○ Trudeau on Trump and trade 54
○ Why GitHub is worth billions 21
○ Private equity trips on toys 58
June 11, 2018 ○ EUROPE EDITION
Before the next financial crisis
By Mohamed A. El-Erian
10
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June 11, 2018
⊳ Toys “R” Us paid $400 million in interest on $5 billion of debt every year for a decade
PHOTOGRAPH BY SARAH ANNE WARD FOR BLOOMBERG BUSINESSWEEK. PROP STYLIST: ANDREA GRECO
1
DEBRIEF
54
FEATURES
58
Justin Trudeau on trade, gender equality, pot, and that pipeline
Fun and Games and Debt As Toys “R” Us unravels, a tale of remarkable financial bungling unfolds
62
Paradise Tainted Bernardo Paz built one of the world’s great art retreats, but at what expense?
CONTENTS
IN BRIEF AGENDA THE BLOOMBERG VIEW
5 6 6
A roaring job market; Mexico strikes back Fed rates may rise; Trump and Kim will meet after all The visa system for temporary farmworkers is broken
10
Global growth is in sync. That may be about to change
BUSINESS
15 18
Cargill, America’s largest private company, has to reboot European broadcasters unite to create their own Hulu
TECHNOLOGY
21 23 25
Why GitHub is worth $7.5 billion to Microsoft Fungal DNA sequencing could yield new drugs Sisun Lee turned the best hangover ever into a company
PERSONAL FINANCE
27 28 30
Investors’ love of indexing hampers Fidelity Magellan Credit card fraud is down in stores. But not online Will you miss the fiduciary rule?
ECONOMICS
33 35
Playing to pensioners holds back Italy’s economic reform Twilight for Three Mile Island … and U.S. nuclear energy
REMARKS
1 2
3
Bloomberg Businessweek
2
June 11, 2018
How to Contact Bloomberg Businessweek Editorial 212 617-8120 Ad Sales 212 617-2900 731 Lexington Ave., New York, NY 10022 Email bwreader @bloomberg.net Fax 212 617-9065 Subscription Customer Service URL businessweekmag .com/service Reprints/Permissions 800 290-5460 x100 or email businessweekreprints @theygsgroup.com Letters to the Editor can be sent by email, fax, or regular mail. They should include the sender’s address, phone number(s), and email address if available. Connections with the subject of the letter should be disclosed. We reserve the right to edit for sense, style, and space. Follow us on social media
POLITICS
40 44 46
Trump talks fair trade while undermining the world order Putin milks Russia’s World Cup hosting for all it’s worth The second-place surprise in California’s governor race
SOLUTIONS
49 51 52
Attempts to close the B-school gender gap fall short A Q&A with Scott DeRue, dean of the Ross School USC revamps its MBA curriculum, just to keep up
75 78 80 82 83 84
Saskia de Rothschild takes charge of Château Lafite Cars: The race—and it’s some race—to hit 300 mph Travel: On private jets, partying kids have a blast Critic: Stealing diamonds the Ocean’s 8 way doesn’t pay The One: For Father’s Day, think patio shoe Game Changer: José Quiñonez gives credit where it’s due
PURSUITS
PHOTOGRAPH: MICHELLE GUSTAFSON/BLOOMBERG
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IN BRIEF ○ U.S. job openings outnumbered job seekers for the first time on record. Total unemployed Job openings
Bloomberg Businessweek
June 11, 2018 By Kyle Stock
○ U.S. leaders quietly asked OPEC to increase oil production by 1 million barrels a day to mitigate surging prices for crude and gasoline, caused in part by the collapse of Venezuelan output.
8.8m 6.7m 6.3m 3.3m 4/2003
4/2018
○ The U.S. Supreme Court ruled in favor of a Colorado baker who refused to make a wedding cake for a gay couple. The majority found that a lower court had inappropriately dismissed the baker’s religious beliefs, a narrow judgment that left the door open to diferent outcomes in future cases.
○ Facebook disclosed that it had given at least four Chinese device makers access to user data. 5
PHOTOGRAPHS: SPADE: UERGEN FRANK/CORBIS VIA GETTY IMAGES. PORK: GRANDRIVE/GETTY IMAGES. DATA: BLS
The group includes Huawei, which has been flagged by the U.S. as a security risk because of its close ties to the Chinese government.
○ “Of course, it has to be led by a man, because it is a very challenging position.” Qatar Airways CEO Akbar Al Baker responded to a question about the lack of women working in aviation in the Middle East, igniting a controversy. He later ofered an apology, saying his comment had been “sensationalized.”
○ Mexico retaliated against new U.S. tarifs, imposing duties of up to 25 percent on American steel, pork, and bourbon, among other products. At the same time, it cut tarifs on pork imports from other countries.
○ Designer Kate Spade died in an apparent suicide on June 5. Her namesake brand, known for its sophisticated-yet-practical handbags, was sold to Liz Claiborne for $124 million in 2006. She was 55 years old at the time of her death.
○ Bayer closed its
$63b
merger with Monsanto on June 7, almost two years after the deal was announced. The combined companies will be known solely as Bayer, avoiding negative associations with the Monsanto name.
○ Australian authorities charged ANZ, Citigroup, and Deutsche Bank with criminal cartel conduct in their handling of a
$2.3b
sale of ANZ stock. The banks said they would fight the allegations.
○ With at least 300 people dead or missing, the Volcán de Fuego continued to erupt near Antigua Guatemala. ○ Jordan Prime Minister Hani al-Mulki resigned after protests over austerity measures, including higher income taxes. ○ Ethiopia announced plans to sell state assets, including Ethio Telecom and Ethiopian Airlines, in a privatization push. ○ Howard Schultz stepped down as Starbucks executive chairman, fueling speculation that he’ll run for president in 2020.
AGENDA
Bloomberg Businessweek
⊲ May’s Search for Nays Theresa May has to persuade Britain’s House of Commons to reject several amendments to the European Union Withdrawal Bill passed in the House of Lords, including one aimed at keeping the U.K. in the EU customs union. Failure could jeopardize her already shaky hold on power.
June 11, 2018
⊲ President Donald Trump and Supreme Leader Kim Jong Un are scheduled to meet at the Capella Hotel in Singapore on June 12.
⊲ South Africa’s scandalplagued Gupta family will auction some assets to pay creditors. The family has denied corruption allegations.
⊲ The E3 Expo, the video game industry’s premier conference, runs June 12-14. Look for rivals Nintendo Co. and Sony Corp. to announce new games.
⊲ Despite a challenge from the U.S. Senate, which voted in May to maintain net neutrality protections, the regulations are set to expire on June 11.
⊲ South Korea holds local elections on June 13, plus by-elections to ďŹ ll 12 vacancies in its National Assembly.
⊲ The Federal Reserve’s rate-setting committee meets on June 12-13. Expect it to raise rates a quarter-point, to between 1.75 percent and 2 percent.
6
Import Food—or Labor? ○ The U.S. visa system for temporary agricultural workers is broken
American farmers have been complaining of labor shortages for several years. The complaints are unlikely to stop without an overhaul of immigration rules for farmworkers. Congress has stymied eforts to create a more straightforward visa for agricultural workers that would let foreign workers stay longer in the U.S. and change jobs within the industry. If this doesn’t change, American businesses, communities, and consumers will be the losers. Perhaps half of U.S. farm laborers are undocumented immigrants. As fewer such workers enter the country, the characteristics of the agricultural workforce are changing. Today’s farm laborers, while still predominantly born in Mexico, are more likely to be settled rather than migrating and more likely to be married than single. They’re also aging. At the start of this century, about one-third of crop workers were over the age of 35. Now more than half are. And picking crops is hard on older bodies. One oft-debated cure for this labor shortage remains as implausible as it’s been all along: Native U.S. workers won’t be returning to the farm. Mechanization isn’t the answer, either—not yet, at least. Production of corn, cotton, rice, soybeans, and wheat has been largely mechanized, but many high-value,
labor-intensive crops, such as strawberries, need labor. Even dairy farms, where robots do a small share of milking, have a long way to go before they’re automated. As a result, farms have grown increasingly reliant on temporary guest workers using the H-2A visa to ill the gaps in the workforce. Starting around 2012, requests for the visas rose sharply; from 2011 to 2016 the number of visas issued more than doubled. The H-2A visa has no numerical cap, unlike the H-2B visa for nonagricultural work, which is limited to 66,000 a year. Even so, employers complain they aren’t allotted all the workers they need. The process is cumbersome, expensive, and unreliable. One survey found that bureaucratic delays led the average H-2A worker to arrive on the job 22 days late. The shortage is compounded by federal immigration raids, which remove some workers and drive others underground. Petitioning each year for laborers is no way to run a business. In a 2012 survey by the California Farm Bureau Federation, 71 percent of tree-fruit growers and almost 80 percent of raisin and berry growers said they were short of labor. Some western farmers have responded by moving operations to Mexico. Without steady access to a reliable workforce, more will be tempted to move south. From 1998-2000, 14.5 percent of the fruit Americans consumed was imported. Little more than a decade later, the share of imports was 25.8 percent. Rural U.S. communities that might have beneited didn’t. In efect, the U.S. can import food or it can import the workers who pick it. For more commentary, go to bloomberg.com/opinion
ILLUSTRATION BY JONATHAN DJOB NKONDO
THE BLOOMBERG VIEW
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REMARKS REM MARKS
10
How H w to Fix a F Fragile ragile Sys System tem B e I Too
REMARKS
Bloomberg Businessweek
○ The world seemed to have figured how to grow in sync. But without better policies, that exceptional pickup may end soon ○ By Mohamed A. El-Erian Brexit, tarifs, currency meltdowns in Argentina and Turkey, a China growth scare, and a inancial near-implosion in Italy—to name just a few events—have surprised many policymakers, companies, and investors in the past two years. The inclination is to treat each as the product of the particular circumstances of each country; and the implication is to play a game of whack-a-mole with each. There’s validity to such a case-by-case approach. But it risks overlooking that something deeper is going on here—a common thread, if you like. And the ramiications will be accentuated by what are now widening inequalities brought about by difering growth rates and policies in advanced economies as the U.S. increasingly outpaces other economies. The more this is understood, the better the world will be able to navigate surprises. And if politicians and companies step up more forcefully, the higher the probability of avoiding most of them altogether. It wasn’t supposed to be like this. In the 10 years since a global inancial crisis damaged many lives and almost tipped the world into a multiyear depression, eforts have been made to strengthen the banking system and reduce its risk of contaminating the real economy. Years of experimental, unconventional measures by central banks to keep interest rates down and inject liquidity have bought time to heal. Awareness has spread that too many years of low and insuficiently inclusive growth does more than undermine economic performance and potential—it tears at the fabric of society, erodes trust in key institutions, and fuels the politics of anger. Finally, an unusual consensus has emerged among economists as to the critical mass of policies needed to break out of the “new normal” of disappointing growth. The sense of economic optimism associated with all this has been reinforced by 2017, a truly exceptional year when inancial markets and corporate proitability thrived, seemingly in deiance of political and geopolitical challenges. Building on what was already an impressive multiyear rally, world stock markets surged more than 20 percent. Investors also made money in virtually every other asset class, including government bonds that usually are negatively correlated to stocks. And all this occurred in the context of extremely low volatility. Meanwhile, corporate proits rose from one record to another, leaving many companies ample cash on their balance sheets to buy back stock, boost dividend payments, pursue mergers and acquisitions, and enlarge investment programs. The growing sense of optimism was ampliied by the emergence in 2017 of an exceptionally broad pickup in
June 11, 2018
growth around the world. Hailed as a synchronized and self-perpetuating phenomenon, it’s been expected to establish a more accommodating environment for new pro-growth policies on the part of individual countries and for the type of global policy coordination that can make the whole much larger than the sum of the parts—or, to paraphrase Christine Lagarde, managing director of the International Monetary Fund, an environment to ix the roof while the sun is shining. Yet recent developments have exposed cracks in this seemingly happy coniguration. Many elements of the surge are strained, stretched, and vulnerable to sudden disruptions. While some of the particular manifestation of these cracks may come as a surprise, the overall phenomenon shouldn’t— especially if you consider the following ive factors: It takes time to restore trust. Despite the improvements, a signiicant trust deicit remains. The most visible display is in the continued vibrancy of anti-establishment movements and causes—from the elections of Donald Trump in the U.S. and Emmanuel Macron in France to the new government in Italy and the Brexit saga in the U.K.—and the related erosion in the standing of “expert opinion.” These all relect voters choosing to disrupt a system viewed as having served them poorly and lacking credibility. The less trust there is, the harder it is to win political consensus on even the most bipartisan economic issues, such as infrastructure modernization in the U.S. In some cases, such as in the Brexit-focused U.K., and in Italy, where negotiations over a new government led to questions about the country’s commitment to the euro zone, national attention risks being held hostage by one issue, making it hard to deal with the challenges of an unusually luid world. With that, political anger remains. Lack of policy action makes everything bumpier. The resulting policy paralysis has been visible in economic areas. Among the most systemically important economies, the U.S. is virtually the only one to have embarked on multiple reforms that can sustain higher growth rates. U.S. companies have welcomed deregulation and tax cuts, with some signs that their greater willingness to boost spending adds to the strength of the labor market. But, apart from the U.S., policy eforts lag realities on the ground. As a result, the synchronized global economic pickup is starting to sputter. Europe’s recent economic bounce is turning out to be more the result of a natural healing process than policies. As such, it will be hard to sustain—especially worrisome when you consider that countries such as Greece and Italy are operating at gross domestic products still below the levels that prevailed before the inancial crisis and barely above those when they joined the euro zone and adopted its single currency. In some large emerging economies, the recent growth spurt may turn out to be a temporary phenomenon rather than a true breakout. Witness Brazil (where the surge after the impeachment of Dilma Roussef may be fading away) and Russia (where economic improvement is tied to higher oil prices). Even in India, the jury is out on how the recovery from the demonetization shock can be sustained at a high level.
11
REMARKS
12
Bloomberg Businessweek
Some issues remain poorly understood. The political constraints on decisive policy action are compounded by some economic puzzles, the biggest being persistently sluggish productivity. Add the breakdown in historical relationships— such as that between unemployment and wages and inlation— and you get legitimate questions about how quickly, if at all, it will be possible to arrest and reverse a notable increase in the inequality of income, wealth, and opportunity. The resulting sense of analytical unanchoring is accentuated by the general impact of technological change and, speciically, the growing inluence of artiicial intelligence, big data, and mobility. This trio is changing not only what we do but also, more fundamentally, how we do things. The massive expansion in possible activities, including a much larger scope for the empowerment of the individual, comes with a greater risk of marginalization, alienation, and radicalization. The gradual withdrawal of the inancial safety net creates risk. All this comes at a time when central banks are slowly getting out of the business of suppressing inancial volatility. Unlike in past bouts of inancial instability, none of the systemically important central banks has attempted to repress volatility this year, be it the Federal Reserve refraining from countering the February spike or, more recently, the European Central Bank saying little and doing nothing to calm disrupted Italian bond markets. Many have realized this is part of a general withdrawal of central banks from carrying, almost single-handedly, the bulk of the economic and policy responsibilities in the wake of the Great Recession. The process is most advanced in the U.S. As such, markets are comfortable with the Fed maintaining its rate-hiking cycle. It’s just a matter of time until the ECB and Bank of Japan embark on the Fed’s path— irst stopping the exceptional purchase of securities, then announcing a timetable for a reduction in balance sheets and initiating a multihike rate cycle. And while the Fed has shown that a “beautiful normalization” is indeed possible, it remains to be seen whether all three central banks can deliver this simultaneously. Growth diferentials are the thing to watch. With the latest U.S. jobs report showing the economy maintaining a healthy momentum, including an impressive pace of job creation and rising wages, growth diferentials will continue to favor the U.S. With the Fed continuing to hike this year, the U.S. will also maintain considerably higher interest rates, another factor that will support the dollar. And if the world slips into a trade war, the damage to the U.S.—which, given the size and diversity of its domestic resources, remains a relatively less open economy overall, and therefore less sensitive to trade disruptions—would likely be less than that sufered by other advanced countries. Both scenarios involve risks for emerging economies. If local conditions are already vulnerable, as in Argentina and Turkey, a stronger dollar and higher U.S. interest rates increase the threat of a local currency slide that destabilizes other segments of inancial markets, forces major increases in domestic rates, and dampens economic activity. And if trade
June 11, 2018
wars break out, the less favorable global trading environment will increase the threat of inancial instability. The probability of disruption isn’t limited to poorly managed economies and/or those lacking strong balance sheets. Even the healthiest can be afected, especially in the short term, adding to the potential surprises for policymakers and investors. As illustrated by the recent tremors, technical factors can help spread distress across borders—the most important being the disruptive sway of “crossover” inancing (that is, from opportunistic investors seeking quick proits) over less lighty, “dedicated” capital lows from established institutions. Indeed, you need only look at the generalized sell-of in emerging-market assets in May across countries and investment segments to get a sense of the forces in play. The good news is that the intensiication of these trends isn’t inevitable. Policymakers have the knowledge and ability to counter disruptive forces. What they need is the political will to implement a comprehensive approach, one that’s based on experience and able to course-correct as needed. The longer it takes for policymakers to move in earnest, the more important it is for individual companies to take action. Strengthening balance sheets, reducing exposure to currency swings, enhancing trust, and lessening reliance on short-term inancing can play important roles in building resilience. More open mindsets and a willingness to invest in people and technology can help increase agility. This mix of resilience and agility is also what investors need to navigate a luid global environment. They should focus on solid balance-sheet investments, avoid being chased out of the markets by the occasional volatility spike, and stand ready to exploit temporary mispricings that volatility often creates. They should favor U.S. investments relative to the rest of the world and, if they feel trade tensions will indeed lead to big trade wars (which I think can be avoided), tilt their risk exposures further in the direction of domestically oriented opportunities. As important as individual country factors have been, all those recent surprises relect some bigger forces in the global economy. Absent a comprehensive multicountry efort to create and sustain higher and more inclusive growth, they’ll prove just part of a bigger set of actual and potential surprises for policymakers—ones that could even come together to seriously undermine the prospects for healthy growth and genuine inancial stability over the medium term. Companies and investors should hope that governments will step up to their growth policy responsibilities. Remember, it’s much less a question of what’s technically desirable and more one of what’s politically feasible. There’s still low-hanging fruit to harvest. But in waiting and continuing the game of whack-a-mole, they would be wise to do what they can now to increase resilience and agility. Absent policies that unleash the considerable potential of the global economy, the surprises they’ve seen so far could risk being just the beginning of a truly global economic slowdown and more intense inancial instability.
There are many ways of writing the future. Ours is written in future perfect. That’s why it is the moment to invest in a country that looks ahead as one of the main economic engines in the eurozone. The moment to invest in a country full of opportunities. More info: www.tesoro.es
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In Spain, the future is written in future perfect.
CONTENTS
○ Rival broadcasters in Europe join forces to battle Netflix and HBO
1
Can a 153-Year-Old Cargill Reinvent Itself? ○ In the internet age, America’s largest private company needs to be more than a middleman William Wallace Cargill pioneered the modern agricultural trading industry in 1865 when he established a string of grain warehouses across the American Midwest. Having a deep-pocketed buyer that could take delivery locally gave farmers an easy way to quickly get cash for their crops, lest they rot in the ield waiting on a sale or transport to a faraway market. The ability to store huge amounts of grain also gave Cargill the lexibility to time his own sales to maximize the spread between what he paid farmers and what he could get from distant food processors or exporters. That business model of playing the middleman between farmers and their ultimate customers has enjoyed a lucrative 153-year run, turning Cargill
Inc. into the largest privately held company in the U.S. It had revenue of $109.7 billion in 2017 and employed about 155,000 workers—more than the population of Dayton—in oices across 70 countries. And the roughly 100 members of the founding Cargill and MacMillan families who still own the company have become fabulously wealthy, with 14 billionaires among the ruling clan, one of the largest concentrations of wealth in any familycontrolled business anywhere in the world. Yet Minnesota-based Cargill’s business is falling victim to a scourge that’s already upended media, retailing, and other venerable industries: digital disruption. Cargill long made fat proits by having far more information about global commodity prices than the local farmers it negotiated with or the food companies it sold to. But today, even a small Iowa farmer with a smartphone or a tablet can get real-time data about weather conditions and prices facing his Brazilian counterparts. This change has decreased farmers’ dependence
B U S I N E S S
FLOTO + WARNER/OTTO ARCHIVE
⊳ Soybeans at a Cargill grain elevator in Albion, Neb.
