics and more complex plotting, production budgets have become massive, with a major game frequently running $50 million and up, compared with a couple hundred thousand dollars three decades ago. Marketing can cost another $50 million or so, and there are ancillary expenses like customer service that movie producers don’t have to worry about (Blizzard spends upwards of $100 million a year just to operate call centers for World of Warcraft). “The hits have to hit hard and fast because the life cycle of an individual title is typically 24 to 30 months,” says Jordan Weisman, chief executive of Harebrained Schemes, a Bellevue, Washington, gaming company. “So you have to get all of your revenue right away. That’s why it’s a challenging business.” Last year U.S. video game sales were $15.9 billion, while Hollywood’s domestic box office was $10.5 billion.

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Activision was started by four former Atari programmers in 1979, a period of industry soul-searching after the rise and fall of the first video game hit, Pong. The company had a successful stretch in the 1980s (Kaboom! and Pitfall! were huge), but a misguided expansion into business software led to enormous losses. Then someone had the unfortunate idea of changing the company name from Activision to the nerdy-sounding Mediagenic. By 1991, the business was at death’s door, with $30 million in debt and $2 million in assets. Along came the peripatetic Kotick, who was in his twenties and had cobbled together a résumé that included restringing tennis rackets, renting out New York’s Studio 54 on off nights, and starting a software company that briefly competed with Apple. “I never studied business,” says Kotick, who majored in art history at the University of Michigan. “It’s either in your DNA or it isn’t.”

Kotick orchestrated a bankruptcy reorganization that left him operating the company with three partners, among them Las Vegas casino mogul Steve Wynn, who had befriended Kotick some years earlier. They changed the name back to Activision and moved from Silicon Valley to Santa Monica because Kotick figured that being close to Hollywood talent might lead to games that resemble movies and TV shows. As it turns out, there’s not much overlap—L.A.’s video game industry is relatively compact, with a full-time workforce of about 6,000, plus several thousand freelancers (the entertainment industry employs 20 times that amount). Activision is a kind of mother ship—you’d be hard-pressed to find anyone in the business who hasn’t been connected with the company in some way. “We used to refer to Activision as ‘Game College,’ ” says Eric Gewirtz, who worked there in the late 1990s as an intern and went on to become a designer for several titles before cofounding Seismic Games. “Tremendously long hours and a college dorm life mentality—it was a blast.”

Opinions about Kotick are not nearly as effusive, largely because of what some consider an intemperate style (he once called Activision’s corporate culture a mix of “skepticism, pessimism, and fear”). Not being a big gamer himself doesn’t help Kotick’s standing. Jeffrey Katzenberg, head of DreamWorks Animation, described him in Forbes as “a crazy, ambitious, funny lunatic.” Kotick went through a well-publicized skirmish in 2010 when the two former lead developers of the production house Infinity Ward filed suit against Activision. They say that the company fired them on trumped-up charges of insubordination and breach of contract right before they were to receive sizable royalty checks for Call of Duty: Modern Warfare 2. Activision countersued, claiming that the developers were “self-serving schemers who attempted to hijack Activision’s assets for their personal gain.” The case remains in litigation. About 30 Infinity Ward staffers siding with the developers quit over the squabble, though Kotick is quick to point out that the production house received 5,000 résumés after their departures. “I’ve had the pleasure of being sued by Bobby a number of times,” says Weisman. “It’s almost a sign of affection from him.” Like other game developers, he admires Kotick but says that creative types are treated too much like commodities that can be easily replaced.

When I bring up his less-than-flattering reputation, Kotick shrugs. “Look, I can’t control what people write or say. They spend a lot more time thinking about that than I do,” he says, claiming that the comments he makes at investor conferences often get blown out of context (video game bloggers are prolific and often fiery). “Besides,” he adds, “it’s very easy to criticize the CEO of the market leader. I’m here because the shareholders give us the capital to generate a return, which we do.” For all the parallels with Hollywood, Kotick runs Activision like a packaged goods business, which means being cautious, unemotional, and focused squarely on profit. That’s why he’s dragging his heels about social networks. The business model is just too shaky.

Last summer San Francisco-based Zynga, which created FarmVille and other casual games for use on Facebook, began preparing a public offering that valued the company at up to $20 billion—an insanely high number for a business that’s only four years old. Then came a sharp drop in earnings, followed by the stock market tumble, and by October the number being thrown around was closer to $10 billion. With the IPO being finalized, reality is setting in. Since Zynga’s games don’t cost anything to play, the company makes its money through the sale of add-on virtual goods like imaginary chickens or skyscrapers—and only 5 percent of the 150 million unique monthly users spend money on those items. In addition, Facebook takes a 30 percent cut of whatever Zynga collects. True, the games are relatively cheap to develop, but when so few players are paying customers, it’s bound to raise questions. Recognizing the vulnerabilities, Zynga has announced plans to start its own social network, though it will continue to offer games on Facebook. Denis Dyack, president of Canadian video game developer Silicon Knights and an outspoken critic of casual gaming, told a trade publication earlier this year that when the business crashes, “it’s going to crash very hard. I don’t see there’s an economy there.”

That’s why I like Activision’s go-slow approach. Media companies are throwing lots of spaghetti against the wall these days to figure out how best to deliver entertainment content, whether it’s in movies, TV, books, or video games, and everyone still seems to be searching. Do you rely on advertising or subscriptions or pay as you go? The confusion could continue for years—and even when the new ways of business are more or less established, Activision might fare best by expanding in its own way and at its own pace. “You put some things out there,” says Kotick. “Some work, some don’t, and then one really takes off and that pays for your failures. Then you go on to the next one.”

Enter the Big Top

By Mark Lacter — Sat, 01 Oct 2011 00:00:00 GMT

Cirque du Soleil’s Iris, the entertainment troupe’s ode to moviemaking, is already drawing large audiences to the Kodak Theatre in Hollywood, but for anyone who has yet to check out the 72 performers, 200 costumes, 20 video projectors, and 166,000 watts of sound power, there’s no hurry. The show will be running in L.A. for at least ten years. Assuming that the audiences are big enough to earn a profit (anything over 65 percent of capacity each night), Iris could easily become the single greatest economic infusion Hollywood has ever seen. What’s remarkable is that the production took shape during the worst downturn in 80 years—and without studies or commissions or pro forma public hearings. All it required were three well-connected L.A. guys: an entrepreneur, a real estate developer, and a city councilman.

Up until now Hollywood development has been by stutter step. No one would dispute that the place has come a long way over the last half-dozen years, with busloads of tourists congregating on the cement footprints in front of Grauman’s Chinese Theatre, at the nearby Madame Tussauds wax museum, and in front of the El Capitan. Yet even boosters will tell you that away from the main attractions, Hollywood streets still show their seedy side, especially at night. You often just want to get in and get out. “At least Times Square has Broadway and the shows,” says L.A. businessman Gary Shafner. “You come here, you put your foot in the footprint, and you’re done.” The elegant and mostly unused Kodak Theatre has been a glaring example of lost opportunities. Despite being home to the Academy Awards, the theater is ill suited for many concerts and shows—too much verticality and not enough seats. “It doesn’t make economic sense for artists,” says Shafner. “You have Universal and then you have the Greek Theatre, Nokia—you have all these theaters with bigger capacities. Why would I play a 3,400-seat theater when I could play a 5,000-seat theater and earn a lot more money?”

Shafner, who tries to stay under the radar, has contacts who are spread throughout the city. A onetime assistant to rock promoter Bill Graham and former tour manager for Bob Dylan, he is a partner in National Promotion & Advertising, which plasters ads on vacant lots and construction sites. Going back more than a decade, he has contributed almost $30,000 to elected officials, including Mayor Antonio Villaraigosa and 13 of the 14 current city council members. He also happens to be a pal of Shaul Kuba, whose real estate company, CIM Group, owns the Kodak Theatre, Hollywood & Highland, and the adjacent Renaissance Hotel. Shafner has a fondness for Hollywood, and the Kodak in particular (he arranged to hold his wedding there with programs designed in the format of a Playbill and posters announcing the couple’s “Big Fat Kodak Wedding”).

He knew that the place was a loser. Everybody did. “What about having Cirque du Soleil?” Shafner suggested to Kuba, one of his many supersize ideas for the Kodak. With its graceful combination of street gymnastics and circus-style arts, a Cirque show would generate business not only at the theater, but at nearby restaurants, clubs, hotels, and shops. Of course, lots of cities around the world want a permanent Cirque du Soleil show, and most get turned down before the courtship advances very far. “They want to get rid of the riffraff,” says Shafner.

Cirque du Soleil was founded in 1984 when a group of street performers—fire-eaters, mimes, jugglers, and acrobats—banded together in the Quebec town of Baie-Saint-Paul. Originally funded as a nonprofit organization, the company went through several rough financial stretches, and by the fall of 1987, when founder Guy Laliberté had his troupe perform downtown at the Los Angeles Festival, Cirque was close to shutting down. “We literally had no money to put gas in our truck to go home if we failed,” Laliberté recalls. “We said, ‘We live or die in L.A.’ And when I saw movie stars—household names—actually standing in line to buy tickets, I began to think maybe there was a possibility.”

The privately held company has expanded from two traveling shows in 1990 to the current 22, both touring and permanent (a Michael Jackson-themed North American tour launches this month). Ticket sales make up most of the annual revenues, which approach $1 billion, with corporate sponsorships providing a financial cushion. The approach to the shows, performed in more than 300 cities, has remained basically the same from the beginning: promote the production and not the performers (they can be replaced), avoid dialogue so that all audiences can keep up, and seldom include animal acts, which are expensive and often a turnoff. This pairing of ballet and Barnum & Bailey, enhanced over the years with digital effects and lavish art direction, has yet to be successfully imitated. There’s been occasional carping, mostly from would-be competitors, about how the acts are beginning to look alike, and ticket prices, which can run more than $200, are not for the budget conscious. But each night in Las Vegas alone, up to 15,000 people—about 20 percent of them repeat customers—watch O, Mystère, Zumanity, and four other permanent shows. Cirque du Soleil is a global money machine.

*****

For Kuba the biggest challenge in landing Cirque may have been setting up the first meeting. It took over a year. “I didn’t encourage him. I didn’t want to waste his time,” says Daniel Lamarre, Cirque du Soleil’s chief executive. The company was in the process of opening several permanent shows in Japan, Macau, and Las Vegas, and he wasn’t looking for more. But Kuba called so many times (“It became sort of a joke,” says Shafner) that Lamarre finally agreed to squeeze a half hour in between two meetings in Las Vegas. As Kuba and Shafner made their pitch, Lamarre became intrigued, remembering that Cirque had brought down the house during a four-minute bit at the 2002 Academy Awards. He and Laliberté arranged a second meeting, this time at the Kodak. “It was really Guy who sat in the theater, looked at the sight lines, and saw the possibility of it,” says Shafner.