June 11, 2018 Edited by James E. Ellis and David Rocks Businessweek.com
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on the middlemen and lowered the spread that Cargill and other big buyers used to make on such deals. American farmers have also expanded their in-house storage by almost 25 percent over the past 15 years, according to U.S. Department of Agriculture data, giving them some of the timing lexibility that only middlemen previously had. “The days of ‘Hey, we’re going to buy your crops, we’re going to store it, we’re going to play the carry’—you know, sell it at a proit—it’s over,” says Cargill Chief Executive Oicer David MacLennan. That’s pushing MacLennan to remake Cargill into less of a trading operation and more of an integrated food company betting on growing global demand for proteins. Already the world’s No. 1 supplier of ground beef and the secondlargest beef packer in the U.S., trailing only Tyson Foods Inc., Cargill is expanding aggressively into aquaculture. The company is also spending heavily on technology services that will tie today’s internet-connected farmers more closely to Cargill’s slimmed-down trading business or the new farm productivity apps it’s rolling out. MacLennan, who became CEO in 2013, says he decided three years ago that the company could no longer rely on the occasional crop failure, export ban, or supply shortage to save the day. “I thought, Boy, if we wait for something to change without disrupting ourselves, we’ll be in trouble,” he says. “What’s that old adage? You put a frog in a pot of water and slowly turn up the heat, and the frog doesn’t notice it’s been boiled. I didn’t want to be the frog in the boiling water.”
His view that farmers increasingly won’t need to rely on agribusiness giants for pricing intelligence is gaining ground within the industry. “We probably [will] witness the disappearance of the dinosaurs of the international agri trade,” says Hartwig Fuchs, a veteran trading executive and, until February, the CEO of Nordzucker AG, one of Europe’s top sugar producers. “Unless they redeine their business and focus on true function that beneits their customers, they might have to go.” The revolution goes beyond digitization. Agriculture is moving from a pure commodities business, where each bushel of wheat or corn is considered functionally identical, to an ingredients business, where consumers demand diferentiation, such as organic produce and foodstufs grown without genetically modiied organisms. That transition makes the life of a trading-based company more diicult, says Jonathan Kingsman, author of Commodity Conversations, because it restricts its ability to ind the lowest-priced goods on the market. When traders can no longer “substitute one origin for another, that reduces their ability to make money from the supply chain,” says Kingsman, who once traded sugar for Cargill. All the changes were certainly the trigger for the current makeover at Cargill, a low-key company accustomed to slow, incremental change. In mid-2015, Cargill reported a quarterly loss—its irst in 14 years—followed by several other weak quarters. “It was a strong signal that our performance wasn’t acceptable,” MacLennan says. “It was a company that I felt needed a jump-start.”
A Cargill technician lowers a feed tray into a shrimp tank
*2017 RESULTS; CARGILL’S FISCAL YEAR ENDS MAY 31. DATA: COMPANY REPORTS, BOND PROSPECTUSES, CREDIT RATING REPORTS, BLOOMBERG RESEARCH. PHOTO: COURTESY CARGILL
BUSINESS
Bloomberg Businessweek
June 11, 2018
He’s tweaked the commodity giant’s portfolio of businesses. Several underperforming units are gone, including Cargill’s energy trading unit, a hedge fund with several billion dollars under management, and extensive pork operations that it sold to meat processor JBS SA for $1.45 billion in 2015. The company is even selling of some of its North American grain elevators. “They’ve chopped a lot of wood,” says Todd Duvick, a managing director at Wells Fargo Securities LLC. “It hasn’t been quick, but it’s been fairly thoughtful and deliberate.” MacLennan’s biggest shift so far is a large investment in aquaculture, a fast-growing source of protein. The Food and Agriculture Organization of the United Nations says farmed ish overtook wild catches as the main source of seafood for human consumption in 2014, replicating the shift that occurred centuries ago in livestock when humans started to raise cows, pigs, and other animals as food. The aquaculture industry’s revenue totals about $163 billion annually, the FAO says. Three years ago, Cargill bought EWOS, one of the world’s largest producers of feed for the salmon aquaculture industry, for €1.35 billion ($1.58 billion), its second-largest deal ever. And it’s looking for more ish-meal investments. “Certainly the world’s going to eat more ish going forward, so we will continue to invest in aquaculture,” MacLennan says. Even as Cargill increases its investment in beef and poultry, which it says many consumers
consider to be healthier than pork, MacLennan is eyeing new forms of protein in line with the growing appetite for “clean food” in the U.S. and Europe. Over the past year, the company has invested in Memphis Meats Inc., a startup that’s developing beef, chicken, and duck grown directly from animal cells without raising and slaughtering livestock or poultry, and Puris, which manufactures organic and non-GMO protein from peas and other vegetables. Cargill doesn’t disclose proits by business line, but people familiar with the matter say its animal feed and protein business accounts for about twothirds of its net income. “While Cargill is best known for its trading business, Moody’s expects that these operations will become a smaller proportion of the company’s earnings and cash low over time,” says John Rogers, senior vice president at credit ratings agency Moody’s Investors Services Inc. The corporationwide embrace of technology is also helping Cargill’s traditional business of buying and selling crops. It recently invested in a spinof from Los Alamos National Laboratory that originally used satellite photographs to track opium crops in Afghanistan for the Pentagon. Now it’s helping Cargill analyze crop conditions with a level of detail that was unthinkable only a few years ago. Being able to more precisely predict the condition of crops near each of its scores of grain elevators will give it an edge in calculating customized prices to offer at individual facilities, helping maximize proits. When William Wallace Cargill
○ Cargill net income $4b
2
0 1992
2017
The World’s Top Agricultural Commodities Traders The so-called ABCDs have long ruled agribusiness Archer-DanielsMidland Co.
Bunge Ltd.
Cargill Inc.
Louis Dreyfus Co.
Year founded
1902
1818
1865
1851
Headquarters
Chicago
White Plains, N.Y.
Wayzata, Minn.
Rotterdam, Netherlands
Employees
31k
32k
155k
19k
Revenue*
$60.8b $1.6b
$45.8b $160m
$109.7b $2.8b
$43b $317m
Ownership
Listed on the NYSE since 1924; State Farm, with a 10 percent stake, is the largest shareholder
Went public in 2001 in New York when the controlling families sold part of their stake
Privately held; the Cargill and MacMillan families own more than 90 percent
Privately held; controlled by a trust on behalf of the children of Margarita Louis-Dreyfus
What they do
The biggest corn processor and a major ethanol trader, ADM is also the most industrial of the big players
Bunge is the largest soybean trader in Latin America—and a perennial M&A target
The world’s largest food commodities trader, Cargill acquired Continental Grain in 1999 and EWOS in 2015
Big trader of grains and oilseeds and the leader in raw cotton and rice, it’s struggling and didn’t pay a dividend last year
Net income*
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built the company, he helped revolutionize grain storage by constructing more-eicient warehouses with features such as multiple loors and conveyors. Now the company is again betting on agricultural innovations, this time by developing software advances its farm customers can use to increase the eiciency of their own operations. The company sells software that helps farmers identify individual cows by using facial recognition gear, keep track of what they eat, and measure how much milk they produce to better manage a herd’s productivity. Poultry Enteligen, available at Apple Inc.’s App Store, works with a gadget to scan the quality of animal feed. And the company’s IQuatic system uses microphones to monitor underwater movement to help determine the best times to activate automatic feed dispensers at shrimp farms. “We are trying to bring digital transformation to the industry,” says Neil Wendover, an executive in the Cargill Digital Insights department. MacLennan is also shaking up the company’s insular culture. Cargill is hiring more computer engineers and software developers and breaking its tradition of promoting mostly from within. In 2013 it hired Marcel Smits from food giant Sara Lee Foods LLC to be chief inancial oicer. MacLennan has trimmed the company’s layers of bureaucracy, cutting the number of business lines from almost 100 to a dozen, and he’s largely ended the iefdoms that historically made Cargill more akin to a confederation of businesses than an integrated company. “My belief was we need to be simpler,” MacLennan says. “We need to be in fewer businesses.” The changes are beginning to turn around Cargill’s inances. In 2017 the company’s adjusted net proit reached a seven-year high of $3 billion, compared with $1.4 billion in 2012, the year before MacLennan took over as CEO. “They have reset the foundations of the company,” says Bill Densmore, a senior director at credit rating agency Fitch Ratings. “The structural changes are profound. They have taken down several hundred million dollars in costs.” So far, the family shareholders have shown support for the transformation. The company pays the Cargill and MacMillan clan members only the equivalent of 20 percent of the average proit of the previous two years, a pittance compared with payouts of as much as 50 percent across the S&P 500. But with each new generation of the family—the company is now on its seventh—the stake of each individual shareholder gets thinner. At some large family-controlled businesses, that scenario has led to pressure for a sale or initial public ofering that would provide a windfall for family members. Rival
agribusiness giant Bunge Ltd., for example, went public in 2001, allowing its family owners to sell a large chunk of their stake. Based on price-earnings ratios for its publicly traded peers, Cargill could be worth almost $50 billion. MacLennan says the company won’t take the IPO route the way rival Glencore Plc, the world’s largest commodities trader, did in 2011. “Statistically, a family company lasts two generations, so we’ve already beaten the odds,” he says. “At 153 years and seven generations, I like our chances of staying private over the long term.” To make sure that happens, MacLennan says his priority is to learn from other industries, such as retailing, that have already weathered digital disruptions. “I don’t want us to be one of those companies that missed it,” he says, “and that becomes obsolete without even realizing they’re becoming obsolete.” —Mario Parker and Javier Blas THE BOTTOM LINE Cargill, the largest private company in the U.S., grew fat by buying from farmers who often didn’t have access to market information. The internet age requires a new strategy.
Building a European Hulu ○ Rival broadcasters are teaming up as Netflix, Amazon, and HBO add more shows in the region
For the past two decades, Spain’s state-run RTVE and private rivals Mediaset España and Atresmedia have been ighting for viewers’ hearts with slates of game shows, sports, comedies, and glossy morning news. Now, in a plot twist worthy of the steamiest soap opera, they’ve decided to hook up: This summer the adversaries are launching LovesTV, a shared 18-channel streaming platform with programming from all three networks. The goal is to “aggregate broadcasters and serve as a common entry point into the digital world,” says Arturo Larraínzar, strategy director at Atresmedia. A similar script is playing out across Europe, as long-standing foes in Britain, France, Germany, and Italy set aside rivalries to co-produce programs or ofer shows online. The reason: interlopers from across the Atlantic. Netlix Inc. this year is doubling its European programming budget, to $1 billion; Amazon.com Inc. will soon have at least a dozen original series from Europe, up from one in 2014.
June 11, 2018
○ MacLennan
MACLENNAN: JASON ALDEN/BLOOMBERG. ILLUSTRATION BY KHYLIN WOODROW
BUSINESS
Bloomberg Businessweek
And Home Box Oice Inc. is boosting its non-U.S. oferings this year by 40 percent, to 250 hours of shows. These newcomers could spur a mass defection of viewers to the increasingly convenient web, and Europe’s traditional broadcasters are scrambling to ind a response. “Consumers no longer care where they watch our content, so why should we still draw strict lines between linear and nonlinear, oline and online?” asks Bert Habets, chief executive oicer of RTL Group, a traditional broadcaster that’s launched streaming sites in France, Germany, and four other countries. The model the Europeans say they’re emulating is Hulu LLC, the U.S. streaming service owned by perennial antagonists Comcast, Time Warner, 21st Century Fox, and Walt Disney. Since its launch in 2007, Hulu has grown to 20 million subscribers, who pay $8 to $40 a month for access to hundreds of shows. Just as the U.S. networks have gone online to hold onto America’s 120 million TV-watching households—and the ad dollars they represent— European companies say they can build a simple video platform to keep viewers from clicking away. “People want this overriding interface,” says Alan Wolk, co-founder of media analysis website TVRev. “It’s confusing to have a diferent app for every network.” Building a Hulu in Europe, with its dozens of languages and patchwork of regulations, will be trickier than in the U.S. Broadcast rights for most shows are sold country by country, so it’s diicult to put together a seamless service for the entire region. Diferent rules about storing recorded shows in the cloud—France, for instance, has more relaxed guidelines than the U.K.—could be a roadblock. And regulators in Germany and the U.K., citing antitrust concerns, have blocked broadcasters’ eforts to cooperate. “I don’t think it’s going to be simple to do a pan-European play,” says John Turner, a partner at media adviser OC&C Strategy Consultants. That hasn’t stopped the broadcasters from trying. In recent months, ProSiebenSat.1 Media SE in Germany has teamed up with Discovery Inc.—which owns the popular Eurosport franchise—to create a service called 7TV, and the two are seeking partners in other countries. Britain’s media regulator has encouraged a similar alliance between the BBC, ITV, and Channel 4. Spain’s LovesTV will ofer livestreams of all three of its networks and allow viewers to see the past week’s shows to catch up on episodes they may have missed. The American upstarts are also spurring erstwhile rivals to sacriice exclusivity and share costs. The BBC and Channel 4 have teamed up with Hulu and AMC Network Entertainment. And public
broadcasters in France, Germany, and Italy have agreed to cooperate on what they call “bigger” shows; they say they’d welcome companies in other countries as well. “If we pool our resources, we can have a strong voice on the international scene,” says Delphine Ernotte, head of France Télévisions SA. Even with shared resources, they’re likely to lose some premier programming to the cash-rich Americans. Netlix spent about $7 million per episode of The Crown, roughly ive times what ITV— the U.K.’s biggest commercial broadcaster—paid for Downton Abbey (though the company doesn’t release igures for its shows). With so much money available, “screenwriters and directors increasingly want to work with the multinationals,” says Karin von Abrams, an analyst at researcher EMarketer Inc. “The funding is better, and they can actually see their projects become reality.” The broadcasters will ind themselves in competition with homegrown rivals such as the TVPlayer platform in the U.K.—part-owned by Hearst Communications Inc. and Walt Disney Co.—and French startup Molotov.TV. The two-year-old company has signed up 5 million users with its Netlixlike interface ofering three dozen channels for free and premium bundles starting at €4 ($4.67) a month. Molotov founder Jean-David Blanc says he’s in talks with British, German, Italian, and Spanish companies to expand into those countries. “The content providers, the producers, they want to maximize their chances to ind their audience,” he says. “So the world is changing, obviously.” —Thomas Seal, Stefan Nicola, and Rodrigo Orihuela THE BOTTOM LINE As American upstarts target Europe with bigbudget series, broadcasters across the region are setting aside old rivalries to co-produce shows and create streaming platforms.
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“It’s confusing to have a different app for every network”
CONTENTS
○ Looking for cancer cures in mushroom and mold DNA
○ A former Tesla stafer turns internet millionaire in his spare time
Undo
ILLUSTRATION BY 731
○ By buying GitHub, Microsoft may be able to reset its relationship with programmers Oh, GitHub, we knew ye … pretty well, actually, over the past decade. At least programmers did. To us you’ve been comically unavoidable, from your “Octocat” mascot to the fake, fully furnished Oval Oice at your San Francisco headquarters, complete with a special Octocat-emblazoned rug that proclaimed “United Meritocracy of GitHub.” Of course, that rug came up a lot when people debated the concept of meritocracy. And part of the reason they were debating it was the sexual harassment investigation that led one of your co-founders to resign—#MeToo before #MeToo. The company seemed to normalize after that, though
we also knew you’d been looking for a new boss for a while. Congrats on your $7.5 billion purchase by Microsoft Corp.! To civilians, it can be baling what in God’s name GitHub Inc. does or why it’s worth so much. The key thing to understand is that git is free software and GitHub makes it easier to use that software. Git keeps track of changes in sets of iles. The irst version, written by Linux creator Linus Torvalds, was released in 2005. Git isn’t for beginners. You typically use it from a command line, as opposed to with a mouse. Want to start tracking changes? Go into any directory and type “git init,” and you’re of to the races. From there, git lets you get Borgesian about your iles. Everyone can make his own “branch” (copy) of the master tree of code and change whatever the hell he wants without breaking anything—git keeps track of it all. This means everyone can have a
T E C H N O L O G Y June 11, 2018 Edited by Jef Muskus, Jim Aley, and Julie Alnwick Businessweek.com
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copy of every change, and you can make tons of mistakes while coding and always have a giant ininite Undo button if you need it. It’s great, but again, not for beginners. Enter GitHub in 2008. GitHub makes it easier for large, loosely coordinated groups of programmers— in corporations, for instance—to use git. It has a well-designed web interface. If you don’t think that’s worth $7.5 billion, you’ve never read the git manual. GitHub rode the wave of git adoption to become the central repository for decentralized code archives. As a result, 27 million users maintain 80 million projects on it—some private and closed of, some open sourced, many abandoned after a weekend of inspiration. That’s a signiicant portion of the software in the world. Everybody uses GitHub. The likes of Google and Facebook Inc. use it to release code, as does Walmart Inc. Your company probably uses GitHub. It’s free to use; you pay for more storage and advanced features. The truly huge thing GitHub does is called a “pull request.” I’m a programmer, and my boss says, “Paul, go update our mailing list component to be GDPR-compliant.” I download all the recent changes to our mailing list code, create a new branch called “gdpr,” then get to work. A week later I’ve got my code basically functioning. I upload that branch back to GitHub and click a few buttons to issue my pull request. My team can see the work I’ve done, in shades of green (additions) and red (deletions). If they like the look of my changes they can approve them, and, if everything goes well, those changes will be merged right into the “master” branch. Built in is that Undo button: The old version, the new version, and my interim version are all right there if I need them. Nothing is erased. If something goes wrong, I can revert to an old version. In the pre-git era, you updated your software annually and sent customers loppy disks. But if you’re running a big software platform, you might update your servers constantly—many times a day or every 20 minutes. You might have hundreds or thousands of people working on hundreds of code repositories in thousands of code branches—a huge weeping willow of code. You might have open source projects where total strangers show up, make their own changes, then issue a pull request back to you from out of nowhere. Could you use the strangers’ code? Sure. Do you have to? Nope. GitHub made the complex social dynamics around software development easier to manage and track. That’s how code happens in 2018. The process
used to be the sort of thing people did in slow and ad hoc ways, a few times a year, and only after a lot of inighting over email. Now the same process might happen 10 times a day, and the inighting is right there in the pull requests. Hundreds of people might be working on one code thing or 10 people on 100 code things. GitHub makes that doable. I can’t imagine life without it. I’d much rather tell a newbie to get a GitHub account than suggest she read the git manual. If all companies are becoming software companies, GitHub is a primary enabler. A truly fun aspect of Microsoft’s acquisition of GitHub is that it was announced before Apple Inc.’s Worldwide Developers Conference. This is like when Passover overlaps with Easter in New York City. The WWDC, sacred nerd summit of Appledom, is where they announce things like a new “night mode” for the operating system and try to convince programmers that Apple Watch matters. But GitHub is nerd infrastructure. Huge portions of modern culture—Google’s TensorFlow machine-learning software, for instance, and even other programming languages, such as Mozilla’s Rust—run on code managed there. For Microsoft to trot this out during WWDC is a real thunder-stealer. It’s nice to see global-platform capitalism played with a little verve. GitHub represents a big Undo button for Microsoft, too. For many years, Microsoft oicially hated open source software. The company was Steve Ballmer turning bright colors, sweating through his shirt, and screaming like a Visigoth. But after many years of ritual humiliation in the realms of search, mapping, and especially mobile, Microsoft apparently accepted that the 1990s were over. In came Chief Executive Oicer Satya Nadella, who not only likes poetry and has a kind of Obamaesque air of imperturbable capability, but who also has the luxury of reclining Smaug-like atop the MSFT cash hoard and buying such things as LinkedIn Corp. Microsoft knows it’s burned a lot of villages with its hot, hot breath, which leads to veiled apologies in press releases. “I’m not asking for your trust,” wrote Nat Friedman, the new CEO of GitHub who’s an open source leader and Microsoft developer, on a GitHub-hosted web page when the deal was announced, “but I’m committed to earning it.” Git is one of those things that, in my experience, people who love computers … just love. In mixed company, it’s a terrible subject, but with another nerd over beers you could talk for hours, and I have, about what git did, what it means, where it came from, and how bad it used to be in the days of CVS (not the drugstore) and
June 11, 2018
GitHub made the social dynamics of software development easier to manage and track
ILLUSTRATION BY CAROLINE DAVID
TECHNOLOGY
Subversion (which replaced CVS) and Microsoft Visual SourceSafe (which was a crime against software), and how git represents a way of seeing the world in a new way. When you drink and talk about git, the conversation tends to drift into strange territories. If only everything worked like this! Why are we still sending iles around via email? Why aren’t there multiple branching versions of everything? Why do we pretend that there’s any canonical version of anything? (Because we have to make money.) Git acknowledges a long-held, shared, and hardto-express truth, which is that the world is evershifting and nothing is ever inished. It’s always been this way. Computers are mercurial, but Microsoft strapped an operating system on top of them—irst with DOS, then with Windows— and commoditized that processing power. The web was messy and luid, and Google made it easy to search. The social graph is vast, so Facebook wrote a special database to make it easy to see your friends. The way you truly win big in software is to take something deeply abstract, weird, and confusing, then put an interface on top that makes it look like the most normal thing in creation. I had idle fantasies about what the world of technology would look like if, instead of iles, we were all sharing repositories and managing our lives in git: book projects, code projects, side projects, article drafts, everything. It’s just so damned … safe. I come home, work on something, push the changes back to the master repository, and download it when I get to work. If I needed to collaborate with other people, nothing would need to change. I’d just give them access to my repositories (repos, for short). I imagined myself handing git repos to my kids. “These are yours now. Iteratively add features to them, as I taught you.” For years, I wondered if GitHub would be able to pull that of—take the weirdness of git and normalize it for the masses, help make a post-ile world. Ultimately, though, it was a service made by developers to meet the needs of other developers. Can’t fault them for that. They took something very weird and made it more usable. Microsoft gets that, and my guess is that GitHub will still be humming along in some form come 2048—this is an industry that can think in decades. Underneath all that commoditization, the weirdness remains. —Paul Ford, CEO of Postlight, a digital platform and product shop in New York City. He’s on Twitter at @ftrain and on email at paul.ford@postlight.com THE BOTTOM LINE GitHub has dramatically accelerated coding and made itself indispensable to programmers. The company can be an invaluable goodwill-builder for Microsoft—if it doesn’t screw it up.