Unlike Vegas, with its almost constant visitor churn, L.A. is not an obvious Cirque target. No show has been permanently based here (Phantom of the Opera had the longest run, at four-and-a-half years). Also, Cirque shows are pricey to mount, requiring a complement of sophisticated lifts, platform stages, and set pieces. The Kodak’s limited backstage would need to be significantly revamped in order for Cirque to match its production standards in Vegas, which any Hollywood show would inevitably be compared with. “So we said [to Kuba], ‘You work on the backstage part, and we’ll invest in the show itself,’ ” Lamarre told me, sipping a double espresso at the Beverly Hills Hotel. (Shafner says he doesn’t have a stake in the deal.) The cost of the project was $103 million—$51 million from CIM and $52 million from Cirque (shows that require the construction of a theater can run twice that). With eight performances a week, excluding six weeks to prepare for the Academy Awards, Lamarre figured he could sell 700,000 tickets each year. “If we had come with a typical Cirque du Soleil show,” he said, “I don’t know how long we would have lasted. But having the Hollywood theme makes it different.” That theme traces the history of motion pictures, with dance, acrobatics, live video, animation, and filmed sequences.

Cirque didn’t flinch at the up-front costs, but CIM was entering unfamiliar territory. The firm is a real estate giant, with office and retail properties in Mid City, Hollywood, and West Hollywood (along with about a dozen other cities in the United States). But as with any real estate company, business is usually transacted by leveraging assets—that is, buying stuff with other people’s money. In the Cirque deal, CIM was willing to put up $21 million of its own cash, which still left $30 million to borrow. Kuba, who is notoriously press shy and declined repeated requests for an interview, told the Los Angeles Business Journal that private financing fell through because of tight credit markets in 2008.

That’s around the time he contacted another friend, city council president Eric Garcetti. Over the years city agencies have given nearly $100 million worth of loans and subsidies to CIM. With the Cirque deal in the balance, Garcetti’s office came upon a little-used loan guarantee program overseen by the U.S. Department of Housing and Urban Development. The program, known as Section 108, is aimed at perking up low-income communities in cities that receive federally funded Community Development Block Grants (the average household income in the area near the Kodak is less than $35,000 a year). As part of the plan, the city would borrow $30 million and pass it on to CIM. Los Angeles collects $450,000 as a finder’s fee. Having the city serve as an intermediary between HUD and a private entity was permissible but unusual. So was the size of the loan, which ranked as Section 108’s largest in 2010.

At first Los Angeles city councilman Dennis Zine wondered if it was a great idea to put that much money into a single project. A Los Angeles Times editorial questioned whether the city had made its case for what could be risky public investment (“too many assertions and too little evidence”). The loan, however, is virtually risk free for taxpayers: Money comes from private investors who buy federally guaranteed notes that will collect interest. In addition, no project funded under Section 108 has ever gone into default; factoring in a worst-case scenario, the CIM loan would be collateralized with the Hollywood & Highland complex. In the end the city council approved the $30 million loan with no objection.

On the week that previews began, I met Garcetti at a coffeehouse a few blocks from his Silver Lake home and asked him whether any lessons could be drawn from what he and his buddies had done. “Number one is that government has to have a human face,” he said. “If I hadn’t been a part of the mix, I don’t think we could have convinced Cirque to come. Lesson number two is that government works best in tough times. If we take resources that can withstand downturns and that are available when private markets dry up, that’s when we need to step up.” Well, maybe. This might not have been a sweetheart deal (the loan processing was much slower), but it was certainly a relationship deal, and the connections Kuba has cultivated with much of the city council are bound to rub good-government types the wrong way. That’s life in the big city—elected officials always seem a little more willing to help the folks who shell out tens of thousands of dollars in campaign contributions.

But the Cirque du Soleil deal reflects another aspect of L.A. commerce, something that shouldn’t be overlooked in a city that’s considered so business unfriendly: It’s that the benefits of deal making—whatever you think of the effects—can go well beyond the deal makers themselves. Business owners along Hollywood Boulevard believe this single show will be a game changer for years to come. It was the simplest of ideas resulting in, potentially, the biggest of paybacks: Hollywood gets a major attraction, Shaul Kuba gets a long-term tenant, Cirque du Soleil gets another $70 million in revenue each year, and Garcetti gets major political points. And what about Gary Shafner, the guy who came up with the idea in the first place? He wants to open the largest candy store in L.A., only a few steps from the Kodak.

Photograph by Dustin Snipes

Not Worth The Weight

By Mark Lacter — Fri, 05 Aug 2011 15:59:00 GMT

Concertgoers walking into the lobby of the Fred Kavli Theatre for the Performing Arts in Thousand Oaks will notice a donors wall near the entryway that’s filled with the names of corporations, foundations, and individual philanthropists who helped underwrite the venue. Near the top is Bank of America, which routinely contributes hundreds of millions of dollars to community organizations throughout the United States. Except that this sponsorship wasn’t BofA’s idea. Underneath the bank’s familiar nameplate is the faded but recognizable lettering of the company whose name used to be on the wall: Countrywide Financial Corporation, a major player in getting the theater off the ground. Three years after Bank of America purchased Countrywide for $4 billion, it hasn’t been able to brush off the old name—and the juxtaposition couldn’t be more awkward. About the last thing the bank wants to do is remind people that it wound up with Countrywide, the mortgage giant that was based in Calabasas.