Bloomberg Businessweek
June 11, 2018
This Fungus Could Help Cure Cancer ○ Scientists are mining the DNA-sequence data from mushrooms and mold to find new drugs
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Maureen Hillenmeyer doesn’t know exactly what’s growing in her incubators, but she has high hopes. The rectangular plates in the backroom of Hexagon Bio are heated to 86F and illed with yeasts unlike any other. The fungal microorganisms have been painstakingly outitted with custom-printed DNA parts that give ordinary baker’s yeast the capacity to make new compounds that could potentially cure disease. “When we know it’s making a molecule, then we go in and say, ‘Is that molecule doing something interesting to cancer cells?’ ” says Hillenmeyer, co-founder and chief executive oicer of Hexagon, based in
Bloomberg Businessweek
Menlo Park, Calif. “That’s the real ield testing.” The company’s approach to drug discovery is half computation, half biology. A team of data scientists uses proprietary algorithms to mine a trove of data extracted from the DNA sequences of more than 2,000 species of mushrooms and molds, known as the fungal genome. Hexagon then predicts which strings of DNA, or gene clusters, are most likely to produce speciic types of chemical compounds. If all goes according to plan, the yeasts will generate about 100 compounds that are particularly lethal to certain types of cells and proteins, making them the sturdy foundations of new treatments for infectious diseases and cancer. As Hillenmeyer walks through an adjacent lab, she leans over to check on Anton— the robot that handles the liquid DNA—and notices an acrid aroma, one of the few signs of the process. “It’s a little fragrant today,” she says. The chemical ingenuity of fungi often goes unsung, though almost three-quarters of all antibiotics and 49 percent of all anticancer compounds approved by the U.S. Food and Drug Administration originated with living organisms such as mushrooms and mold. Blockbusters including penicillin and statins, which lower cholesterol, came from fungi. Hillenmeyer began experimenting with yeasts at Stanford 15 years ago. She co-founded Hexagon with Brian Naughton, formerly of genetic-testing company 23andMe Inc., and biochemists Colin Harvey and Yi Tang in late 2016, not long after her team discovered 22 compounds that showed pharmaceutical promise. So far, Hexagon has raised $8 million from private investors; it’s looking to hire more biologists and data scientists. “We have a computational approach that allows us to identify what these compounds evolved to do,” she says. “The statins, in particular, are drugs that we would have discovered if they hadn’t been found.” Those now yield about $10 billion in sales a year, but Hillenmeyer is looking elsewhere. “We want to move into new chemical space and disease space,” she says. Genome mining has attracted hundreds of millions of dollars in investment as the cost to sequence DNA has shrunk and the capacity to store digitized biological data has surged, allowing researchers to expand their knowledge of the microscopic organisms that live almost everywhere on Earth, inhabiting soils, sea sponges, and the human gut. Although previous corporate eforts failed to produce commercially viable drugs—because of growing costs and a dearth of genome data—Hexagon’s generation of startups is poised to proit from advances in molecular biology and computational software. “Things are accelerating like crazy,” says David
Mead, co-founder of Varigen Biosciences Corp., a startup in Wisconsin that’s also developing specialized technology to mine microbes for new drugs. Biologists now take days to run experiments that once took him years to conduct. “Big Pharma tried this big DNA stuf about 10 years ago, and it didn’t go very well, because the tools weren’t quite ready, and so they gave up,” Mead says. “Hopefully, they’ll come back around and start noticing these things with the next generation of tools.” In May, Lodo Therapeutics Corp. inked a genome-mining deal with a unit of Roche Holding AG for as much as $969 million. In January, Pizer Inc. invested $162 million in a microbe-mining agreement with Adapsyn Bioscience Inc. of Hamilton, Ont. Startup LifeMine Therapeutics Inc., in Cambridge, Mass., scored $55 million in venture capital. Despite the inlux of cash, gene mining won’t be a cure-all for the drug industry, says Terry Roemer, chief scientiic oicer of Prokaryotics Inc. Once a compound has been shown to have the right properties,
June 11, 2018
⊳ Fungi grown on petri dishes at Hexagon Bio
a company still faces plenty of hurdles—regulatory and otherwise—in turning it into a lifesaving medication, says Roemer, whose New Jersey-based business uses genomic tools to study human pathogens and develop drugs that target disease. Those obstacles have Hexagon looking for other ways to get an edge on competitors. Along with DNA sequencing and automated workstations, it’s also using new technology that helps make it cheaper and easier to synthesize a physical copy of DNA. Hexagon essentially downloads and prints copies of gene clusters rather than laboriously cloning that DNA from wild fungi. Once the data team picks out a set of genes, the company sends an order to a commercial DNA vendor that prints out custom strands. Back inside the Hexagon oice, Brandon Burr, a software engineer, demonstrates how he can redesign a yeast with the press of a button. “I’m just dragging and dropping genes,” he says. A cure could be a click away. —Peter Andrey Smith THE BOTTOM LINE Technology is revitalizing the search for drugs derived from natural organisms by enabling companies to predict medicinal chemistry based on DNA sequence data.
COURTESY HEXAGON BIO
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How to
E-Commerce
“A lot of people say, ‘If you believe in something, do it 100 percent,’” says Sisun Lee. “I actually think that’s horrible advice.” So during 2016, the first year of his startup, 82 Labs, Lee also kept working as a product manager at Tesla Inc. In year two, however, he quit to focus on his product: an American version of the South Korean hangover cures that helped him out during a vacation in Seoul. In April he closed an $8 million Series A funding round that valued the company at $33 million. —Zeke Faux
ILLUSTRATIONS BY KATI SZILÁGYI
First Things First ① Research
A little Googling revealed that the secret ingredient in Korean hangover drinks was dihydromyricetin (DHM), a compound found in the Japanese raisin tree. He contacted a leading DHM researcher—Jing Liang, a professor at the University of Southern California—as an informal consultant. For academics, “their passionate interest is intrinsic motivation,” Lee says.
② Test
To ensure there was U.S. demand for a hangover cure, Lee created thehangoverdrink .com, posted pictures of a fake product, and pitched it on Facebook. After a few dozen orders came in, he decided to start production—and refunded those early buyers.
③ Connect
Lee posted an ad on the freelance site Fiverr ofering $30 to someone who’d find all the hangover-drink factories in South Korea. He ordered sample batches of a formula devised by his academic friend, then gave out baggies of the stuf to his network. After one of them praised the drink on Product Hunt, a site that recommends consumer novelties to early adopters, thousands of people asked to try it. “You’re building a community,” Lee says. “All of a sudden they’re invested in helping you.”
④ Commit
The appearance on Product Hunt helped persuade angel investors to hand Lee $450,000. He also hired attorneys, who told him that calling something either a “drink” or a “cure for hangovers” would require approval from the U.S. Food and Drug Administration. He renamed it Morning Recovery and rebranded it as a dietary supplement.
⑤ Crowdfund
Up to this point, Lee had spent about $15,000, but the factories that could make Morning Recovery for 82 Labs required a minimum order of about 200,000 bottles, for $100,000. Instead of risking his investors’ money, he presold the product via a crowdfunding campaign on Indiegogo. A branding agency, agreeing to run the campaign for about 15 percent of the funds raised and no upfront cost, raised $250,000 in about a month.
⑥ Sell
Lee started marketing Morning Recovery directly online, charging $29.95 for a sixpack of 3.4-ounce bottles. By October he’d hit $1 million in sales. To reach his natural customer base—impulsive drunks—Lee wants to put his product in bars, nightclubs, liquor stores, and late-night restaurants. He needs to gain market share before what he calls an “existential threat” rears up: Red Bull GmbH, Coca-Cola Co., or some other big rival making its own hangover drink.
Raise Money
Building a retail distribution network takes money. Lee says venture capitalists including Altos Ventures, Slow Ventures, and Thunder Road Capital were happy to give it to him because, unlike many VC darlings, 82 Labs already made money. Now that he’s flush, he’s trying to get Morning Recovery onto shelves in Chicago, Los Angeles, and San Francisco, his three best online markets. His goal is to build a scalable model. “We can take that playbook and get bigger and bigger,” he says.
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CONTENTS
○ Credit card fraud evolves. Enter the internet mall cop
○ Goodbye, fiduciary rule. Hello, investor vigilance
3 Personal Finance
Pretty Good. Not Good Enough
ILLUSTRATION BY THOMAS COLLIGAN
○ Fidelity Magellan Fund has made a comeback, but investors are skeptical of active managers Jef Feingold runs Fidelity Magellan, once the world’s most famous mutual fund. But there’s a good chance you’ve never heard of him, which says a lot about the plight of active money managers these days. From the late 1970s through the ’80s, most Americans who invested in the stock market knew the man behind Magellan. Peter Lynch posted market-beating returns of 29 percent a year, leading many ordinary investors to think the path to riches was choosing the right money manager. Lynch’s successors, including Jefrey Vinik and Robert Stansky, got plenty of media ink in the 1990s, even if they never came close to matching Lynch’s numbers. Now, indexing is king, and many individual investors would rather ind the lowest-cost benchmark tracker than bet on hot managers. Magellan’s journey from icon to afterthought may be the starkest example of the eroding trust in professional stockpickers. Feingold’s record is strong: Under his tenure, which began in September 2011, Magellan has bested the S&P 500 every full year but 2016. Annualized gains have averaged more than 15 percent, currently putting the fund just a bit ahead of the index. The fund has outdone more than 90 percent of funds with a similar investing
style over the past one, three, and ive years. What Magellan isn’t doing is winning cash from customers. Magellan was once so popular that Fidelity closed it to new investors in 1997. Assets topped out at almost $110 billion in 2000, when it was the largest fund in the business. But investors have pulled money out for 18 straight years, even though Magellan reopened to new investors in 2008. “If we do our job well and generate alpha, hopefully that is what will matter to shareholders,” says Feingold in a conversation at Fidelity headquarters in Boston’s inancial district. Alpha means beating the index. “People expect us to perform. They expect we will beat the benchmark every year.” At $17.5 billion, the fund is about the same size it was when Feingold assumed the helm. This actually obscures the outlow of cash, because the fund’s holdings grew in value over the same period, ofsetting the redemptions. Fidelity’s biggest equity fund, at $150 billion in assets, is now the Fidelity 500 Index Fund, a passive one that tracks the S&P. There are glimmers of a turnaround: Magellan in March had its irst month of net deposits in a decade, according to Morningstar Inc., and its overall redemptions this year have slowed. Still, the tide is against it. Newly released data show that actively managed U.S. stock funds and ETFs saw $67 billion in outlows this year through April. Their passive counterparts hauled in $59 billion. “You need a compelling argument to get investors to buy your fund, and it isn’t clear Magellan has one,” says Lawrence Glazer, managing partner at
F I N A N C E
June 11, 2018 Edited by Pat Regnier Businessweek.com
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Maylower Advisors in Boston. Other prominent managers at Fidelity, such as William Danof at the $128 billion Fidelity Contrafund, have also been stung by withdrawals, despite strong performance. Feingold and his deputy, Kwasi Dadzie-Yeboah, who joined Magellan in 2015, previously worked together at the smaller Fidelity Trend Fund. Like Lynch—who regularly asked analysts pitching stocks, “Is the story getting better?”—they try to identify businesses poised for an upswing by scrutinizing factors such as free cash growth. “We are looking for companies whose fundamentals are improving,” Feingold says. “That is where we hunt.” Feingold is a lanky and bespectacled Harvard MBA and Brown University grad who climbed Fidelity’s ranks after a stint as an analyst at Morgan Stanley. As an investor, he takes a traditional approach, looking at companies one by one. This style has been challenged, not only by indexing but by increasingly popular quantitative strategies that use computers to sort through reams of data to identify stocks with better odds. That’s where DadzieYeboah comes in. The Ghana native has a quant background and supplements Feingold’s work with a methodology he’s honed over more than a decade. He dubs it “automating our investment philosophy.” When the story and the signals agree about a stock, the managers get an additional shot of conidence. Magellan’s recent results have been driven in part by technology holdings such as Apple Inc. and Amazon.com Inc. The managers have also shown a knack for spotting battered old-economy companies on the cusp of a rebound. They quadrupled their stake in equipment maker Caterpillar Inc. from June 2016
Drifting Toward Average
To Catch a Credit Card Thief When Chad Evans took a job in 2016 as manager of online investigations for retailer PetSmart Inc., he thought he’d be ferreting out small-time credit card fraudsters. But sometimes he catches glimpses of what may be larger, darker crimes. Evans and his team spend their days in a squat Phoenix oice building combing through online transactions to find suspicious patterns. He’s basically an internet mall cop, tasked with nabbing virtual shoplifters. Not every company has an Evans. Many websites accept fraud as a cost
June 11, 2018
Annualized returns of Fidelity Magellan Fund managers Magellan S&P 500 Peter Lynch (1977-90)
Morris Smith (1990-92)
Jefrey Vinik (1992-96)
Robert Stansky (1996-2005)
Harry Lange (2005-11)
Jef Feingold (2011-present*)
0
15%
30% *AS OF MAY 31; DATA: BLOOMBERG, MORNINGSTAR
through September 2017, in time to catch a rally. Fidelity watchers agree that Magellan has improved—just not enough to ignite enthusiasm. John Bonnanzio, editor of Fidelity Monitor & Insight, and James Lowell, editor of Fidelityinvestor.com, both say there are better Fidelity funds to buy, including Contrafund. The bottom line, according to Bloomberg Intelligence senior ETF analyst Eric Balchunas, is that for an active U.S. stock manager, pretty good is no longer good enough. “The data show that unless you really trounce the benchmark, it’s very diicult to get lows,” Balchunas says. “You are up against a secular shift.” —Charles Stein THE BOTTOM LINE Magellan used to be America’s biggest mutual fund. Now, in spite of solid recent performance, it’s dwarfed by the company’s own index fund.
○ How virtual mall cops hunt down scammers trying to use stolen cards online
of doing business. But online frraud has soared in recent years—a side efect of th he introduction of chip cards, which have made it harder for crooks to create fake cards to use in stores. This has forced many merchants to rethink their approach. Along with rejecting suspicious purchases, they’re tracing them to their sources and building cases against the perpetrators with police. That’s why the 33-year-old found himself in a police car one day last year, parked down the street from a customer’s home on an all-day stakeout in
ILLUSTRATION BY THOMAS COLLIGAN
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PERSONAL FINANCE
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Tucson. Weeks earlier, Evans and his team had spotted something weird. Several people had complained that their cards had been stolen and used to buy $400 Garmin Trashbreaker electronic dog collars. His security software determined the orders were linked, but they were being shipped to houses all over the country, including in Tucson. When the next order came in, Evans decided to follow it. Evans called police departments around the country and told them what he knew. Locally, he worked with the Pima County Sherif ’s Oice to set up a controlled delivery of the dog collar. When the recipient arrived home to pick up the package, police swarmed. Evans later spoke to him and learned that he was hired through a posting on Craigslist. Evans says the man was paid $20 to receive a package and ship it to a freightforwarding center, which would combine his items with other shipments and send them overseas. Evans persuaded the man to share a list of everything he’d shipped for the service. “It was water iltration systems, duct tape, containment fences, tents, clothing, blankets, shoes,” Evans says. After seeing the list, he says, “we started thinking human traicking and human smuggling.” Evans and his team began to compile documents and other data and presented the case at the FBI ield oice in Phoenix. Scammers have been coming up with ways to cash in on stolen numbers since Diners Club introduced the irst credit card more than 60 years ago. In the early days, thieves stole numbers one at a time, looking through trash and mail for receipts or bank statements that would contain the information. But dozens of high-proile data breaches—like those at Equifax Inc. and Target Corp.—mean more consumers have to worry that their inancial information is out there. Hackers place it for sale on the dark web, where identity thieves buy iles containing dozens of names, addresses, and card numbers. The good news for consumers is that they’re rarely liable for fraudulent transactions, but they still have to worry about monitoring their cards for suspicious activity and deal with the inconvenience of getting a new card whenever one is compromised. For years, fraudsters would take those numbers and print them onto blank plastic cards to use at brick-and-mortar stores. But in 2015, Visa Inc. and Mastercard Inc. mandated that banks and merchants introduce chip card technology, which generates new codes for each transaction that can’t be copied and stored by hackers for later use. The move helped cut the amount of counterfeit fraud in half,
according to a report by Capco, a consulting irm. Not all merchants beneited from the added security of chip cards. Those that take orders over the phone or online have seen fraud costs balloon. So-called card-not-present fraud is expected to cost retailers around the world $71 billion over the next ive years, according to Juniper Research Ltd. “Fraud never really goes away,” says Justin Griggs, a senior vice president for product commercialization at payments processor Total System Services Inc. “These guys aren’t packing up shop. They’re just moving on to the next point where they ind the most signiicant vulnerabilities.” There are many ways online fraudsters can proit from their exploits. An increasingly popular one: The scammer will use a stolen credit card to purchase an item online and opt for in-store pickup. Then they’ll return that item for cash at a nearby location. Merchants are in a bind. When they beef up fraud-prevention tools, it can slow down the checkout process and hinder sales. The alternative: raise the risks for scammers by tracking them down and handing the evidence over to police. “There’s a righteous indignation amongst a small group of these merchants now,” says Brad Wiskirchen, chief executive oicer of Kount Inc., which provides fraud-detection services to retailers, including PetSmart. “There’s more and more merchants now that are saying, ‘Hey, I’m going to stop him from ripping me of, and then I’m going to stop him from ripping anyone else of, too.’ ” The bad guys do share criminal know-how, according to Steve Mott, a consultant to the payments industry. Using forums on the dark web, they’ll trade secrets about their luck with exploiting vulnerabilities at certain merchants. “They know the retailers that are lackadaisical,” says John Bode, a New York State Police investigator who’s focused on organized retail crime. “They’re watching the trends as much as we are.” Evans says it took time to learn how to hand of his indings to police. “I’ve taken my lumps of being laughed of the phones, but I’ve learned how to present these cases,” he says. Updates on the case with the dog collars have been few and far between, but Evans says the FBI told him that Interpol is now investigating. “The message I try to send to my fellow merchants is that not all these guys are trying to feed a drug habit or want to buy these items for themselves,” Evans says. “They can be involved in something more sophisticated.” —Jenny Surane and Zeke Faux THE BOTTOM LINE The introduction of chip-based credit cards in the U.S. has cut down on counterfeit card fraud in stores. But online merchants still have a costly problem on their hands.
June 11, 2018
“Fraud never really goes away. These guys aren’t packing up shop” 29
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Who’s Looking Out for You? ○ The uncertain fate of the fiduciary rule shows why investors always need to be vigilant
would be diicult to go back to the old ways of doing business,” says Brian Gardner, an analyst at Keefe, Bruyette & Woods Inc. “It just looks bad.” Also, companies such as Primerica Inc. and Ameriprise Financial Inc. poured millions of dollars into training employees on the new rules, revising procedures and documents. “I don’t think some irms are particularly interested in going back and re-creating a new compliance regime to somehow take advantage of the absence of the iduciary rule,” says Gardner.
While the rules remain uncertain, the debate has heightened public awareness of the investor-adviser relationship. The word “iduciary” even seeped into popular culture, with comedian John Oliver devoting a segment of his HBO show to the iduciary rule. Meanwhile, investors have to take the initiative, says Christine Lazaro, professor of clinical legal education at St. John’s University School of Law. They should “be comfortable asking more questions and not feel like they’re inadequate in some way because they don’t already know this information,” she says. “Have that conversation, and ask about anything that you don’t understand.” —Katherine Chiglinsky THE BOTTOM LINE An Obama-era rule that required some brokers to put clients’ interests ahead of their own has been struck down in court and may not be revived.
ILLUSTRATION BY THOMAS COLLIGAN
30
Among all the inancial reforms launched during the Obama administration, the iduciary rule may have been the most important to ordinary investors. Issued by the Department of Labor in 2016, the rule required brokers working with retirement accounts to put clients’ interests ahead of their own—for example, by recommending an annuity that was better for the client rather than one from a company that paid the broker a bigger commission. The regulation was hailed as an historic win by consumer advocates, and the inancial-services industry began remaking many of its products and pay structures to comply. Now the regulation is all but dead. In March a federal appeals court struck it down, and the Trump administration has not appealed the ruling. Where does that leave retirement investors? The outlook is anything but clear. In April the Securities and Exchange Commission released its own plan for investor protection. In a proposed rule that runs hundreds of pages, the agency says it wants brokers “to act in the best interest of the retail customer” but adds, “We are not proposing to deine ‘best interest’ at this time.” Instead, the agency lists “obligations” of brokers to ensure they don’t place their own interests before those of their clients and says inancial companies must “establish, maintain and enforce policies” that are designed to spot and mitigate conlicts. “We don’t know what they mean by ‘best interest,’ ” says Barbara Roper, director of investor protection at the Consumer Federation of America. “And that is a problem they need to ix because this regulation, as drafted, depending on how it’s interpreted, could be anything from the status quo to a signiicant improvement in investor protection. And if it’s vague, it’s going to be diicult to enforce.” The advent of the iduciary rule led the industry to make changes that may not be reversed, according to Aron Szapiro, Morningstar Inc.’s director for policy research. After the Labor Department’s announcement in 2016, inancial companies began moving to comply with it. Bank of America Corp.’s Merrill Lynch stopped ofering many commission-based retirement accounts in favor of ones that charge fees. “At the very least, from a PR standpoint, it
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CONTENTS
○ The infamous Three Mile Island nuclear plant may soon be history
Who’s Holding Italy Back?
MARTYN THOMPSON/TRUNK ARCHIVE
○ Populist politicians indulging pensioners are ruining the country for the young At just 31 years old, Luigi Di Maio, head of Italy’s populist Five Star Movement, is no one’s image of a gerontocrat. Yet since helping form a new coalition government, Di Maio has given priority to rolling back a gradual increase in Italy’s retirement age— even though doing so would help older Italians while adding to the debt burden on his own generation.
Dismantling a money-saving 2011 pension measure is one of a handful of issues on which Di Maio sees eye to eye with his coalition partner, Matteo Salvini, 45, of the right-wing, anti-immigrant League party. Asked earlier this year about former Prime Minister Silvio Berlusconi’s goal of preserving the “good parts” of the 2011 measure, Salvini said, “It’s no problem, because there are no good parts in it.” It’s not easy to be young in Italy, even apart from the pension burden. The country’s economic output is smaller now than it was in 2004, and employment policies are skewed to protecting jobs, not creating them. The number of Italians registered
E C O N O M I C S
June 11, 2018 Edited by Cristina Lindblad Businessweek.com
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June 11, 2018
as living abroad rose 60 percent from 2006 to 2017, to almost 5 million. Among those who stay, it’s common for unemployed young people to live with their parents instead of starting their own families, which is one reason the country has one of the world’s lowest birthrates. It’s understandable that after years of stagnation, Italian voters were eager for a change in government. But for a country that needs optimism and entrepreneurial vigor, the new leadership has a backward-looking agenda. The League wants tax cuts and tight restrictions on immigration. Five Star wants a guaranteed minimum income for all. Both say they want to stay in the European Union—but threaten to defy its rules on migration and debt. Support from both Five Star and the League for repeal of the 2011 retirement age increase relects the extent to which the pet issues of the elderly have been swept up into the broader populist agenda. Perhaps surprisingly, it’s not the old who put Five Star and the League in power. Five Star, which was founded by a comedian and styles itself as a popular movement rather than a political party, draws most of its strength from younger voters: Its support among those 65 and older is only half as strong as among those younger than 35, according to polling by Quorum/YouTrend for the March 4 election. The League’s support isn’t as skewed by age, but 65 and older is still its weakest demographic, the same poll shows. (Di Maio and Salvini compromised on law professor Giuseppe Conte to be their government’s prime minister.) It’s hard to see how this coalition will boost an economy that grew just 1.6 percent last year. Marta Morazzoni, 23, a native of Milan who’s studying economics in Spain, says she voted for the center-left Democratic Party, formerly headed by Matteo Renzi, but knows many people her age who supported extreme parties or didn’t vote at all. Says Morazzoni: “Many people don’t even really care about leaving Europe or not leaving Europe, or giving the vote to Salvini or not, because they are so fed up with all our politicians that they do not make the distinction.” She’s not planning to return to Italy after her studies, because she has little conidence that those in government can turn things around. “In the last 25 or 30 years,” she says, “my country hasn’t changed.” The disenchantment of many young Italians can become a self-fulfilling prophecy. Sergio DellaPergola, an Italian demographer who emigrated to Israel and teaches at the Hebrew University of Jerusalem, is struck by how much more optimistic his adopted country is than his native one. “In Israel, people start families even without resources,” he says. “Babies bring optimism, and
optimism brings babies. So the economy works.” The new government may muddle through, as previous ones have. Yields on government bonds have fallen since shooting up at the end of May. High rates would make it hard or impossible for Italy to pay interest on its government debt, which at more than 130 percent of gross domestic product is second-highest in the EU after Greece’s. But rolling back reforms—such as Renzi’s Jobs Act of 2015, which made it easier for large companies to ire people— may doom the country to become the perennial sick man of Europe. “We need to have a vision for the next 30 years,” says Paola Subacchi, who is a senior research fellow at Chatham House, a policy institute in London, as well as a visiting professor at the University of Bologna. She favors limits on deficit spending, improvements in public education, infrastructure investment, and less red tape. She says Italy’s new leaders should strongly commit to sticking with the euro currency and remaining in the European Union, which would reassure investors and keep Italy from having to pay higher interest rates than other euro zone countries with which it competes. EU leaders would be more likely to cut Italy some slack on budget rules if they were conident that the government would spend wisely, investing for the long term, says Subacchi. Restoring hope is the irst step that’s needed, says Lucrezia Reichlin, a former director-general of research at the European Central Bank and an economics professor at London Business School. “You do not want to subsidize the losers, but you have to give them something to transform themselves,” she says. Reichlin launched Ortygia Business School in the Sicilian city of Siracusa last year to teach a new generation of executives and support the growth of the countries of the Mediterranean. One of her goals is to draw young people to Italy, both Italians who have left and others coming to the country for the irst time. “We need to create incentives for young people to move to Italy.” In a Eurobarometer survey of “active aging” conducted in 2011, Italians came in second to last (ahead of Slovenia) among EU nations in the percentage who said they would like to keep working after reaching the age at which they would qualify for a pension. Pair that with the popularity of rolling back the retirement age increase and you see a country in a quitting mood. Changing that attitude should be any new government’s top priority. —Peter Coy, with Alessandra Migliaccio
○ Share of 25- to 29-year-olds neither employed nor in school or training in 2016
THE BOTTOM LINE Five Star and the League favor rolling back Italy’s retirement age increase, but their platforms are short on proposals to stem a brain drain and get the economy growing again.
Greece 33.5% Italy 32.4 France 19.2 U.K. 14.7 Germany 12.3 Sweden 8.0
○ Change in real net worth since 1995, by age of head of household -60%
18-34
-22
35-44 -8
45-54 0 55-64
65+
59%
○ Italian population ratios Births per thousand Deaths per thousand 11
9
7 2002
2017*
*ESTIMATE. DATA: EUROSTAT, INTERNATIONAL MONETARY FUND, ITALIAN NATIONAL STATISTICAL INSTITUTE
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Lights Out at Three Mile Island
FROM TOP: RICHARD HERTZLER/LNP MEDIA GROUP; COURTESY OF JIMMY CARTER LIBRARY
Cheap gas threatens to do what antinuclear activists couldn’t, which is put the infamous power plant out of business
In his four-decade career at Three Mile Island, Mark Willenbecher has watched the nuclear power plant overcome some towering odds. He was on the job in 1979, when one of its two reactors experienced the U.S.’s irst and only nuclear meltdown. In the ensuing panic, his pregnant wife and young son had to lee their central Pennsylvania home. While citizens in Harrisburg, Pa., and other cities around the country held protests demanding Three Mile Island’s closure, Willenbecher suited up in radiation-protection gear and helped get the facility back online. Today, both of his sons are employed at the plant, where their father is training a new generation of nuclear reactor operators. It’s not entirely uplifting work, either for Willenbecher or his students, who will wrap up their training in the summer of 2019. That will be just a few months shy of Sept. 30, which is around when Exelon Corp. plans to take Three Mile Island oline—not because its technology is antiquated and unsafe, but because it’s no longer proitable. “They’re looking at us going, ‘Are we going to have a job?’” says Willenbecher, standing in the living room of his split-level home a few miles from the plant, which he calls “a second home.” For the cluster of small towns stretching along the Susquehanna River south of Harrisburg,
the closure of Three Mile Island will be a powerful blow. Last year alone the plant sent $1.5 million in taxes and other payments to surrounding Londonderry Township, Dauphin County, and the local school district. And while the nuclear plant may not be the area’s biggest employer—that title goes to various entities with “Hershey” in their names, from a medical center to the amusement park just up the road—its 675 workers make good money. The average salary is $89,000, according to Exelon. That’s helped boost the median household income of Londonderry (population 5,242) to nearly $63,000, according to U.S. Census Bureau data—higher than the statewide median of $55,000. Through its 44-year existence, Three Mile Island has been a big draw for generations of highly skilled engineers, mechanics, and others who’ve often come up through the ranks of the U.S. Navy or top-light universities. “These people go out to dinner, buy houses, go to Home Depot,” says Steve Letavic, manager of Londonderry Township. “How do we replace that as a region? I don’t think you can.” Across the U.S., more communities are grappling with such questions, as the owners of nuclear plants dating to the 1960s and ’70s begin to put their facilities into premature retirement. The plants are having trouble staying competitive in an era of cheap natural gas, a product of the shale boom. Also, nuclear power’s attraction as a clean energy source has been eclipsed by no-emissions alternatives such as wind and solar power. Three Mile Island began operating in 1974, a time of unbridled ambition for nuclear power. The Arab oil embargo had exposed America’s dangerous reliance on foreign energy, sparking a drive for independence. The enthusiasm for nuclear died on March 28, 1979, when equipment that pumped cooling water into Three Mile Island’s reactor No. 2 failed, triggering the meltdown.
○ Willenbecher
35
⊳ President Carter and the first lady toured the plant shortly after the 1979 accident
ECONOMICS
Bloomberg Businessweek
June 11, 2018
Sirens rang out across the region, residents led en masse, and the national media swarmed in. Within days, President Jimmy Carter arrived, strapped on a radiation badge and protective boots, and toured the control room—a photo op designed to soothe a panicked nation. But the damage was done. Antinuclear activists went on the ofensive: A march on Washington just weeks after the accident drew 125,000, including Jerry Brown, then in his second term as California governor. More than 60 projects already under way were canceled, because of a combination of pushback from local communities and a regulatory crackdown. Nuclear’s reversal of fortune is visible all over Three Mile Island. On the outside, four giant cooling towers climb into the Pennsylvania sky, but two of them haven’t emitted any steam since the accident. On the inside, some of the areas of the plant look like they’ve been frozen in time since the ’70s. Willenbecher is reminded of this whenever he introduces a young group of engineers to the control room, where red and green blinking lights, small computer screens, and large knobs
and levers ill the teal panels that cover the room from loor to ceiling. “They look at it like, ‘I think I saw this in the Apollo 13 movie,’” he says. “But it’s functional. It works well. And at the time, it was the top of the line.” Like it or not, the U.S. remains the world’s nuclear energy leader, home to almost a quarter of the planet’s roughly 400 gigawatts of generating capacity, according to the International Atomic Energy Agency. That dominance, however, is looking increasingly shaky. While the U.S. leet reached a peak of 112 nuclear reactors in 1990, only 99 are in operation today, according to the U.S. Energy Information Administration. And just one new plant has been licensed in three decades. In France, nuclear power meets more than 70 percent of the country’s electricity needs; in the U.S. that igure has hovered at about 20 percent for decades. Today more than a quarter of U.S. nuclear power plants are failing to make enough money to cover operating costs, raising the risk of more early retirements, according to a recent study by Bloomberg New Energy Finance. Utility giants such as Exelon are looking to
The control room at Three Mile Island in April
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policymakers to help them keep aging reactors running. At the federal level, the Trump administration has been trying for more than a year to come up with a way to bail out the country’s coal and nuclear facilities, saying their ability to generate power around the clock adds “resilience” to the national grid. The latest attempt came on June 1, when Trump directed Energy Secretary Rick Perry “to prepare immediate steps” to halt the shutdown of such plants. Even so, nuclear advocates have thus far had better success mobilizing resources at the state level. In Illinois, the state that leads the U.S. in nuclear power generation, lawmakers passed controversial legislation in 2016 to subsidize nuclear plants with so-called zero-emission credits. States including New York and New Jersey have enacted similar policies, but Pennsylvania has been a tougher sell. A nuclear energy caucus in the state legislature has failed to pass anything helpful yet. Its eforts have been stymied, in part, by forces supporting the state’s booming natural gas industry. Exelon, which operates the largest nuclear leet in the country, isn’t ready to call it quits. It’s seeking policy change at the state, regional, and national level “that properly values nuclear energy for the value it provides from an environmental standpoint, from a resilience and reliability standpoint, from a fuel diversity standpoint, and as an economic engine for the communities in and around the plants,” says David Fein, Exelon’s vice president for state government afairs. Part of the problem is that after decades of stagnation in the nuclear energy sector, Americans simply aren’t engaged in the subject—whether for the technology or against it. “People on both sides of the nuclear debate are graying,” says Eric Epstein, the longtime chair of the watchdog outit Three Mile Island Alert. “If you attend a nuclear meeting, it reminds you of being at an AARP social function.” While the name Three Mile Island may no longer resonate with young Americans, surrounding communities won’t soon forget its presence. When the plant inally closes, crews will remove the nuclear fuel from its reactors and place it in long-term storage containers on-site. Then they’ll dismantle and cart of buildings and other infrastructure, some of which is radioactive. The U.S. has no inal resting place for spent nuclear fuel, with debate and lawsuits continuing to swirl around one possible site, Nevada’s Yucca Mountain. As a result, no retired U.S. nuclear power site has ever reached the point where it doesn’t need to be guarded. “You worry what will happen if it shuts down,”
Over Reactors The U.S. leads in nuclear power ...
... but nuclear’s share has leveled of as few new plants have been built since the 1970s
Gigawatts of nuclear electrical capacity, 2017
Share of U.S. net electricity generated from nuclear power*
U.S.
20% 100
France 63 Japan
10 40
China 35 Russia
0 26
1960
2017
*FIGURES AT FIVE-YEAR INTERVALS UNTIL 2000 DATA: INTERNATIONAL ATOMIC ENERGY AGENCY, U.S. ENERGY INFORMATION ADMINISTRATION
says Pat Devlin, an otherwise laid-back 36-year-old who’s part owner of Tattered Flag Brewery & Still Works in Middletown, Pa. Since opening in 2016, Tattered Flag has become a hit with Three Mile Island employees, in part thanks to a smooth-tasting, double India pale ale that Devlin and his partners christened “TMIPA” in honor of their history-making neighbor. “You’re talking about people with some inancial freedom that can come to a craft beer bar,” Devlin says, looking regretful. “We’ll obviously see that go along with a couple of other local businesses, which is a shame.” Around the corner, Barbara Scull is wondering what the closure will mean for the Middletown Public Library. A few years back, the power plant donated a cluster of eight desktop computers as part of its annual gift of technology to the library. On a quiet morning, she walks past the PCs as a couple of senior citizens tap at keyboards and stare into the screens. A sign hanging above their heads reads: “Three Mile Island. Clean. Safe. Reliable.” Scull points to a shelf of books that explore the complexity of those claims. Reaching past titles such as Three Mile Island: Thirty Minutes to Meltdown and The Nuclear Survival Handbook, she grabs the more academic-sounding Atomic Accidents: A History of Nuclear Meltdowns and Disasters. Scull recalls she would often steer local students who were working on projects about nuclear’s place in America’s energy mix to this corner of the library. “I haven’t had to assist anyone recently,” she says with a sigh. “Even this is drying up.” —Tim Loh THE BOTTOM LINE The U.S. leads the world in nuclear power capacity, but the shale boom threatens to drive more plants into early retirement—a trend the Trump administration wants to halt.