Looking back, I remember the deal actually making some sense. BofA had visions of being the Walmart of banking, but that could only happen by bulking up on the mortgage business, an industry that Countrywide had pretty much cornered. With this single purchase Bank of America would go from 4 million mortgages to 14 million and inherit a new customer base that could be persuaded to open BofA checking accounts and CDs. “Countrywide presents a rare opportunity for Bank of America,” said former BofA chief executive Kenneth Lewis at the time the acquisition was announced in 2008—and despite growing signs of delinquency problems among Countrywide home buyers, many in the banking industry agreed. This was before the failures of Bear Stearns and Lehman Brothers, and expectations were for no more than a rough couple of years, followed by smooth sailing.

Instead the purchase has been a disaster, arguably the most expensive, ill-advised deal in the history of banking. Once BofA took over, it discovered a rat’s maze of bad loans, many of them resulting from Countrywide having given mortgages to people whose financial conditions weren’t adequately reviewed. After the first few months of teaser rates and other come-ons, a good percentage of the new borrowers couldn’t pay. Suddenly the bank’s servicing arm, which until then was mainly responsible for taking checks out of envelopes, had to arrange complicated loan modifications and foreclosures. This was done poorly—people complained of long waits for customer service, or lost paperwork, or receiving incorrect information that created more trouble. BofA was even sued for improperly foreclosing on active duty soldiers, including some who had suffered severe injuries (the bank has since stopped foreclosing on those properties).

Today Bank of America has 1.3 million customers who are delinquent by 60 days or more on their loans (81 percent of those come from the Countrywide acquisition). Its mortgage division lost $8.9 billion in 2010, and a recent settlement with investors will result in a $20.4 billion charge for the second quarter of 2011. Influential bank analyst Dick Bove expects BofA’s mortgage side to lose billions more during the next three years because of loan problems, although the bank as a whole will still make money. “Every time they turn over a rock, there’s another snake,” says Tony Plath, associate professor of finance at the University of North Carolina at Charlotte and a longtime BofA watcher. “It’s going to take them five years to get through the bottom of the snake pit. You just have to slug your way through it a loan at a time.”

From its earliest days as a San Francisco-based institution, Bank of America has been a huge player in the L.A. area. There are 350 banking centers, 1,500 ATMs, $200 billion in retail deposits, and 16,000 employees in Southern California. The Countrywide deal places BofA among the region’s largest employers (along with Northrop Grumman, Ralphs, and Boeing). Not that the company is advertising its expanded presence—mortgage operations are located in a gated Mediterranean-style office complex off the Ventura Freeway, formerly the headquarters of Countrywide (and before that, Lockheed). The place has the look of an exclusive club, with a guard stationed in front and only a small plaque to indicate that it’s a Bank of America office. I found the same restraint at the much larger BofA compound in Simi Valley, where thousands of employees take calls from often desperate mortgage holders hoping to prevent foreclosure. After driving up a narrow road, I turned onto 450 American Way, where dozens of people with badges around their necks were walking in and out of the massive two-story building that once served as a warehouse for Bugle Boy jeans. I tried approaching a couple of folks, but they had been instructed to avoid reporters. When I got back in my car and pulled into a visitors’ parking space, a young man in a blazer and earpiece came up to me to ask what I was doing there. Leaving, I noticed he was speaking into his shirtsleeve, which was most likely hiding a transmission device.

Countrywide, you see, remains a sore subject. Current CEO Brian Moynihan couldn’t escape shareholder grousing during the company’s annual meeting last May (“I can’t revisit that decision,” he told the Financial Times. “I have to figure out what to do with the company now.”) At the bank’s headquarters in Charlotte bad news often gets telegraphed with a single word: “Calabasas.” To be fair, the current Calabasas executives didn’t orchestrate the Countrywide purchase (Kenneth Lewis left the bank under fire in late 2009). In fact, the BofA executives charged with untangling the mortgage problems “have been accessible and willing to listen and made a decent effort of reaching out to stakeholders,” says Barry Zigas, director of housing policy for the Consumer Federation of America. “But it’s just been a very difficult process.”

*****

Countrywide was started in 1969 by two New Yorkers, David Loeb and Angelo Mozilo, who after a few early stumbles recognized that the best way to attract borrowers was through low interest rates and stellar service. Sounds basic, but at the time it was revolutionary; up until then the mortgage business had been dominated by banks and savings and loans. Because it couldn’t accept deposits like a traditional bank, Countrywide had to borrow money to originate loans and then sell those loans to other financial institutions. Almost from the start the two men set their sights on California, the nation’s premier housing market. By the mid-1990s, after the company outgrew its Pasadena headquarters, Mozilo began buying office properties in Calabasas, Simi Valley, and other nearby communities—up to two-and-a-half-million square feet.

Mozilo’s flashy veneer—the elegant suits, carefully coiffed white hair, perpetual tan—was a deliberate counterpoint to his hardscrabble upbringing. A Bronx butcher’s son who worked his way through Fordham University, Mozilo made it a point to remind people how he was rebuffed by Ivy League types on Wall Street. “I must say, it bothered me when I was younger,” he told The New York Times, “their snobbery and their looking down on us.” A reverse snobbery came into play, with several of his senior executives holding degrees from lower-tier institutions (among them Cal State Northridge). Several former employees I spoke to describe a bruising corporate culture: Success was measured strictly by volume, leaving work an hour early was duly noted, and anybody who challenged company policies could be demoted or dismissed (one executive who was fired eventually won $3.8 million in damages). The place was a sweatshop, but the sweatshop made tons of money. During the real estate bubble between 2001 and 2006, Mozilo received $470 million in compensation, raising the ire of shareholder groups and presaging several investigations down the road.

By the summer of 2007, Countrywide hit a wall with its fast-and-loose lending style. Subprime defaults were rising rapidly, home prices were plummeting, and Wall Street bankers—the same ones who had fueled the company’s growth—were no longer willing to purchase Countrywide’s suspect mortgages. Mozilo himself acknowledged that the industry was running wild. Entering the picture around that time was Bank of America, which had gotten out of the subprime market six years earlier because the business had become, according to Lewis, “volatile and risky.” Of course, that was before the housing boom, when anybody who wasn’t bringing in buckets of cash was considered a rube, and before Bank of America executives realized the importance of having a significant mortgage component to its business. With Countrywide short on cash, BofA invested $2 billion; several months later it bought the whole place. In his farewell remarks Mozilo said BofA shareholders would “reap the benefits of what we have sowed.”

As it turned out, Countrywide’s financial hole was much deeper than anyone had imagined. Numerous investigations and lawsuits centered on how the company had allegedly misled borrowers and shareholders. Bank of America didn’t help its case by hiring David Sambol, Mozilo’s number two, to head the combined home loan operations, providing him with an extravagant compensation package totaling $28 million. New York Democratic senator Charles Schumer, a member of the Senate’s committee on banking, strongly objected to Sambol’s selection (“You cannot divorce Countrywide, the company, from the executives who pioneered Countrywide’s predatory practices,” he said), and within five months of his hiring BofA quietly disclosed that Sambol would retire and another executive, Barbara Desoer, would oversee the business. Even so, the bank was stuck with paying Sambol the $28 million, plus country club dues and accounting services. The following year Bank of America killed off the Countrywide name.

When I spoke to Desoer, president of Bank of America Home Loans and a longtime BofA executive, she seemed determined to avoid linking the bank’s mortgage woes with the Countrywide acquisition. What she did say was something only a corporate manager could love: that the loan problems presented “a wonderful development opportunity” for employees because it allowed them to get experience in default servicing. This is no doubt true, though it’s a little like saying that being stuck at the bottom of a mine shaft provides experience in self-sufficiency. Still, Desoer noted many service improvements, including tighter lending practices and easier access to customer representatives. Paperwork isn’t being lost as much, either. “We’re in a good place relative to meeting the needs of the customers,” she said.

I guess I was hoping for a bit more contrition. Then again, it might not matter. As costly and misguided as the Countrywide acquisition has been, Bank of America owns a hugely valuable asset that eventually will start paying off (assuming people begin buying houses again). Mozilo, too, is short on contrition—despite having to settle with the Securities and Exchange Commission for $67.5 million (more than two-thirds of which was paid by others) and being the subject of an intense FBI probe (now closed). “Countrywide was one of the greatest companies in the history of this country,” he told federal investigators looking into the financial crisis, “and probably made more difference to society, to the integrity of our society, than any company in the history of America.” What’s amazing is that the statement is not entirely hogwash—Countrywide did enable millions of home buyers, many of them minorities, to accumulate equity and advance up the economic ladder. That’s no small accomplishment. You just have to overlook all the rest.

Illustration by Richard Mia

A Current Affair

By Mark Lacter — Wed, 01 Jun 2011 07:00:00 GMT

Coda Automotive has its headquarters nine blocks from the beach in Santa Monica, offices that used to house the local operations of Google. It’s an unlikely location for a company in the rough-and-tumble car business, but then again, Coda hardly resembles the kind of automaker that owned assembly plants in Maywood and South Gate 50 years ago. There are no factories, no dealerships, and much of the sales and marketing efforts are conducted online. Most everything about Coda comes down to a large lithium-ion battery that powers the four-door sedan. “Our goal is to put an electric car into every garage in the world,” reads a mission statement near the entrance. That’s quite a goal, though early expectations for when the car is launched later this year are modest: sales of 10,000 vehicles over the first 12 months, mainly to early adopters, rental car companies, and government agencies (refundable deposits of $499 have been accepted for months). After the initial rush, Coda’s prospects blur; there’s already plenty of competition from the Chevy Volt, Nissan Leaf, and Tesla S, among others—and no one knows how many customers are willing to buy in.

Start-ups are always supposed to be ambitious and aim for the new and different (intoxicating words for deep-pocket investors). But breakthrough success requires more—namely a product that offers some added value compared with what’s already on the market. Think digital cameras. Think iPhone. Electric vehicles don’t do that, at least not now. If anything, they create hassles, starting with the high price (Codas cost $44,900, although federal tax credits are worth up to $7,500), limited driving range (90 to 120 miles), lengthy recharging times (up to six hours), and the dearth of public recharging stations. Plus the Coda isn’t exactly stylish, with a generic chassis that resembles Mitsubishi’s midsize models.

Given all these drawbacks, Coda has plenty of explaining to do—never a great way to sell a product. “How are you going to get a consumer to pay more for a lesser good?” asks Brett Smith, an analyst with the nonprofit Center for Automotive Research in Ann Arbor, Michigan. “The electric vehicle is a significantly lesser good than the internal combustion engine. --At some point the technology has to be economically viable.” That blasted internal combustion engine—it continues to do a very good job of getting people from here to there. It’s also become more reliable and fuel efficient in recent years, something that drivers are bound to appreciate with gasoline at around $5 a gallon. Perhaps the biggest advantage about gas is its inherent convenience (at least until oil reserves run dry). “Gasoline pours,” says Smith. “It has an enormous amount of energy content.” Electricity takes a long time to transfer into a battery, and that limits driving options.