“These people go out to dinner, buy houses, go to Home Depot. How do we replace that as a region?”
DATA: U.S. ENERGY INFORMATION ADMINISTRATION
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CONTENTS
○ John Cox shows California is a purpler shade of blue
P O L I T I C S
June 11, 2018 Edited by Matthew Philips Businessweek.com
How Trump Brought His Party To the Trade War
ILLUSTRATION BY MEKA KARAM
40
○ What World Cup boycott?
POLITICS
Bloomberg Businessweek
○ Trump’s tactics have a political edge and may destabilize global trade
threatening U.S. leadership, the entire global trading order, and the stability of the world economy. And for what? Trump and his lieutenants claim their goal is to make trade “fair” and stop the rest of the world from taking advantage of the U.S. and hurting American industry. There’s a kernel of truth to that grievance. Some countries have been less open to foreign investment than the U.S. and have at times imposed higher tarifs or other barriers on American imports than the U.S. does on its products. China has been an especially poor trading partner—pilfering U.S. technology, blocking market access for U.S. companies, and heavily subsidizing competing industries. More broadly, cheaper imports have forced thousands of U.S. factories to close over the past 20 years. However, it’s hard to tell what Trump’s policy actually is. His team of trade negotiators seems hopelessly divided, sowing confusion by spewing contradictions. Hard-liners such as U.S. Trade Representative Robert Lighthizer and Trump trade adviser Peter Navarro seem to relish a global slugfest, especially with China, seeking nothing short of an overhaul of America’s trading relationships. Meanwhile, Treasury Secretary Steven Mnuchin, who’s often led the talks with China, has been much more cautious. Internal divisions have recently turned into overt squabbling. A week after Mnuchin declared that the trade war with China was “on hold,” the White House announced it was moving ahead with tarifs. Navarro called Mnuchin’s comment “an unfortunate sound bite.” Beijing has deftly exploited team Trump’s inighting—dangling the prospect of reducing the trade deicit, a Trump obsession, to dodge concessions in areas it considers more critical, such as its industrial policies, and to forestall tougher action favored by White House hard-liners. At the end of the latest round of talks, on June 3, it was Beijing making the threats. If Washington presses ahead with sanctions, “all the economic and trade achievements negotiated by the two sides will not take efect,” a Chinese statement in state media warned. The original list of demands presented by the White House to China shows Trump’s team has a comprehensive understanding of the mercantilist nastiness Beijing uses to extract technology from foreign companies, hobble their success in China, and promote its own champions. But in the latest round of talks in Beijing, the negotiations seemed to have degenerated into haggling over the terms of proposed Chinese purchases of American products. Beijing oicials ofered to buy almost $70 billion of soybeans, natural gas, and other products on the condition that Trump drops his
The Trump administration is doing its best to convince the world that its decision to slap tarifs on a host of foreign-made goods is no big deal. The dispute with Canada is “a family quarrel,” according to top Trump economic adviser Larry Kudlow. As for the growing rift with Europe over Trump’s policies on trade and other issues, Secretary of Commerce Wilbur Ross says they’re “blips on the radar screen” and “everybody will get over this in due course.” America’s closest allies give a very diferent impression. After Trump imposed steel and aluminum tarifs on the European Union, Canada, and Mexico on May 31, Jean-Claude Juncker, president of the European Commission, called the move “protectionism, pure and simple.” Canadian Prime Minister Justin Trudeau deemed the tarifs “an afront to the long-standing security partnership between Canada and the United States,” while French President Emmanuel Macron was more blunt, warning that Trump’s action was “illegal” and “creating economic nationalism.” He ominously added: “And nationalism is war.” Trump has become the bully of the global economy, using the immense leverage of the U.S. market and the close to $3 trillion of foreign goods and services Americans buy every year to bludgeon friend and foe alike into rewriting trade pacts and ofering favorable concessions. For the most part, the rest of the world has stood irm, either granting minor compromises or simply ighting back. The EU, Canada, and Mexico have all retaliated against Trump’s metal tarifs by slapping duties on U.S. products ranging from cheese to motorcycles. His decision to confront China was risky enough. A trade meltdown between the two biggest economies in the world would no doubt wreak havoc on global trade and perhaps tip of a superpower confrontation akin to the Cold War. But at least that efort was taken against a country that has routinely abused the free-trade system. Browbeating close partners such as Germany, France, and Canada could prove even more dangerous, with potentially far-reaching economic, political, and strategic repercussions for U.S. relations with other countries. These partnerships are core to a world economic order—crafted by Washington seven decades ago—that’s served as the backbone of global prosperity and American political and economic dominance. By undermining them, Trump could well be
June 11, 2018
“We are headed toward becoming a highly developed Third World country”
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threatened tarifs. Other thorny issues critical to the future of U.S. competitiveness—such as the protection of U.S. intellectual property and China’s market-distorting industrial policies—got sidelined. That has some in the business community worried. “If we continue down this path of focusing on reducing the deicit by selling China more food and fuel,” says Jim McGregor, chairman for greater China at consulting irm APCO Worldwide LLC, “we are headed toward becoming a highly developed Third World country that supplies China with natural resources and in the future can license technology from them.” Trump’s approach to South Korea has shown similar tendencies. He’d derided the U.S. freetrade pact with Seoul as “horrible” and threatened to scrap it in 2017. But after negotiations, he was satiated by a few tweaks—mainly, a quota on Korean steel exports to the U.S. and extended protection for U.S. pickup truck makers. In a report on the deal, Krystal Tan, an economist at research irm Capital Economics Ltd., concluded that Korea’s concessions “will make little practical diference,” but Trump declared the new deal “great.” This is to say nothing of the fraught push to renegotiate the North American Free Trade Agreement. One of the main sticking points is over a proposal to factor labor cost diferentials into trade in automobiles. Adopting it would force Mexico to hike wages in its auto manufacturing sector by as much as ive times or sufer extra duties on its car exports—efectively depriving the country of its comparative advantage. The idea is to push factories out of Mexico and into the U.S. It’s one of several proposals Claude Barield, an American Enterprise Institute scholar, called “poison pills,” perhaps intended to scuttle Nafta altogether. Trump may now favor negotiating bilateral deals with Canada and Mexico. Connecting the dots across these trade negotiations reveals a simple common denominator: politics. Trump is arm-twisting trading partners for concessions to aid and protect a small number of industries—steel, automobiles, agriculture, and energy—that just so happen to prevail in states that voted for him. Other threatened actions have the same aim. Trump wants to hike tarifs on imported cars in the name of “national security,” a transparent attempt to force automakers to manufacture more cars inside the U.S. In that regard, his trade policies aren’t about “fair” trade at all. They’re about solidifying his political base and rewarding his supporters. The efect Trump’s trade talk has had on domestic politics is stunning. In the span of one election cycle, he’s managed to turn the GOP away from
free trade and toward protectionist policies. A recent survey by the Pew Research Center shows Republicans are far more likely to oppose freetrade agreements and favor tarifs than Democrats. The political nature of Trump’s tariffs may appear to make him less dangerous: In the end, he’ll settle for a few favors and not disrupt the global order. But the cost of his approach is far steeper. What he’s doing is strikingly similar to the way China behaves—using state power to manipulate trade in favor of certain special interests. Jörg Wuttke, a former president of the EU Chamber of Commerce in China, notes that Trump is badgering the Chinese state to intervene to redirect customer-determined lows of trade toward the U.S. and away from other countries—including close allies. “All he’s doing is moving the furniture,” Wuttke says, “and that’s our furniture.” As a result, the U.S. is becoming isolated from its own allies. At a meeting of Group of Seven inance ministers on June 2, the other six ganged up on Mnuchin over Trump’s tarifs and demanded collective cooperation on resolving trade issues. “It was the U.S. against everyone else,” said Japanese Finance Minister Taro Aso. That, too, opens the door for China. Trump had a chance to team up with allies in Europe and Asia to pressure China to change its trade practices. Instead, he’s allowed Beijing to portray Trump as the problem in world trade. Chinese oicials recently made a big show of lowering tarifs on a range of goods, from apparel to appliances. Although this may have minimal impact on U.S. exports, it has value in painting Beijing as the grown-up—with an eye on driving a deeper wedge between Washington and its allies. Since the end of World War II, the U.S. has championed an economic order based on rules and norms, given credibility by the consistency of U.S. foreign policy and Washington’s commitment to upholding this global order. Behind it all were core guiding principles—that a prosperous world is a safe world, that trade makes alliances stronger, and that openness ultimately wins the day. By stripping U.S. policy of its higher purpose, bullying allies, and twisting trade to suit his narrow political needs, Trump is upending all of this. Without U.S. support, the entire global order, which has produced so much growth and wealth over the past 70 years, could well crumble, clearing a path for the very thing that Trump claims to be striving to prevent: a dominant China and a diminished U.S. That’s something the world may never “get over.” —Michael Schuman
○ Estimated annual value of current or planned retaliatory tarifs against the U.S.*
THE BOTTOM LINE In a quest for supposed “fair trade,” Trump is undermining the global trading order and playing into the hands of China by bullying allies with tarifs.
$2b
Canada
$1.6b
European Union
$800m
India
$646m
Mexico
$611m
China
$538m
Russia
$440m
Japan
$267m Turkey
*ESTIMATES FROM WHITE & CASE AS OF MAY 31 BASED ON MEASURES THAT CITE THE VALUE OF U.S. EXPORTS IN PRIOR YEARS OR PLANNED TARIFFS COMPARABLE TO THOSE PUT FORTH BY THE U.S.; DATA: WHITE & CASE, WORLD TRADE ORGANIZATION, CANADA DEPARTMENT OF FINANCE, MEXICO SECRETARIAT OF ECONOMY
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June 11, 2018
In World Cup Politics, It’s Moscow 1, London 0 ○ Despite sanctions and furor over Putin’s policies, Russia is poised to gain internationally from the soccer tournament
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On May 19, Russian billionaire Roman Abramovich missed the Football Association inal at London’s Wembley Stadium, where his team, Chelsea, beat Manchester United. British oicials hadn’t renewed Abramovich’s visa—making him pay the price for a deep freeze in relations with the Kremlin after the poisoning of a former Russian spy and his daughter in England. Prime Minister Theresa May had already announced that no ministers or diplomats would attend the soccer World Cup starting in Moscow in mid-June, and taking aim at the Russian most famously linked with football was a logical next step. When Russia won its bid to host the planet’s most watched sporting event eight years ago, Vladimir Putin made clear he intended the tournament to showcase his country at its best. But today he’s getting global attention for meddling in U.S. elections, backing the brutal Syrian regime of Bashar al-Assad, and waging a not-so covert war in eastern Ukraine. In March, the U.S. and European Union expelled more than 100 diplomats over the poisoning of ex-spy Sergei Skripal and his daughter. Washington the next month slapped new sanctions on Russian oligarchs, some of whom have built or own infrastructure for World Cup matches. In spite of all that, the Russian president looks set to score a win. The British hard line has failed to catch on, with only Iceland saying its oicials will stay away in solidarity. Just as he did with the Sochi Winter Olympics in 2014, Putin—the longestserving Russian leader since Joseph Stalin—has used the event as an excuse for infrastructure investment. Russia is spending some $11 billion on the World Cup, not just on stadiums, but also on upgrades to airports and transit across the country. “It’s a great platform for him, and Lord knows he’s paid enough for it,” says Matthew Rojansky, director of the Kennan Institute, a research group in Washington. “He will appear as presidential and gracious and diplomatic as he can. If what he’s looking for is praise and adulation from world leaders, that’s
probably not realistic, and I suspect he knows that.” The tournament kicks off on June 14 with an opening ceremony and a match between Russia and Saudi Arabia at Moscow’s Luzhniki Stadium. Staging the show is the general director of the state-controlled Channel One TV station, Konstantin Ernst, who put together Sochi’s opening, which extolled the glory of Mother Russia while glossing over the more sordid bits of its history. Details of the World Cup entertainment program remain scant, but American stars Will Smith and Nicky Jam and Kosovar pop singer Era Istrei will perform the event’s oicial anthem, Live It Up, at the inal on July 15. After blaming Russia for poisoning the Skripals with a deadly nerve agent called Novichok, Prime Minister May said that while the English team will participate in the World Cup, the royal family and other oicials won’t be there. That will make it the irst time in more than a decade that neither Prince William—who serves as president of the Football Association—nor Prince Harry will attend. And Foreign Secretary Boris Johnson in March said he thought Putin would bask in the glory of the World Cup like Hitler did at the 1936 Olympics in Berlin. “This is a huge philosophical victory for Putin,” says Bill Browder, founder of Hermitage Capital Management, a vocal opponent of Putin who made his fortune investing in Russia in the 1990s. “He knows most British people will care more about their football than the politics of Russia.” A nightclub in the southwestern city of Volgograd, the site of England’s June 18 opener against Tunisia, is betting on that. The Gryadushka bar says it will ofer a cocktail called the “Novichok”—with what it calls top-secret ingredients including extracts from birch trees. More than 60 members of the European Parliament have signed a letter calling on EU leaders to back the U.K. in boycotting the World Cup. “While we agree that sport can help build metaphorical bridges, as long as Putin is blowing up real ones
Bloomberg Businessweek
POLITICS
June 11, 2018
When Soccer Meets Sanctions This month the world’s top soccer players and throngs of fans, including an estimated 30,000 Americans, will travel to Russia for the 2018 FIFA World Cup. Many will fly into airports and sit in stadiums linked to businessmen or companies currently under U.S. sanctions.
Gennady Timchenko, Russia’s 11th-richest man, owns the Stroytransgaz group, which helped build the Nizhny Novgorod and Volgograd World Cup stadiums.
Avia Group Nord LLC operates a terminal for business aviation at St. Petersburg’s Pulkovo Airport.
Sports arena Linked to sanctioned company or individual Airport
Viktor Vekselberg, Russia’s sixth-richest man, controls airports in four World Cup cities—Yekaterinburg, Nizhny Novgorod, Rostov-on-Don, and Samara—through his Renova group.
Russia
St. Petersburg
Baltic Sea
Moscow
Nizhny Novgorod
Yekaterinburg Kazan
Kaliningrad
Gazprom, the world’s biggest natural gas exporter and only Russian FIFA partner of the World Cup, partially funded the St. Petersburg Stadium.
IFD Kapital financed the construction of Moscow’s Spartak Stadium.
Saransk Samara
Andrey Skoch, a deputy in the State Duma, is a part owner of Moscow’s Vnukovo International Airport.
Vladimir Putin’s judo sparring partner, Arkady Rotenberg, holds a minority stake in Moscow’s Sheremetyevo International Airport.
Billionaire Oleg Deripaska’s Basic Element controls the Sochi/Adler airport. Volgograd
Rostov-on-Don
Sochi
Black Sea
in Syria, we cannot pretend this World Cup is just like any other major sporting event,” the letter says. It hasn’t gotten much traction, and French President Emmanuel Macron and German Chancellor Angela Merkel have indicated they will attend in the likely event that their teams advance in the tournament. Putin has focused on ensuring the venues are prepared and has touted the importance of Russia hosting the event for the irst time. He appears in a promotional video doing a header in the Kremlin with Gianni Infantino, the president of FIFA, global soccer’s governing body and the organizer of the tournament. But he’s also courted controversy by personally inviting Sepp Blatter, the former FIFA chief who was banned from soccer for six years after a corruption scandal. Putin’s spokesman, Dmitry Peskov, has brushed of any eventual boycott of the event. “The most important thing at the World Cup isn’t functionaries or oicial representatives,” he told journalists. “It’s the game.” Hundreds of thousands of fans from around the world are due to descend on 11 Russian cities, from the Baltic Sea port of Kaliningrad to Yekaterinburg, east of the Ural Mountains. Roughly 2.5 million tickets have been sold, more than half of which were snapped up by non-Russians. Although the U.S.
Caspian Sea
failed to qualify for the competition, the Russian government says 30,000 Americans will likely attend, making them the biggest foreign contingent. And Russia has simpliied the normally complex and expensive visa process by giving World Cup ticket holders “Fan IDs” that serve as visas. While the event will expose Russians to people who don’t subscribe to the Kremlin worldview, there’s also a risk of trouble from extremist fans known as “ultras.” Clashes between Russian and English fans in Marseille at the 2016 European Championship left more than 30 injured. And FIFA ined the Russian football federation 30,000 Swiss francs ($30,500) after fans directed monkey chants at black French players during a March game in St. Petersburg. Russian security has banned more than 450 people from World Cup matches because of their history of causing trouble. “The Russian security forces will do whatever they can to prevent incidents,” says Sylvia Schenk, a German lawyer who sits on the FIFA advisory board for human rights. “Russia wants a good image.” —Stephanie Baker and Jake Rudnitsky THE BOTTOM LINE After the poisoning of a former Russian spy in England, the U.K. said its oicials won’t attend the World Cup. But few other countries say they’ll join the boycott.
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California Gets a Two-Party Race
just north of San Diego and became a full-time state resident seven years ago. Not only has he never held political oice—he’s never won a race, having run unsuccessfully for the House of Representatives and the U.S. Senate from Illinois in the early 2000s and president in 2008. With a largely self-funded campaign that relied on small private gatherings rather than public rallies and advertising, Cox quietly wooed voters with pledges to crack down on immigration and to lower taxes. With less than a month to go in the race, a tweeted endorsement from Donald Trump gave him an edge over intraparty rivals. Yet that endorsement from the president will make it harder for Cox to reach Sacramento. California voters haven’t elected a Republican to a statewide oice since 2006. State data released last month showed that for the irst time, Republicans are the third-largest bloc of voters in California, falling behind independent voters with no party ailiation. Led by outgoing Governor Brown, who enjoys record approval ratings for a two-term governor, the state’s Democratic leaders have assailed what they see as an assault by Trump on California’s eforts to ight climate change and protect immigrants from deportation. Consolidating the Democratic vote behind Newsom will ultimately be good for the party, says Bob Shrum, a veteran Democratic strategist. Avoiding the clash between two members of the party will likely free up more money to low to congressional races. There are seven Republican-held seats in districts Hillary Clinton won in 2016, and those are crucial to Democrats’ bid to recapture control of the House of Representatives. Cox’s vision of a failing California is at odds with much of the data underscoring the dramatic turnaround the state has made in the eight years since Brown began his inal two terms. Its economy is the world’s ifth-largest and is outperforming the U.S. in the growth of jobs, manufacturing, and corporate proits. Still, the state faces daunting challenges: rampant homelessness, a worsening housing crisis, and the nation’s highest poverty rate when accounting for the cost of living. Newsom says he’ll tackle these by following in Brown’s footsteps of governing as a progressive while also shunning proligacy. As for keeping California as the leader of blue states’ resistance to Trump, “we take a back seat to no one in terms of our aggressiveness,” Newsom said during a recent stop on his bus tour. Voters are “also looking for leadership, not just resistance.” —Esmé E. Deprez, Romy Varghese, and Lucas Shaw
○ Conservative John Cox will vie with favorite Gavin Newsom to be the state’s next governor
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Just before midnight on June 5, Tony Krvaric struts around the lobby of the posh U.S. Grant Hotel in downtown San Diego wearing a red “Make California Great Again” hat and a big smile. “It’s a new day and a fresh start for California,” he says, beaming. That’s because John Cox, the Republican candidate for governor, had just given what amounts to a victory speech to an overwhelmingly older, white crowd. Although Cox inished more than 250,000 votes behind Democratic Lieutenant Governor Gavin Newsom, he trounced the Democrats’ nextstrongest candidate, former Los Angeles Mayor Antonio Villaraigosa. That means that under the state’s top-two primary system, Cox moves on to face Newsom in the November general election. For a state that’s seen as the epicenter of the Trump resistance movement, this wasn’t supposed to happen. Until a few months ago, Californians had been preparing for a Democrat vs. Democrat faceof between Newsom and Villaraigosa to lead the country’s biggest, and arguably most liberal, state. That contest would have forced the Democrats into a debate about what the party stands for in the Age of Trump. Voters would have chosen either the liberal values of Newsom, who as mayor of San Francisco in the mid-2000s made a name for himself as a champion of gay marriage, and has campaigned for universal health care, or the more moderate pragmatism of Villaraigosa, who positioned himself as a iscal conservative and hoped to carry the support of Latinos, the state’s biggest ethnic group. Instead, Newsom, 50, is all but guaranteed to follow Jerry Brown as the next Democratic governor of California. (Registered Democrats outnumber Republicans in California by almost 2 to 1.) Yet Cox’s second-place inish provides a much needed morale boost for the state’s Republican Party. It shows California may not be as deep a shade of blue as many thought. And it gives Republican voters a reason to come to the polls in November, which may end up boosting the fortunes of GOP candidates in down-ballot races. Cox, a 62-year-old real estate mogul from the South Side of Chicago, entered the race as a virtual unknown. He moved to a wealthy speck of a town
THE BOTTOM LINE With Cox in the race, Republican voters will have more incentive to go to the polls, while Democrats will be able to devote more money to congressional contests.