Makers of electric cars are responding to this headache in different ways. The Volt comes with an internal combustion engine so that when the charge runs out, the vehicle switches over to gasoline power. The Leaf runs only on battery power, though Nissan has kept down the cost ($32,780 before the federal credit) and markets the car more for driving around town than for going away on vacation. Renault is working with Palo Alto-based Better Place in developing a network of fueling stations where drivers receive a fully recharged battery that can be swapped into the vehicle in less than five minutes.

Coda’s strategy falls somewhere in the middle: no internal combustion engine but a battery that can provide more energy per charge than many other electric cars. Nestled near the ground and taking up the entire space between the rear wheels and front axle, the battery is made up of 728 lithium-ion cells and gives off 34 kilowatt-hours of energy (lithium-ion batteries pack lots of energy for their weight and discharge slowly when not in use). Longer battery life means greater range, which is good. Electric cars are also cleaner: The Coda emits about 0.375 pounds of carbon dioxide per mile; a gas-powered car getting 22 miles to the gallon emits about 1 pound per mile. The downside is that the batteries are expensive to make, almost as much as the rest of the vehicle, and they require a separate recharging station that’s priced at more than $1,000 (and don’t forget the huge increase in electric bills).

The presumption is that when prices eventually come down, sales will start to pick up. But wind and solar advocates have been promising the same thing for years, and costs remain prohibitive. Morgan Stanley projects that electric vehicles will make up only 5 percent of the global automotive market by 2020; the consulting firm J.D. Power and Associates says it will be more like 7.3 percent. When I asked Coda’s new chief executive, Philip Murtaugh, what his expectations were, he said after a long pause, “I have absolutely no idea. The thing I do know is that petroleum is getting scarce compared with 50 years ago, and it’s a foregone conclusion that at some point we’re going to run out of that stuff. So we have to come up with a different way of running automobiles.”

*****

Coda (the name was chosen with the idea that electric vehicles could bring an end to the internal combustion engine) is an outgrowth of Miles Electric Vehicles, which was started in 2004 by Miles Rubin, an entrepreneur and longtime environmental activist. Rubin, who is 82, got the idea for an electric car company in 2003 after visiting a Chinese plant that made batteries for cell phones and laptops. Why not make them big enough to power automobiles? At first his Santa Monica-based company sold low-speed cars and trucks that were designed for limited distances (business parks, college campuses, and the like). By 2008, Rubin, whose eclectic career included a stint running Polo/Ralph Lauren Jeans, wanted to expand the low-speed idea into a full-size, battery-operated vehicle. He enlisted engineers to work on the technology and later brought on former Goldman Sachs executive Kevin Czinger, who wound up spinning off Coda from Miles Electric (now a separate company based in Oxnard). “It was all about the battery,” says Steven Heller, Coda’s executive chairman and the onetime head of mergers and acquisitions at Goldman Sachs. “If we could crack that, we would have a profitable company.”

Heller had no experience in the car business other than growing up near the big auto factories in Dayton, Ohio. What he did have was plenty of contacts in the New York financial world. Within a year or two Heller and Czinger were able to collect an impressive list of investors: Hank Paulson, former Treasury secretary and former CEO of Goldman Sachs; Les Wexner, CEO of Limited Brands (parent company of Victoria’s Secret); and Mack McLarty, former White House chief of staff for Bill Clinton. The company also received backing from numerous hedge funds and private equity firms—and the more big names that signed on, the more attractive the investment became to others. All told, Coda collected better than $200 million, a formidable war chest for such a speculative play.

The pitch to investors centered not just on the battery but on the economical way in which the car could be put together. Coda’s strategy was to avoid making its own parts, instead outsourcing the car’s components to several dozen manufacturers around the world. “We are a capital-light company,” says Heller, explaining that a drop in car production has resulted in excess capacity at plants around the world. “It struck us as advantageous to assemble the car on a contract basis.” Instead of establishing dealerships, they opted to sell their sedan on the Internet. The site’s “Range Phobia” feature lets visitors plug in their daily commutes, which typically run less than 40 miles a day, well under Coda’s range on a single charge. If customers want a test drive, they’ll be able to visit a company-owned retail store where several vehicles will be available (the first location is scheduled to open later this year at Westfield Century City).

The plan was to have Codas on the road by late 2010. But start-ups can be messy. Last fall Czinger announced his resignation, a move that surprised most everyone in the industry and immediately raised suspicions about the state of the company. (Before Czinger, the chief financial officer and the head of sales also stepped down.) Following Czinger’s departure, the launch date was moved to the second half of 2011. All this had to be awkwardly explained last November at the Los Angeles Auto Show, where Coda was promoting its vehicle.

“You’ve seen this movie before,” Heller told me, stressing that Czinger remains an adviser and shareholder. “There is the initial entrepreneur with the vision and ideas and technologies, and then when it comes time to scale up and commercialize the product, a different set of skills is required, and that usually means a different CEO.” It took several months to hire Murtaugh, a cigar-chomping General Motors veteran who was getting acclimated to the new job when I interviewed him by phone from China. “I’m old,” said the executive, who’s 54, “so I have the advantage of living through a lot of things that these Coda people haven’t lived through yet. I have the benefit of making mistakes a long time ago.”