June 11, 2018
○ Cox
○ Newsom
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Business Schools
S O L U T I O N S
Wharton grad Divinity Matovu
Investing in Women MBAs
Parity in applications and degrees awarded continues to elude B-schools
June 11, 2018 Edited by Dimitra Kessenides Businessweek.com
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Bloomberg Businessweek
In 2015, when Divinity Matovu was preparing to enter the full-time MBA program at the University of Pennsylvania’s Wharton School, she was caring for her 3-year-old daughter, grieving her mother’s death, and going through a divorce. “I was very concerned about whether I’d be able to pull this of and actually do the program,” she says. Her decision to proceed was influenced by women she met in prep programs, including one run by Forté Foundation, a consortium of companies and schools whose mission is to increase the share of women business leaders. Matovu says the mentor she was paired with through Forté’s 10-month MBALaunch program boosted her confidence and was “critical” to her success. After completing her degree last year, she took a job at Lyft Inc.’s San Francisco headquarters, overseeing driver community management. MBALaunch is part of a larger efort to close the gender gap in B-schools and the workplace. The push has taken on greater urgency in the past year, as gender parity in MBA programs continues to elude schools, despite some improvements. Many are teaming with nonprofits such as Forté and the National Association of Women MBAs, holding networking events for women and ofering scholarships. “The more women you have in classrooms, the more women who want to come to your business school,” says Forté Executive Director Elissa Sangster. The share of women to receive full-time MBA degrees from U.S. schools was below 38 percent from mid-2012
Columbia MBA student Lindy Gould
June 11, 2018
through mid-2017, according to AACSB International, an accrediting organization. Also, since 2012 the number of women applying to full-time MBA programs has “hit a plateau,” according to a 2017 paper from the Graduate Management Admission Council. Meanwhile, about 21 percent of S&P 500 company board members are women. “If we can get more women to come into business school, that’s a way to build the pipeline to efect change longer term,” says Ellen Taafe, the director of women’s leadership programs at Northwestern University’s Kellogg School of Management. “This is not a women’s issue. It’s a human issue.” Kellie McElhaney teaches The Business Case for Investing in Women at the University of California at Berkeley’s Haas School of Business. First ofered in 2013, the course was initially based on McElhaney’s research that showed a strong correlation between the number of women in leadership roles and how well companies perform. She found that companies with greater numbers of women in leadership have higher share prices and better returns on equity and investment. McElhaney says business schools must commit to developing leaders who champion diversity. The popularity of her course and heightened interest culturally around its themes led McElhaney and the school to launch the Center for Equity, Gender, and Leadership in November. Through specialized courses, fellowships, and student research teams, McElhaney wants the center to help graduate more women—and men—who understand the business value of equity and how to achieve it. Today’s generation of students is frustrated by the slow pace of progress, she says. The competition to draw female applicants is intensifying. “Right now, schools are spending a lot of energy on trying to attract female MBAs,” says Pam Delany, director of recruiting and admissions at Arizona State University’s W.P. Carey School of Business. In 2015 the school announced it would grant scholarships to cover tuition for all students, male and female, accepted into its full-time MBA program. The share of women enrolled rose to 39 percent in 2017, from 30 percent when the scholarship was created. Carey’s dean, one of only a handful of female B-school deans in the U.S., and mentorships with senior executives are also a draw, Delany says. In 2015 the University of Maryland’s Robert H. Smith School of Business pledged parity by 2020. Women made up about 34 percent of its full-time MBA intake last fall, less than when it committed. “We will not back away from the challenge,” Smith School Dean Alex Triantis wrote in an email. “Having a goal has created a greater sense of urgency.” Achieving parity is only an initial step—the biggest hurdle is getting businesses to change their corporate cultures to create more equitable workplaces, says Julie McReynolds, national director of operations at the
SOLUTIONS
Bloomberg Businessweek
National Association of Women MBAs. “There is a perception in the business world that ‘oh, this problem is solved,’ and it’s really not,” Kellogg’s Taafe says. Columbia Business School MBA candidate Lindy Gould, whose Instagram bio describes her as a “lover of bananas, half-marathons, and dismantling the patriarchy,” is eager to help underrepresented groups. She was elected co-president of her MBA program in March. She says schools should do more, from hiring diversity oicers to requiring classes on managing diverse teams. “I don’t think that’s a crazy thing to ask,” she says.
Q&A
Gould’s plan is to work in diversity and inclusion when she graduates next year, then run for local oice in New York. She says she was drawn to B-school by “the challenge of moving into a more male-dominated space and carving out a larger space for women. I wanted to push myself to lead in spaces that I don’t think were designed for me to lead in.” —Nick Leiber
THE BOTTOM LINE The share of women in full-time MBA programs in the U.S. has plateaued over the past five years. B-schools are ofering fellowships and other programs aimed at closing the gender gap.
Ask the Dean
Two years ago, Scott DeRue, at 40, became one of the youngest business school deans in the U.S. The University of Michigan’s Ross School of Business has since risen in the rankings, seen a jump in applications, and pulled in more money from big donors. DeRue talked to Bloomberg Businessweek about innovation, leadership, and B-school branding.
PHOTOGRAPH BY SASHA ARUTYUNOVA FOR BLOOMBERG BUSINESSWEEK; ILLUSTRATION BY JOSH FREYDKIS
The word “innovation” is used a lot by B-schools, especially to tout how they’re evolving and changing. What does innovation mean at Ross—what’s really changing?
Business schools are preparing talent, people, for jobs that don’t exist today but will 5, 10 years from now. So the question is, how do we prepare and ready talent for that future world of work? We believe work is more global, more cross-functional, it’s rife with uncertainty and ambiguity. So innovation is not about creating a solution to a problem, it’s about identifying what the problem is and framing that problem in the context of innovations. We should ask ourselves, “What are the experiences we are providing our students that are going to ready them to address those problems?” and then provide an experience that is as close to the action as possible.
Does that make the traditional curriculum a relic?
A core part of the educational experience here is enabling students to put the business fundamentals taught in the classroom into action. I don’t
June 11, 2018
see this as an either-or situation. Things we do in the classroom still are important—it’s a stereotype that the real-world experiential stuf happens elsewhere. Students have to learn some fundamentals, and then put those fundamentals into other experiences. Can B-schools address the disconnect between real-world leadership and the kind that’s taught in the classroom?
I talk a lot about leading from where you are. Too often in this world, people see leadership as a position. But there are people in authoritarian
positions that don’t really have power, they ofer no leadership. And then there are those people that don’t have those positions, but their leadership is truly powerful and we’d follow them almost anywhere. We’re focused on helping our students to develop the concept of leadership from whatever position they’re in, to apply leadership to the job they hold. They should know they have a voice and influence—that’s powerful. I say, “I don’t teach leadership. I design experiences that enable you to discover it and learn it.”
Do rankings matter?
They do matter. They’re one source of information for people. And absent other information, rankings are the primary source of brand perception in the market. Every dean should be concerned about the brand of the school they’re leading. At the same time, it’s essential that every dean leading a business school tell a compelling story that presents the full picture. Why are we doing what we’re doing? We’re here through our research and ideas to shape the conversations around the most important business issues in the world. The rankings capture an element of that but not the full story. —Dimitra Kessenides
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Bloomberg Businessweek
Case Study: Curriculum Overhaul
To stay relevant and competitive, USC’s Marshall School of Business revises its course requirements
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At the University of Southern California’s Marshall School of Business, a curriculum revamp two years in the making will be unveiled in late August. Suh-Pyng Ku, the vice dean for graduate programs who led the efort, says that while faculty revisit and tweak their own course materials, an in-depth review of the structure of the MBA program and every required course ofered hadn’t been conducted in six years. “Curriculum change is hard,” Ku says. “But if you don’t do it, you’re going to be irrelevant or not competitive.” That’s a challenge for all business schools. “Students gauge where they will attend based on the curriculum, and in order for the school to be competitive, they need to be on the cutting edge of what they are ofering,” says Deena Maerowitz, who oversees the college and graduate school advising practice at the Bertram Group, an education consulting company. In the spring of 2017, Ku began soliciting input about Marshall’s MBA courses from students, faculty, alumni, and employers/recruiters. In their survey responses, students described the first term as crammed, leaving them feeling pressured and ill-prepared in core subjects such as accounting. The pacing, they said, was too fast. “We wondered if we were sacrificing their long-term success by compressing so much into the first year,” says Gareth James, a data sciences and operations professor and one of seven faculty members on the curriculum committee Ku convened in November. One adjustment that’s coming in response to the feedback: More time will be devoted to core subjects. That was a tricky task, several committee members say, given their desire to achieve a more balanced mix of quantitative
June 11, 2018
courses—finance and statistics—with qualitative ones, such as communications and marketing. Another objective was to give students more time to learn the harder, numbers-driven material. So accounting and finance courses were extended into the second semester. “We would challenge each other,” Ku says, describing the discussions about what should stay and what should go. “But in the end, it’s not about the importance of my discipline or your discipline, but what do the students need.” Adds James: “There is always a concern that people will try to protect their own turf. But we spent a lot of time hearing everyone out. Ultimately, the goal was to create a well-rounded program.” Concerns about jobs were expressed in many of the student surveys, according to Bridget Hellige, one of two student representatives on the curriculum committee. That’s not surprising—students want well-paying, meaningful work after getting their MBA. And they’ll choose a school with a curriculum that they believe ofers greater chances for success, Bertram Group’s Maerowitz says. Less obvious to committee members, though, were specific aspects of the job search. They discovered that a practice known as casing—when prospective employers present interviewees with a hypothetical business problem to solve—is a source of great stress, according to Hellige. The feedback led to the development of a course to better prepare students to tackle the hypotheticals. Structured Analysis for Unstructured Problems is a one-credit class that will use lectures, case reviews, and other exercises to teach students how to frame problems and deal with incomplete information. Also, given the issues raised about career guidance, Marshall is adding required career services seminars for all MBA students. The first draft of the curriculum proposal was presented to the full faculty in early March for another round of feedback, and by the end of that month they voted overwhelmingly in favor of the plan. Ku says she’s “cautiously optimistic” about the changes. Her work and that of several faculty will continue through the summer, refining and fleshing out course details. Beyond the course changes, the committee also created a structure to formally review course oferings more frequently. “There’s frustration in academia in general, that if a course hasn’t been performing, do you cut your losses or wait another two to three years to see if it catches on?” James says. “But if you change the process, you can switch out as needed.” Says Ku: “It would be hard for people to argue that what we’re doing isn’t the right thing.” —Mary Ellen Egan
THE BOTTOM LINE The fast pace of change in the business world is putting pressure on B-schools, including USC’s Marshall School of Business, to revamp their curricula.
ILLUSTRATION BY JOSH FREYDKIS
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G O I Z U E TA B U S I NE SS P RINC IP LE #16:
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Justin Trudeau Prime minister, Canada
June 11, 2018
‘These tariffs would have devastating impacts on American jobs too’
On the eve of playing host to the G-7—and Trump’s steel tariffs—the Canadian leader talked to Bloomberg’s Stephanie Flanders about trade, gender equality, pot, and a controversial pipeline
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Do you worry that Donald Trump will be unpredictable at the Group of Seven summit in Quebec? International relations with anyone—regardless of whether you agree with them or not—is always about finding that common ground, those common shared priorities. That willingness to make our economies work for the middle class and those working hard to join them is something that certainly unites the president and me—and many of the other members of the G-7—in our goals. We will stay focused on ways to find consensus. The funny thing is a couple of years ago, when I was going to my first G-7, all the questions were, “Listen, you agree on everything, you and Obama, and everyone else. You’re always very aligned. What’s the point of a G-7 when you all come together and agree on everything?” And now that there may be diferences in perspective at the G-7, everyone says, “Well, you don’t agree on anything, so what’s the point of a G-7 coming together?” I think the point is the ongoing conversations and responsibility we have to shape a perspective and an engagement with the world on the big issues that we’re facing. What do you want to focus on? There is one big challenge that is shared not just by the G-7, but by much of the developed world. That is, how do you reassure people that all the changes we’re going through in our workplaces—from automation, to AI, to greater trade deals, to globalization in general—how do we ensure that the growth we create is fairly shared by everyone? Aggressive nationalism, polarization, insularity, anti-trade and anti-globalization sentiments—all those facets are splintering into politics all around the world. People feel the system we have might be good at creating growth, but it’s not good at creating growth that is good for all citizens. There
Photograph by Brendan George Ko
are places that have exacerbated the fears that people have about their future, about their kids’ future. Canada is working very, very hard to allay those fears. We understand there is an anxiety about trade out there in large segments of the population that don’t feel that it has worked very well for them. That is why as a country we’ve been working hard to make a case for trade, working hard to demonstrate that we can find progressive trade deals where issues like protection of the environment, gender equality, workers’ rights are integral in creating growth. The G-7 summit should be about having an honest and rigorous conversation about this shared challenge we face— and some of the solutions we should be putting forward to create growth that is better for everyone. What’s your plan to make the summit memorable? One of the main points we’re putting forward is understanding that gender equality and including women in our success is not just a moral argument, it’s very much an economic argument. We’ve put together a gender advisory council, put together extraordinary leaders from around the world who have been at every ministerial meeting, who are part of every ministerial meeting, who are part of every element of decision around what the G-7 is doing to make sure that we’re thinking about including women and the impact on women of everything we do. You want to make this summit about inclusion, but the G-7 is quite a small club—less than 50 percent of global GDP and representing about 10 percent of the world’s women. Do you think that the G-7 is the right forum to really have these kind of arguments? I think an opportunity to come together as like-minded nations to talk about shared challenges in a very frank and open manner is essential. We’re going to be moving forward significantly on protecting our oceans, particularly around
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the issue of plastics, even though we know that 90 percent of plastics in the world in our oceans come from 10 rivers, not one of which is in a G-7 nation. Why should the rest of the world listen to the leadership of a group of rich countries led mostly by men? That’s why every G-7 involves an outreach session as well where we invite a broad range of countries from around the world. We have a number of African countries, some small island states, the president of the G-20—Argentina. They’re all going to be coming. If you’re sitting around the table at the summit wanting to talk about the importance of diversity, are you going to say to President Trump in person that he should talk in a diferent way about women than he has in the past? I have highlighted to the president in many diferent situations where we disagree. When I went down to the White House, we put together a Canada-U.S. women’s business council that has made significant recommendations on reducing barriers to success for women in business. And President Trump was very much aligned with us. President Trump doesn’t mind having lots of diferent strands of trade policy. How is it afecting Canada? The idea that the export of cars from Canada to the United States is somehow a national security issue for the United States is even less likely to find any real traction and legal grounds on any level than the fact that aluminum or steel from Canada might be a national security threat to the United States because they use our aluminum in their fighter jets and our steel in their armored vehicles. Canada and the U.S. are two countries—if there are any two—that have no national security implications toward each other. The level of integration of the auto industry or the steel and aluminum industries in both our countries means that these tarifs would have devastating impacts on American jobs too. The U.S. sells more goods every year to Canada than it does to China, Japan, and the U.K. combined. We are their No. 1 customer. Any disruption of that flow of goods would be terrible for the Canadian economy, but it would also be terrible for a lot of U.S. jobs in an awful lot of industries. One of the things that the president has prided himself on is being somewhat unpredictable, being willing to disrupt the patterns of well-established traditions and international relations. I think it certainly causes people to take notice. It encourages us in our resolve to indeed modernize Nafta. But I’ve also said very clearly, and Canadians know this of me— that I will stand up for Canadian interests. I will only sign a deal that is good for Canada, and no deal is better than a bad deal. We’ve made that very clear with President Trump.
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You have this problem: a very close, diicult neighbor who’s actually doing well attracting Canadian businesses. They’re going to the U.S., which has lower corporate tax rates, doesn’t have all these regulations. What do you say to those businesses? Business owners are free to make their own decisions about that. I certainly know that I remain focused on the long term. I mean what’s the U.S. debt approaching now, is it a trillion dollars? We have to ask the question whether the tax cuts in the United States are sustainable as a matter of long-term fiscal stability. But it’s creating jobs. Businesses are setting up in America, because they’re worried about being able to do it from Canada. We’re not engaging in a race to the bottom. We’re looking for where the economy is going, where it’s going to be 10 years from now, where it’s going to be 30 years from now, how we can position ourselves for the long term. The people who think that the only advantage Canada ever had against the United States was our dollar was low enough and our corporate taxes were lower are underselling and not realizing the strength that we have within the Canadian economy. If you want to bring a top engineer or a top programmer or a top manager from your company and set them up in Canada, we’ll give you a visa in two weeks. When people realize that being more energy-eicient or being more responsible around renewable energy is a significant goal, they are setting up their shop where they can actually say, “Look, our industry or our business is run 100 percent by green power, because we’re getting more and more renewables online here in Canada.” I am very confident that over the medium term, we are going to be and continue to be extremely competitive to the United States and the world. A few years ago, one of Canada’s strengths was it was the fourth-easiest country to do business in. Now it’s down to 18th. The U.S. has always been much more focused on the ruthless competition of success on a single bottom line, whereas Canada, maybe it’s because of our winters, because of distance between our communities, we’ve always known that we have to be there for our neighbors. We have to make sure they’re a success for all of us. We’re eager to lean on each other to create that success, and with that comes a mindset where we are aware of the need for good public schools, having a public health system, having an opportunity to train and retrain workers in the job market, a strong safety net for people who lose their job so that they can retrain, which we strengthened over the past year. These are the things we’ve chosen to put forward as the right measures of success. And there are an awful lot
“No deal is better than a bad deal. We’ve made that very clear”
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of companies and wealthy individuals who realize that is a much more sustainable path for the long term than the short-term approach that perhaps the U.S. is taking. There’s a lot of businesspeople listening to you probably saying this guy just doesn’t get that we are losing competitiveness. I’ve been quite vocal about Canadians’ need to be more forward-thinking and innovating, more excited about the future, taking bigger risks around the world, taking more risks and smarter risks on investing in Canada, absolutely. But if you’re making a decision based on how you could maximize your profits in the short term, maybe Canada is not the right choice for you. Do you think that legalizing marijuana is going to give Canada a competitive advantage against the U.S.? That’s not why we’re doing it. We’re doing it because the current prohibition on marijuana doesn’t protect our kids from purchasing marijuana. Right now Canada has the highest rate of underage marijuana use of any of 29 diferent countries surveyed in a UN study. We’re not making it hard enough for our kids to buy marijuana. If we treat it at least as rigorously as we treat alcohol, it will be more diicult for young underage people to buy it. It is a C$6 billion ($4.6 billion) a year industry for organized crime in Canada. We’re not looking at it as an economic windfall. It may eventually come that way, but that certainly isn’t our main focus. I ask people, “Is there a black market for beer or alcohol?” No, there is not. Why? Because we have created a suicient legal regime that works. There isn’t enough of a motivation and there’s too many penalties to have a black market that specifically targets young people, so it works for alcohol, for cigarettes. A lot of people look at the political landscape and say you’re in a slightly weaker position than a year ago, that you have the prospect of several provinces moving over to the conservatives in the elections. You have a conservative leader in Ontario who actually is talking some of the language of Donald Trump. On the contrary you can always say that the fact that these conversations are happening—but not taking over the body politic—that there always will be robust debates about the direction a province or country should go in. But at the same time, you don’t have the rise of successful antiimmigrant politicians. There is no anti-immigration mainstream out there in Canada, and that is because people know when we pull together we actually do a better job of creating economic growth, and that has continued to hold. The Parti Québécois leader talks about the threat of “the other.” The leader of the Parti Québécois has been talking about that for a long time. That’s nothing new. One of the most popular things you’ve done recently is prevent a Chinese construction company from buying a Canadian construction irm. We have to set up a very clear framework within which trade will happen. Blocking things on the grounds of national security is, quite frankly, just what Canadians expect us to do. We know we have to engage with China. It’s one of the
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world’s most important economies. We’ve engaged in discussions with China around an eventual trade deal. But how do we make sure that Canadian interests are protected? It’s an important message to share with the Chinese—not in a malicious or an aggressive way—but in a very matterof-fact way, that this is how you will be able to engage with Canada: abiding by important rules around our interests and the rules we abide by in the international sphere. Have other countries opened their doors too wide? There have been diferent choices. I’ve spoken with some Australian colleagues about the challenges that they’ve faced with similar purchases by the Chinese of engineering firms. It’s certainly highlighted to us the potential challenges. Your government has just nationalized the Trans Mountain pipeline, buying it from Kinder Morgan. It will bring viscous, black bitumen from Alberta to Vancouver. When you were a little boy, did you always want to own a C$4.5 billion pipeline? I was raised to believe that the growth of the economy and protecting the environment go together. One of the things that we’ve seen time and time again is people forcing a choice. It’s either the environment or the economy. We wanted to demonstrate that we could get public confidence in building big projects by both protecting the environment and moving forward in a way that contributes to economic growth. That’s why our plans to fight climate change feature both a national price on pollution and also getting our oil to new markets through responsible pipelines. One of the fundamental economic challenges we face in Canada is that because we only have one market for our oil resources—the United States—we lose about $15 billion every year. That’s a $15 billion discount, because we’re captive to their markets. So getting a pipeline to new markets across the Pacific is absolutely in the national interest. However, the new British Columbia government decided that they wanted to try and block that pipeline. The project became too risky for a commercial entity to go forward with. That’s what Kinder Morgan told us. So because this project is in the national economic interest, we’ve stepped in. You’re showing the public sector can do this, but is there a message here that private-sector investors like Kinder Morgan can’t get this kind of infrastructure deal through local governments? But we have also seen a number of pipelines built over the past years, a number of large energy projects built that didn’t need this kind of extraordinary intervention. This happened because one province decided to directly contest the federal government’s authority to regulate and allow construction of interprovincial works. If this comes up again—because you do get these kinds of conflicts on big infrastructure projects—you’re willing to nationalize again? We will always look at things on a case-by-case basis, but as I’ve said, getting this pipeline built is in the national interest, and we are also very confident that as this pipeline gets built, the business case is certainly strong enough that there will be buyers for it. We don’t intend on holding on to this pipeline for the long term.
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How Toys “R” Us, once a mighty category killer, became an object lesson in financial mismanagement The early tale of Toys “R” Us brims with ambition, energy, and no small amount of ruthlessness, as creation stories often do. Charles Lazarus had gone from high school straight to the U.S. Army, where he served as a cryptographer during World War II, and as he cast about for a business venture upon his return, he identiied a market that was largely unexploited: kids. “Everyone I talked to said they were going to go home, get married, have children, and live the American dream,” he often recounted of those days. Lazarus may not have anticipated the full impact of the Baby Boom or the accompanying sprawl, malls, television, and advertising, but he took advantage of Americans’ desire to accumulate and the cultural imperative to conform. He opened the irst big-box toy store, outside Washington, D.C., in 1957, then another and another, until by the mid-1980s there were more than 200 across the country. Toys “R” Us Inc. ofered abundance on a scale that smaller competitors could never equal, much of it at prices they could never match. As its mascot, Geofrey the Girafe, became as recognizable as Tony the Tiger and its “I don’t want to grow up” jingle lodged itself in the brains of a generation of kids, Toys “R” Us became the irst category killer. In 1985, Goldman Sachs called it “one of the outstanding companies in all of retailing,” and for much of the decade, Lazarus was among the highest-paid chief executive oicers in the U.S. His inal opportune move was to step down just as Toys “R” Us peaked. That was in 1994. Four years and two CEOs later, Toys “R” Us was overtaken by Walmart as the biggest toy seller in the U.S. Two years after that, Toys “R” Us struck a disastrous deal to give up its troubled website and exclusively sell its wares online with Amazon.com Inc. By 2004 the company, which now relied on its Babies “R” Us stores for much of its proit, was looking to sell itself. Executives suggested it might have to get out of the toy business altogether. By Susan Berfield, Instead, the private Eliza Ronalds-Hannon, equity irms Bain Capital Matt Townsend, LP and KKR & Co., along with Vornado Realty and Lauren Trust, took over the comColeman-Lochner pany in a $7.5 billion levPhotograph by eraged buyout in 2005. Sarah Anne Ward For the next 13 years the
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owners would watch a succession of executives try to halt the steady slide of Toys “R” Us amid a recession and retail upheaval. As the last big toy store chain, Toys “R” Us had a captive audience. Kids could reasonably be counted on to badger, drag, or otherwise persuade adults to bring them to toy stores, especially if they were fun and hands-on. Those adults would more readily acquiesce if the stores were well-organized and the toys competitively priced. There could have been an alternate ending for Toys “R” Us. Complicating the executives’ eforts, though, was the central fact of the company’s existence: It was living on borrowed money. When Toys “R” Us iled for bankruptcy in September, one igure was particularly clarifying. The company had been paying interest of $400 million on about $5 billion of debt every year for a decade. In the good years, that was almost half its operating proit. Toys “R” Us had U.S. revenue of $7 billion and, even toward the end, a 14 percent share of the toy market, but there was no math that made $400 million look sustainable. When it all came crashing down in March, Toys “R” Us had just about run out of cash, and it could ind no one willing to replenish its accounts. It was a category killer killed by bigger and more powerful rivals, with the inevitable ending hastened by the cold logic of its private equity owners and bankers. But it goes deeper than that. As the company’s advisers liquidate its 735 U.S. stores, make deals for the operations around the world, and determine the value of its intellectual property, it’s become clear that Toys “R” Us didn’t only have an improvident amount of debt—it also had a debt structure as complex and precarious as a Jenga tower, which obscured the company’s tenuous inances. But gravity always wins in the end. For all of its life after Lazarus, through six CEOs, Toys “R” Us tried both growing and shrinking to become more proitable. John Eyler, who became CEO No. 4 in 2000, had the luxury of trying Option A. Under his guidance the company invested hundreds of millions of dollars to make the U.S. stores look less like impersonal warehouses, to retrain an often indiferent sales staf, and to expand a private-label line of toys. It purchased a 192-acre corporate campus in Wayne, N.J., for $36 million and named it the Global Resource Center, the sort of move that often looks like corporate hubris in hindsight. In late 2001, Eyler oversaw the opening of a lagship store in New York’s Times Square, with a 60-foot Ferris wheel, a lifesize Tyrannosaurus rex, and a Barbie dollhouse bigger than many Manhattan apartments. Eyler promised that 20 million people a year would visit, and maybe they did, but the store never made money. It might have been considered a grand marketing expense, but sales and proits at the more utilitarian stores continued to falter, and the company’s stock price continued to drop. In 2004, Eyler and the directors took drastic action. It was a good time for retail companies, with their steady cash lows, to be on the market. Capital was plentiful, and private equity irms were competing for deals. The most attractive thing about
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Toys “R” Us was its real estate portfolio: It operated 1,500 stores globally, including 900 in the U.S., of which it owned almost half. Vornado and its partners igured they could use the real estate, which the company valued at $2.3 billion, for the higher inancial purpose of raising more debt. Eyler left Toys “R” Us when the private equity deal closed. He was only 58 but could aford to retire: He received $65 million on his way out. The new owners helped inance Toys “R” Us by putting about 500 of its U.S. stores into two corporate entities that became the retailer’s landlords. This arrangement allowed the company to eventually sell an additional $2 billion of debt, all backed by its own rent payments. “That’s the beauty of it: Anybody who owns real estate can do this,” Todd Sammann, then a managing director in commercial real estate at Deutsche Bank Securities, told Bloomberg News in 2006. When the next CEO, Gerald Storch, arrived from Target Corp. in 2006, he described Toys “R” Us as dispirited. “Victim thinking” pervaded the company, he told Businessweek. Boss No. 5 purged upper management; then, as might be expected when private equity is involved and a recession is taking hold, he cut jobs and closed stores. But the company also acquired the struggling FAO Schwarz, the oldest toy store in the country, and, as the threat from Amazon grew, three rival websites, BabyUniverse.com, ePregnancy.com, and EToys.com. Storch remodeled stores to combine the toy and baby businesses and introduced exclusive products that could be sold at full price. Yet for all of Storch’s eforts, when a signiicant amount of debt, $725 million, came due in 2009, Toys “R” Us had to take out additional loans—backed by mortgages on more than a hundred properties—to repay it. Analysts praised the company’s operating discipline in dificult economic circumstances, which was enough to convince Bain and its partners that they could follow through on their plan to reduce their stakes in the company and pay down some of its debt through a stock ofering in 2010. Toys “R” Us
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everything better—and that, he said, would only slow the company’s descent. Wall Street appreciated the honesty. But without the cash from the public ofering, the strain on the owners’ patience and lenders’ conidence was severe. Toys “R” Us was left to continually defer its moment of reckoning, each time with fewer resources to draw on. By the spring of 2015, Toys “R” Us had announced it was closing the Times Square store as well as the Fifth Avenue lagship of FAO Schwarz. The Ferris wheel was recycled, the T. rex dismantled. David Brandon, CEO No. 7, joined that summer. He announced that his plan would involve taking some calculated risks. “Not bet the farm,” he told Bloomberg News. “Not be reckless. But what do we need to do that really breaks through? We are going to be testing a lot of stuf that has that potential.” Yet the company had $1.2 billion of debt due in 2017 and an additional $668 million the following year, and Brandon felt compelled to state that he “didn’t take this job to lead a bankruptcy efort.” As the company edged closer to that irst deadline, its surprisingly decent 2015 holiday results—sales increased by 2 percent in established stores, the irst gain in four years—were, nonetheless, not nearly enough to matter. Brandon eventually had to negotiate another swap, ofering cash dividends and equity in the company’s international business. This desperate deal gave the company only a brief reprieve. Toys “R” Us was caught: It didn’t have the money for Brandon to test “a lot of stuf” to make its stores modern, fun, distinctive, convenient—or even two of the four. The baby business was faltering. And though the company had wrested back its website, when it inally upgraded its technology to allow customers to check out in fewer than ive steps, it was already a half-decade behind. By then, Best Buy Co. was holding of Amazon with its Geek Squad; Target had distinguished itself by creating a billion-dollar kids’ clothing line; and Warby Parker had proved that people will try out and buy products in stores if the stores are appealing and the staf knowledgeable. During the summer of 2017, Brandon bargained with lenders, hoping to put of $400 million due the next spring. For the irst time in a decade, though, Toys “R” Us and its inanciers couldn’t come to an agreement. Wariness had inally, unavoidably, set in. The company prepared to ile for Chapter 11 bankruptcy, a last-ditch attempt to get out from under its debt and rebuild on irmer ground. In early September, CNBC reported on the plans, which “started a dangerous game of dominoes,” as Brandon said in a court iling. Almost 40 percent of the company’s vendors refused to ship their products without cash in advance, cash on delivery, or payment of all their outstanding obligations—if Toys “R” Us did fail, their claims would have low priority. It was two months before the busiest season. The company promised all of its cash as collateral to secure a $3.1 billion operating loan from JPMorgan Chase & Co., Goldman Sachs Group, and Barclays Plc, so it could comply
Former employees have started a Facebook page, Dead Giraffe Society intended to raise as much as $800 million. But the market wasn’t interested. The IPO was delayed that year and the next, and when prospects didn’t look any more promising in 2012, the company had to ask lenders to add $225 million to one loan so it could pay of bonds coming due. Then came more trouble. Holiday sales, which usually brought in 40 percent of the company’s annual revenue, were dismal in 2012, and in early 2013 Storch resigned. When Toys “R” Us reported that proit for 2012 had fallen by 75 percent (to a triling $38 million), it also conirmed what most suspected: There would be no stock sale. The board set a threeyear deadline to improve prospects with an undetermined strategy that would be implemented by an unnamed CEO. That executive turned out to be Antonio Urcelay, head of the company’s European division. His strategy was to do
OPENER: PROP STYLIST: ANDREA GRECO; LAZARUS: JACQUES M. CHENET/GETTY IMAGES
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with its suppliers’ demands and stay in business through the holidays. This particular kind of loan, debtor-in-possession inancing, comes with a special guarantee in case the company closes down. The banks get irst dibs on what’s left. In late September, with this inancing in place, Brandon held a press conference at one of the company’s pop-up stores, notably close to its former Times Square spectacle, and said: “It’s the dawn of a new day for the company. It’s the opportunity to do things we’ve wanted to do for a long time but haven’t been able to.” That was Brandon’s last burst of optimism. After a devastating holiday season—sales were 15 percent lower than the year before—Toys “R” Us calculated that it was about $250 million short of what it needed to stay in business until the next holiday season. Brandon could only ofer to close 180 stores and shut down the troubled baby business altogether. That idea found no takers. Eight potential investors looked at the company, and several retailers considered buying it outright, but none made an ofer. Sycamore Partners produced a plan that could have kept open half the U.S. stores, but the retailer’s senior creditors calculated they would see a better return if the company were liquidated and its assets sold of. By February some of the lenders were insisting on that approach. Toys “R” Us made their last wish come true, and on March 9, Bloomberg News reported that the company would close its U.S. operations. Five days later, Brandon gathered the administrative and executive staf at the Global Resource Center to tell them that the U.S. business was in default, other loan covenants were about to be breached, and its lenders had been “arguing, negotiating, at times it seemed like ighting with one another.” Toys “R” Us would have to close all 735 remaining U.S. stores; sell $2 billion worth of merchandise at a discount; take bids for its brand name, mascot, and intellectual property, as well as its leases, oice equipment, and more; and lay of all 30,000 employees. “Many of those involved in the bankruptcy process live by and make decisions by spreadsheets and economics,” Brandon told them. “I get that. It’s how the world works. It’s not how I work.” He sounded exhausted and embittered. Toys “R” Us came to its end in a snarl of recrimination. A week after Brandon’s announcement, with liquidation sales under way, Lazarus, who’d been ill for months, died. He was apparently unaware of the company’s ruin. Brandon left unspoken the other shortcomings revealed by the bankruptcy: a lattice of guarantees, liens, security pledges, and collateral. The inal confounding account is on the last page of the iling; read it if you dare. Almost every company asset—cash lows, property, inventory, equity in the international operations—was pledged to a lender, sometimes twice. Toys “R” Us had nothing left to promise. The retailer’s overseas divisions weren’t part of the bankruptcy, but stores in the U.K. ended up in liquidation, too, after discussions about selling the business fell apart. Smyths Toys, an Irish company, bought operations in Austria, Germany, and Switzerland for about $94 million; Fairfax Financial Holdings
Lazarus during the chain’s heyday
Ltd., a Toronto-based investment irm, was the only bidder for the Canadian division and acquired it for $237 million. The Asian business, the company’s most proitable, has drawn enough interest to require a second round of bidding. An auction for the company’s name, customer data, and baby-shower registry will be held on June 18 in bankruptcy court in Richmond, Va. Target had earlier expressed interest in the registry and the Babies “R” Us website. Hundreds of internet domain names, bought over the years to make sure no one else could use them, are also for sale, sex-toysr-us.com and toysrussucks.com among them. The money gathered from the company’s remains will likely pay of loans of at least $710 million. The company still owes billions more to lower-ranked creditors, including vendors that may be out hundreds of millions. “Every single step of the way, their business judgment has been wrong,” Jef Schwartz, a lawyer for Learning Resources, an educational toy company, said when he made his client’s $2.3 million claim in the liquidation hearings. Bain, KKR, and Vornado, which together collected $470 million in fees and interest payments over the years, will end up losing well over a billion dollars combined. KKR and Vornado have written of their investments; all three companies declined to comment on one of their most public failures. All stores will be empty by July, but until then customers can stand in front of a “selie banner featuring Geofrey,” the retailer said in May. Soon after, Brandon and four other senior executives, now deemed nonessential, left the company. Brandon received almost $7 million in compensation in 2017, including a $2.8 million retention bonus paid just before the bankruptcy iling. He’s already started a consulting company. Former employees have started a Facebook page, Dead Girafe Society. Some rallied outside the oices of Bain, KKR, and Vornado to protest losing their jobs without severance and occupied a soon-to-be-closed Toys “R” Us store in Union, N.J. Twenty miles away, the company began to liquidate its headquarters. Photos of what’s for sale, including a giant Sully from Monsters, Inc. posed next to a pool table, are available online. For their part in one of the biggest unravelings in U.S. retail history, lawyers and advisers have received more than $100 million; they expect to get about a quarter of a billion dollars more before it’s all over. Even the demise of Toys “R” Us is expensive. —With Steven Church
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Beam Drop Inhotim by Chris Burden
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For Artâ&#x20AC;&#x2122;s Sake
Bernardo Paz created an incredible museum in the Brazilian backlandsâ&#x20AC;&#x201D; with a fortune fueled by environmental destruction and financial crime
By Alex Cuadros Photographs by Vincent Catala
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In the hours after the twin towers fell in Lower Manhattan, Bernardo Paz had a lash of inspiration. He called up his curator, Ricardo Sardenberg, who was helping him create a private museum in the hills of southeastern Brazil. Paz had become rich by taking over bankrupt mining companies, and he sensed an historic opportunity to build a world-class art collection. “If there’s a time to go to New York, it’s right now,” Sardenberg remembers Paz saying even as they watched the televised loop of the towers collapsing. As soon as lights to New York resumed, they went. The galleries in Chelsea were quiet, but dealers were relieved to entertain a buyer, and Paz scooped up sculptures and installations by top contemporary artists “for the price of a banana,” in Sardenberg’s words. He favored pieces too unwieldy for most private collections, such as The Forty Part Motet by Janet Cardif and George Bures Miller, in which 40 loudspeakers play 40 individually recorded voices singing an English Renaissance choral composition. No matter that Paz didn’t have a place to display it. He’d have a structure built, large enough for someone to stroll by each speaker and make out a single voice with one ear while hearing the whole chorus with the other, as the artists had intended. Before that September trip, few in the art world had heard of Paz. But in just a few years, his backyard collection would grow into one of the world’s largest open-air museums. Known as Inhotim (pronounced “een-yo-CHEEN”), it’s now a major stop on the international art circuit, despite being located in a depressed mining region 16 hours by plane and car from New York or London. It doubles as a tropical garden and nature preserve, and amid the 700 acres of lora imported from as far away as Madagascar and Sri Lanka, you’ll ind special commissions such as Matthew Barney’s De Lama Lâmina, in which a tractor clutches a ghostly white tree beneath a geodesic bubInhotim ble. Two installations incorporate pools that visitors can swim in. There are also Rio de Janeiro standalone galleries dedicated to individual artists, including one for the works of Adriana Varejão, Paz’s ifth wife (of six). Paz has said he poured as much as $70 million into Inhotim some years. The result, according to Wallpaper magazine, “is a unique dialogue between art, architecture, and nature”—or, as ArtReview would have it, “the Jurassic Park of contemporary art.” To Brazilians, it’s a national treasure that has transformed the country’s cultural life and drawn millions of tourists. But Inhotim is also a monument to the ubiquity of dirty money in the art market. In the inal months of 2017, Paz was convicted of tax evasion and money laundering; his museum was found to have gained from the scheme. And these weren’t the only misdeeds that helped to fund his great project. Over a long history of wrongdoing that has never been fully reported, Paz broke a series of environmental laws and even beneited from child labor to build his fortune.