One obvious danger is lack of focus. While the company wants to remain “capital light,” it’s been trying to secure a $500 million loan from the Department of Energy to build a battery manufacturing plant in Ohio. Discussions are also under way about assembly plants in California (plans for a facility near downtown Los Angeles fell through last year). What’s more, Coda wants to become a battery supplier to other carmakers as well as to wind and solar farms looking for ways to store electricity. “Coda is much more than a car,” Forrest Beanum, the company’s spokesman and vice president for government affairs, told the Columbus Dispatch. “We are a catalyst for a movement, we are a solution to a problem, we are innovation, we are industry leaders, we are jobs, we are progress, we are what we hope the future will be.” For a company that has yet to make its first sale, such unbridled spirit is bound to get the investors a little itchy. Being all things to all customers seldom works.

One afternoon Beanum took me on a drive around Santa Monica, and the car was sprightly enough: nice pickup, mostly quiet ride (aside from a golf cart-type whine), and all the standard appointments (though sometimes laid out unconventionally, as with the small dial on the center console that serves as the gearshift). Maybe the company will sell tens of thousands of these things and become a survivor in an industry that’s certain to consolidate. Yet during my short trip I couldn’t help but keep looking at the display panel that showed how much battery life was left. Will Coda and the others ever be able to get past that? Or will electric vehicles remain one of those promising niche businesses that can never satisfy the doubters? There’s a lot riding on those questions. I just wish I had better vibes about the answers.

Illustration by Serge Bloch

Well Paid

By Mark Lacter — Wed, 27 Apr 2011 20:53:00 GMT

The Westwood headquarters of Occidental Petroleum Corporation has a tomblike feel. No milling around or banter in the hallways—nothing extraneous. Maybe I happened to have caught them on a slow day, but the muted vibe fits into the kind of corporate culture that Oxy has become known for. Long gone are the antics of former chairman and chief executive Armand Hammer, who seemed just as interested in raising Arabian horses and hobnobbing with the Soviet hierarchy as in finding oil reserves. When Ray Irani took over as CEO after Hammer’s death 20 years ago, he put an end to the distractions and went to work turning a profit.

He’s been quite good at it. Today Occidental is L.A.’s largest publicly traded company (based on the value of its stock) and among the most admired of the major energy corporations, with operations in the United States, South America, North Africa, and the Middle East. Last year it earned almost $3 billion, compared with a loss of $1.7 billion in 1990. Market value jumped from $5.4 billion in 1990 to $66 billion in 2009. It carries low debt, follows conservative accounting methods, and has lots of available cash that’s regularly distributed to investors.

But Occidental is not an easy company to love. It’s boring. It’s slow. It has no direct connection with consumers (Oxy doesn’t sell gasoline—oil products are sold to other companies and then distributed at the retail level). It doesn’t buy commercial time during the Super Bowl, and you won’t find the company’s name on a basketball arena. It has next to no civic visibility in its home base of Los Angeles—and little interest in pursuing any. Executive recruiters told Business Week last year that Oxy is “an autocratic environment where managers at the oil giant simply wait for dictates from on high.” Two activist shareholders have complained that senior executives enjoy nearly free rein because of the board’s “entrenchment and ossification.”

All this, however, pales next to what has been the biggest rap against Occidental: how much its chief executive gets paid. Even by the elevated standards of corporate CEOs, it’s outrageously high. In 2009, Irani took home $31.4 million (a shade below the pay of New York Yankee superstar Alex Rodriguez), and over the past decade his compensation totaled nearly $900 million, according to The Wall Street Journal. Only a handful of U.S. executives have collected so much for so long.

The folks at Occidental have a ready explanation: Irani has been getting paid huge amounts of money because the company has been making huge amounts of money, and under Irani’s employment contract, performance is what counts. Nothing wrong with that, but it’s the proportionality of performance and pay that’s at issue. His $31.4 million in 2009 compares with the $27.2 million that was made by the CEO of Exxon Mobil, even though Occidental’s revenues were $15.4 billion and Exxon Mobil’s were $310.6 billion. Actually Irani had cleaned up during the times when Occidental didn’t do so well, with the board paying him $95 million one year just to bury his old contract in favor of a richer agreement. Since then Irani’s compensation package has been a maze of bonuses and incentive programs. “If I buy a factory and I overpay for it, that’s not good for shareholders. If I do that with human capital, that’s not good, either,” says Robin Ferracone, executive chair of the San Marino consulting firm Farient Advisors and the author of Fair Pay, Fair Play. “Oxy is like a poster child for bad behavior.”

The company has turned a deaf ear to such criticism. It’s been the story of Irani’s career, going back to 1983 when he made a stink over his salary before being hired as the head of Oxy’s chemical division. Hammer went along with the pay demands because he recognized how valuable the guy would be, and that remains the company line. Irani, who grew up in Lebanon and received a doctorate in physical chemistry from USC when he was 22, has always been known for his smarts and tenacity. “He’ll give you a look when he’s not happy about something, and it can cut through steel,” says a senior executive (employees address him as Dr. Irani). A notorious stickler for detail, he’ll stop a PowerPoint presentation because a figure on page 43 doesn’t correspond with one on page 23. Irani, who is 75, is anything but a glad-hander around the office, preferring to work with a limited group of managers who then pass on his directives.

He’s also not keen on doing interviews (Irani wasn’t made available for this column). The company did offer me a 20-minute phone interview with chief operating officer Stephen Chazen, who will be the new CEO. Chazen was hired in 1994 after a lengthy stint in the financial industry, and he seems to have a less imperious air (you can call him Steve). But he, too, wants to keep as low a profile as possible. “Ray’s outgoing and showy compared to me,” deadpans Chazen, who has vowed not to have his picture in the company’s annual report, de rigueur for any chief executive. “My goal in life is to continue to walk over to the coffee shop and have no one recognize me.” On airplanes he likes to tell his seatmates that he’s in the insurance business. That usually puts an end to any small talk.

During our short session, he’s surprisingly talkative, except on the matter of executive compensation (Chazen took home $13.5 million last year). When I ask how such a successful corporation could have such a lousy reputation, he insists that it’s a style thing. “It comes from the fact that the company doesn’t spend a lot of time with self-promotion,” he says. “We don’t have a PR firm going around taking pictures of Ray Irani with 24-year-old movie stars cutting ribbons.” Oil companies, Chazen adds, “are never going to be popular. You just have to understand that that’s the deal.”

*****

Occidental Petroleum started in 1920 and scraped along for years as a small, often unprofitable California driller that was traded on tiny West Coast stock exchanges. Hammer, a physician by training whose entrepreneurial interests had included pencils, pharmaceuticals, and Russian artwork, at first viewed Occidental more as a tax shelter than as a way of making serious money. In 1956, he and his wife loaned the company $50,000 to finance the work at two California drills, and much to his surprise, oil was struck. He then started snapping up Oxy stock, and by 1957 became the company’s biggest shareholder—as well as its CEO. Occidental under Hammer was never a pure energy play: In the early 1970s, he arranged a long-term barter agreement with the Soviet Union in which Oxy would supply phosphate fertilizer in exchange for ammonia (he considered it his contribution to détente). The company later acquired a large meatpacker and spent $95 million to fund the construction of a museum adjacent to the Wilshire Boulevard headquarters to house Hammer’s art collection (shareholders went to court to contest the use of corporate dollars for the museum). Once Irani was in charge, he sold off nonenergy assets and dumped his predecessor’s pet projects, including a $480,000 contract for a fourth authorized biography of Hammer. Another sign of pragmatism was the company’s decision not to pursue what had been a 22-year squabble with the City of Los Angeles over the right to drill at a site in Pacific Palisades.

Corporate discipline is a big deal in the oil business. The process of looking for fields, acquiring land, drilling holes, and transporting the extracted product can easily take ten years, and there’s no guarantee of how much oil will be found or what it will be sold for. (That helps explain why net income rose from $5.4 billion in 2007 to $6.9 billion in 2008 and then plunged to $2.9 billion in 2009.) If the fields are overseas, there could be additional delays negotiating financial terms with host governments. The trick for Irani, and now Chazen, has been to determine the allocation of capital—basically which projects should be funded and which should not. “There is no other decision that matters,” says Chazen. “It’s probably 80 percent of your outcome.”

Shareholders certainly haven’t been hurting. Anyone purchasing $100 worth of Oxy stock at the end of 2004 could have cashed out at the end of last August for $275. That same $100 invested in companies making up the S&P 500 stock index would be worth $97. Occidental is slavishly devoted to its stock, to the point where it tries to give investors $2 back for every dollar it keeps in earnings. That’s an unusually rich pledge, which is another reason why Wall Street analysts like the company.

But the public mood has soured so much on big business—especially excessive executive pay—that Irani’s carte blanche governance has been impossible to ignore. “If you’re like a monument unsusceptible to change, like Dr. Irani, then your shareholders begin to get unhappy with you,” says Paul Hodgson, a senior research associate with the Corporate Library, which monitors publicly held companies. The last straw was the board’s allowing Irani to work past the company’s mandatory retirement age of 75. Perhaps a showdown was inevitable when shareholders were given, for the first time, a chance to cast ballots on executive compensation practices. At the annual meeting on May 7, 2010, a majority refused to rubber-stamp Irani’s paycheck. The vote was nonbinding, so Oxy didn’t have to act on the results, though they did shake up the corporate world. Irani was effectively being told, “Enough is enough.”

Several weeks later Relational Investors and the California State Teachers’ Retirement System, both Occidental shareholders and vocal critics of the company’s executive pay policies, sent a letter to the board that demanded change. They threatened to contest management’s control by nominating at least four new directors. “CEO pay at Occidental functions essentially as a corporate giveaway program,” the two organizations wrote. “We are convinced that shareholders would overwhelmingly support our candidates to replace members of the current board, including its chairman.”

The threat got Occidental’s attention. Board member and former U.S. senator Spencer Abraham spent the summer smoothing relations with investor groups, and in August Chazen was promoted from chief financial officer to chief operating officer, a signal that he would be Irani’s successor as CEO. An October board meeting made it official. Whether a change at the top will affect the company’s insular culture is another matter, however. During a brief interview on the day of the announcement, Abraham told me that Irani “might chronologically be 75, but in terms of performance he’s at the top of his game.” A carefully worded press release noted that while Irani had informed the board “of his desire to relinquish the [CEO] position,” he would stay on as executive chairman until 2014. So the reforms are likely to be grudging. But they’re badly needed, if only to show that Occidental can make money for its shareholders without ticking them off in the process. First order of business will be a pay cut for Irani. Instead of his compensation being capped at $93 million a year, he’ll be able to make a maximum of only $28 million.

Illustration by Richard Downs

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