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At 67, Paz has long, flowing white hair and a white beard yellowed by cigarettes. His eyes are blue and intense. He declined to comment for this article, but in the space of a single 2013 interview, he claimed to be the irst foreign businessman to meet Chinese leader Deng Xiaoping (“When I went to China, only the Jews were there”), said he can’t get Paz turned on by a woman over 50 (“I’m a man of few pleasures in life, and one of them is sex”), and spoke proudly of the quilombolas—descendants of escaped slaves—he hires to work in Inhotim’s gardens (one of whom was cured of his wish to “kill white people”). Paz has called Inhotim “a factory of citizens” and “the greatest social project anyone in the world has ever done.” He’s also called himself a socialist. Preparing to head to Davos for the World Economic Forum in 2010, he said, “When I get there, I’m going to look those soft-asses in the face and tell them all to go to hell.” (He actually gave a speech about the unifying power of contemporary art.) Paz is a strange sort of cosmopolitan. He’s happiest at home in Minas Gerais—literally “general mines,” the state where he grew up—and speaks English only haltingly. At an event in California in 2014, he said, “My mother was a poetry, and was a painting, and was a sociologist. And my father was a engineer, and his father was a general, who did all the frontier in Brazil.” Then he switched to Portuguese to recall that his dad sang patriotic hymns to him every night, and that this made him feel like he had to be a hero one day. Today Paz is rich, though it’s hard to gauge just how rich. He’s said Inhotim is worth $1.5 billion, but the pieces commissioned for the museum have never had their values established by a sale. He owns 29 companies, but none are publicly traded and most have ceased operations. Even the active ones lack websites or public-relations oices. His early career also left little trace in the public record. The way he’s described it in interviews, he got into mining by accident. In 1973 his irst wife’s father, a banker in Minas Gerais, took him on at a failing iron-ore company called Itaminas. Paz, then 23, had little training for this. He’d dropped out of high school and worked in a clothing boutique before a stint as a stockbroker. But he was dedicated, working till midnight and waking before sunrise to watch his workers arrive. Soon, he was made the company’s director. Itaminas was swimming in debt. In a foolhardy bid to pay it of, Paz started taking over other insolvent mining companies. “It was the worst sufocation of my life,” he later said. He occasionally drank a whole bottle of whiskey to get to sleep. He was drunk when he bought his irst pig-iron plant to smelt the raw ore from his mines.
PAZ: MARK MAHANEY
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In those days, Paz cared more about proit than great social Brazilian mining executives to sell his product abroad. When projects. To heat his smelting furnaces, he needed fuel. So others succumbed to the economic crises of the ’80s and through a company called Replasa Relorestadora SA, he ’90s, he survived. started cultivating 50,000 acres of eucalyptus, a fast-growing It helped that Paz often failed to pay his taxes, forcing the tree that can be harvested for charcoal. The government government to negotiate installment plans. He claimed he leased him land in northern Minas Gerais to that end, even simply didn’t have the money, but he was pouring cash into though 60 families already used the area for subsistence his garden the whole time. farming. Known as geraizeiros, they’d been there for generations, grazing cattle and growing manioc and corn. Paz has said that children understand contemporary art José Gonçalves Dias, 41, remembers accompanying his better than their parents do—which is partly why he likes it. father in the 1980s to gather squash and watching as Replasa’s On a Wednesday, when entrance is free, I wander Inhotim’s men called the police to haul him away. “It was a humilia- stone paths, passing trees too large to wrap one’s arms tion,” Dias says. “Replasa cracked down on every little thing.” around, and benches carved from giant trunks, and man-made The family couldn’t even gather irewood. lakes, and manicured expanses of lawn, all tended by a small The area had once been thriving tropical savanna. But euca- army of gardeners. At one end of the park, I stop at a piece by lyptus is a thirsty tree, and the geraizeiros noticed that Replasa Yayoi Kusama: 500 stainless-steel spheres loating in a water planted at the headwaters of streams—areas protected under garden. At the other end, guests navigate the steel forest of Brazilian law. Dias’s community now lives along a dusty road Chris Burden’s Beam Drop Inhotim, which the artist created by in cinder-block homes with enclosures for chickens. Showing releasing 71 girders from a crane into a pit of wet cement. Atop me around, he sweeps his arm at a dried-out basin. “We used a hill, a group of boys play with a kind of giant kaleidoscope— to bathe and ish here,” he says. After the stream dried up, Olafur Eliasson’s Viewing Machine, which can be trained on water had to be purchased for $160 a tank—a fortune for them. the surrounding rainforest. From that point, it’s also possible Many left to seek work in faraway cities. Dias stayed and did to make out the red earth of hills torn up by iron-ore mining. what he could to help put food on the table. He says he was Inhotim began as an unintended consequence of Paz’s 10 years old when he went to work in a carvoaria—an array of 1980s takeover spree. One of the companies he bought came crude ovens that turn wood into charcoal. His job was to slather with land in the municipality of Brumadinho, which was then wet mud on the ovens to keep them sealed. Wearing lip-lops known only for its leprosarium. Legend has it that the property as he clambered on top, he sometimes burned his feet. He once belonged to an Englishman locals called ’inho Tim—“Mr. did this job for four years, always of the books, for a Replasa Tim,” in the rural vernacular. Paz decided to make his counsubcontractor. His sister, Maria do Rosário Gonçalves Dias, try home there, and, in the tradition of empire builders since now 44, says she started working directly for Replasa at age 14, Nebuchadnezzar II, he began designing a garden. dispersing ant killer without a mask or boots. Both say many He got advice from the best: Roberto Burle Marx, the other kids worked alongside them. Another geraizeiro, Pedro renowned Brazilian landscape architect, who awakened in Ferreira de Santana, 43, says he did the same work as Maria him some latent aesthetic yen. Paz started buying Brazilian at 16, an age when minors in Brazil are allowed to work but modernist art, but collecting remained a hobby until 1995. not handle pesticides. He was paid half the minimum wage. (A lawyer for Replasa says the company never used child labor and that safety equipment was mandatory.) The press never got wind of any of this. Instead, Paz’s irst major scandal arose from a more visible disaster. In May 1986, seven workers died after a dam broke at one of his mines. Regulators said Itaminas had overloaded the dam with tailings. Just the same, less than two weeks later, Paz was awarded a medal from two Minas Gerais business groups, for Itaminas now employed 4,000 people and earned annual revenue of half a billion dollars. He traveled constantly Viewing Machine by Olafur Eliasson to China, becoming one of the irst
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On a business trip that year he sufered a stroke. He decided to step back from his business empire, move into Mr. Tim’s old house, and throw himself into the garden. His taste in art grew more adventurous. One day he acquired a sculpture that didn’t it in his house. It was an assortment of iron bells hanging from three surreally tall canes—Deleite, by Tunga, one of Brazil’s greatest contemporary artists. Tunga pushed Paz to let the public visit his garden. Inhotim wouldn’t open its gates until 2006, but the project became all-consuming. Paz wanted to create something unique, transformational. He hired the best curators he could ind. One, Allan Schwartzman, now chairman of the ine art division at Sotheby’s, started working on Inhotim in 2003. “You’re in the middle of nowhere,” he remembers telling Paz. “Why would anyone travel 15-plus hours to get here?” But Schwartzman had a solution: “Let’s commission artists to do some of their most ambitious dream projects.” For one of the irst commissions, the American artist Doug Aitken designed Sonic Pavilion, a ive-year project that involved digging a 663foot well and installing microphones at the bottom to transmit the sound of the Earth to a listening station on a hill. The installation costs could be extravagant, and site-speciic works weren’t exactly fungible investments. But Paz didn’t mind. “I don’t know anyone who’s collected on the scale he’s collected without an eye toward what this means in terms of long-term value,” Schwartzman says. One dealer remembers Paz walking up to her stand at a fair, identifying three pieces he liked, and buying them without a second thought. As soon as he moved on, an Inhotim curator stayed behind to cancel the sales, explaining that he was trailing Paz to “unbuy” impulsive purchases. Paz decided to turn Inhotim into a nonproit. He liked to say he was planning the museum for the next 1,000 years. He often spoke of building an airport, four hotels, and a convention center, to establish what he called a “post-contemporary Disney World” that could fund itself in perpetuity. He also dreamed of building self-sustaining villas where people would live and work remotely, creating “a model of life in perfect tune with nature, but also very connected to technology.” He wasn’t afraid to use the word “utopia.” But not long after Inhotim opened, a series of government investigations began uncovering the environmental and labor violations that had helped Paz build his fortune— and then the inancial crimes that had shielded his fortune from taxation. The irst sanction came in 2007, after labor inspectors descended on a charcoal operation that supplied one of Paz’s pig-iron companies, Itasider-Usina Siderúrgica Itaminas SA, and found 36 people working in “slavelike” conditions. According to the inspectors, the workers had been forced to buy their own chain saws, with payments automatically deducted from their salaries, and made to live on a site infested with scorpions. For buying charcoal made under these conditions, Itasider was placed on a government blacklist, cut of from state inancing for three years. Vale SA, Brazil’s largest iron-ore producer, also suspended sales to the company.
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(At the time, Itasider said it had stopped buying charcoal from this supplier. Lawyers for Paz declined to comment.) Then, starting in 2008, Brazil’s environmental protection agency began cracking down on the trade in charcoal from the Amazon region. As far back as the 1980s there had been reports that one of Paz’s companies, Cosipar, used fuel made from illegally deforested trees; Itasider and another of Paz’s pig-iron companies were slapped with $13 million in ines for this and related infractions. In 2009, state inspectors made the irst signiicant survey of Paz’s eucalyptus plantations. They discovered the environmental violation that local farmers had observed decades earlier: Replasa had planted at the headwaters of streams. The farmers, meanwhile, enlisted an activist lawyer named André Alves de Souza, who discovered that Paz had leased the lands from the government and never left them—even though the attorney general for Minas Gerais had determined that the leases were illegally extended by an oicial implicated in a scheme to sell of public lands. Alves iled a suit questioning Paz’s claim to the area, and a judge granted an injunction halting Replasa’s operations. (The case is pending.) Replasa was subsequently denied a key environmental license, and its plantations were mostly shut down. Further denting Paz’s fortune, he had to pledge a pig-iron complex as collateral for his various ines and injunctions; Itasider was eventually producing so little that it dropped out of a local industry group. Despite Paz’s growing fame as a patron of the arts, none of this reached the public consciousness. What inally made headlines was the allegation, in 2009, that he’d received tens of millions of dollars from a mysterious fund in the Cayman Islands. It was no secret to Brazil’s internal revenue service that Paz had neglected what one tax-levy case calculated to be at least $200 million in taxes and social security contributions over the years. But Minas Gerais state prosecutors also uncovered accounting methods they claimed veered into criminal tax evasion. A separate, federal inquiry found evidence that he’d spirited vast sums ofshore, then quietly brought the funds back home to spend on his pet project. The investigators focused on a holding company called Horizontes that Paz had formed to administer Inhotim. In 2007 and 2008, Horizontes had received $98.5 million from a Cayman Islands entity, the Flamingo Investment Fund. Investigators found that, to get around a tax on cross-border investments, the payments had been registered as loans from anonymous parties. But the loans were never repaid, nor any interest charged. Allegedly, Paz used some of the money going through Horizontes to buy land for Inhotim and transferred some to his other companies, ordering employees to cash checks for as much as 500,000 reais ($131,500) at a time. Although investigators failed to track the money from there, they suspected Paz had used it to buy art—which always remained his personal property, on loan to the museum. Responding to the charges, Paz insisted the Flamingo fund belonged to someone else. But he couldn’t say who. At a 2015
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“than to have 10 times the money, which will be poorly spent.” Paz wants to leave a legacy at Inhotim. “It’s my function in life,” he told Judge Velano in 2015. He may yet fulill his goal. In April he struck a deal to pay of $100 million in back taxes by transferring ownership of 20 artworks to the government, including Barney’s De Lama Lâmina and Aitken’s Sonic Pavilion. Citing Inhotim’s importance to the local economy, oicials promised to keep the art at the museum. The deal was, in essence, an imprimatur for the most brilliant trick of Paz’s career— deciding personally how his taxes should be spent for what he saw as the common A pavilion housing the art of Adriana Varejão, Paz’s fifth wife good. Yet, even inside his circle, some feel uneasy about what he’ll leave behind. deposition he searched for a name, theatrically shutting his Paz started buying the work of Brazilian artist Miguel Rio eyes and raising his palm to his face. “He’s the owner of—oh, Branco in the ’90s. The conversations they had helped inspire God,” he said. “It’s the sixth-largest bank in Switzerland. UFC, Inhotim’s creation, and today the museum has a whole building UFC …” (It wasn’t UBS.) Nervously stroking his white mane, to display Rio Branco’s color-saturated photographs of humoccasionally thumping the table in front of him, he framed his ble Brazilians. Now 71, Rio Branco lives and makes his art in a tangled web of money transfers as simple accounting mix-ups. sprawling compound in Araras, in the high mountains north of “Being a businessman in this country is complicated stuf,” he Rio de Janeiro. Sitting on a couch in his studio, surrounded by said. He claimed he’d neglected his taxes only to avoid laying hanging canvases and dusty tools, he’s initially quick to forgive of workers, and resorted to mentioning his stroke and the his patron: “He has that degree of craziness that every artist six wives who’d left him because of his obsession with work. has, which sometimes allows you to do extraordinary things. Federal Judge Camila Velano kept interrupting to return to But he’s not an administrator, obviously.” the substance of the accusations. Exasperated, Paz addressed His expression changes when he hears what Paz did in the her as ilha—in essence, “girl”—before correcting himself. Asked north of Minas Gerais. At irst he insists Paz must not have about his huge withdrawals of cash, he said, “Some time ago, known how his wealth was built—or that if he did, his “conI started taking a lot of tranquilizers and my memory went to science” had since evolved. “Great fortunes are usually probhell, so I now have some diiculty remembering the past.” lematic,” Rio Branco says. “But at least they built something.” This didn’t help his case. Last September, Velano handed He stands up. A half-dozen dachshunds scamper after him Paz a nine-year sentence for money laundering. Three months as he opens the door to his garden and slips into a gap in a later, another judge convicted Paz of evading $10 million in hedgerow, plunging into a labyrinth of manicured bushes and taxes, sentencing him to an additional ive years in prison. tall, lat stones. He keeps coming back to how Paz made his forJustice is slow in Brazil, so Paz could remain free for years tune. Eucalyptus, he says, is “totally destructive.” And those while appeals are pending. His life, though, has changed irre- charcoal ovens: “prehistoric.” Finally he admits that Paz’s minvocably. With his cash low dwindling, museum staf had been ing business had already troubled him. Inhotim might be a signing up corporate sponsors, which began threatening to perfect square of paradise, but extractive industries have laid cut of their donations. Paz saw little choice but to step down waste to forests, leveling whole mountains in search of ore. as Inhotim’s chairman. He used to tour the grounds every “Inhotim for me would be a kind of restitution for that,” Rio morning in a golf cart. Now he barely leaves his art-illed man- Branco says. “But is it enough of a restitution? Maybe not.” sion in a section of the park closed to visitors. Even that restitution, of course, is little solace to the Still, Paz has kept the esteem of many curators and gal- people who bore the cost of Paz’s ambition. Up in northern lery owners who’ve dealt with him. Luisa Strina, a São Paulo Minas Gerais, Dias says he’d never even heard of Inhotim until dealer who sold him four pieces by legendary Brazilian art- his legal battles with Paz. Yet the people who visit the park, he ist Cildo Meireles, says of his tax evasion, “It’s not my prob- says, are just as clueless about Paz’s misdeeds. The only hint lem.” Thiago Gomide, another dealer who’s known Paz for can be found in a plaque denoting one of the park’s endanyears, says the authorities should actually “thank God” he gered plants. It’s a bush with purple lowers—the canela-dedidn’t pay his taxes, because the park might not exist oth- ema, native to a stretch of savanna not far from Replasa’s erwise. “Better for them to have a museum,” Gomide says, ields. —With Alice Maciel
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As a journalist, Saskia de Rothschild covered everything from the art world to prison inmates. Now she’s taken the reins at her family’s global wine empire By Elin McCoy
Photograph by Marlène Awaad
P U R S U I T S 78 Faster, supercar! Sell! Sell! 80 Alice’s adventures at 45,000 feet 82 Would Ocean’s 8 really work? 83 A treat for Father’s feet 84 Helping immigrants land a credit score
June 11, 2018 Edited by Chris Rovzar Businessweek.com
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Abidjan, Ivory Coast, Saskia de Rothschild spent a month interviewing inmates at the notorious La Maca prison for an article in the French magazine Revue XXI. As an investigative journalist, she ilmed for a documentary the irst female U.S. Marines sent to Afghanistan’s front lines; for the New York Times, she embedded with sheep farmers ighting the mining industry in Greenland. But the challenge in front of her now may be her toughest yet. In April the 31-year-old became the youngest person to currently lead a irst-growth Bordeaux estate, Château Laite Rothschild. She’s also the irst female chairwoman of Domaines Barons de Rothschild (Laite), her extended family’s global wine empire, which includes seven other wineries on three continents. The announcement coincides with the 150th anniversary of Rothschild ownership of the château. (The irst vines were planted in the 1670s; Thomas Jeferson visited and became a devoted fan.) De Rothschild won’t only be the face of the company that makes one of the most celebrated red wines on the planet. Her millennial perspective and distinctly global outlook will help shape its future in the face of serious 21st century challenges, including the increasing demand for organic and biodynamic wines and the cutthroat competition in China’s ine-wine market. Speculation has circulated for years about who would succeed Saskia’s father, the ever-charming Baron Eric de Rothschild, 77, who began running Laite in 1974 and expanded the Rothschilds’ wine portfolio. Several branches of the family own shares of the privately held DBR (Laite), which also includes Bordeaux châteaux Rieussec, L’Evangile, and DuhartMilon. There’s also Domaine D’Aussières in Languedoc, Viña Los Vascos in Chile, and joint-venture Bodegas Caro in Argentina. Additionally the company produces three lines of branded everyday wine—Légende, Saga, Château Lafite and Réserve Spéciale—making 3 million bottles a year. But Château Laite Rothschild remains the crown jewel of the business. Set among manicured lawns with crunchy gravel paths and a lake and surrounded by 112 hectares (277 acres) of closely planted cabernet, merlot, cabernet franc, and petit verdot vines, it produces more wine than any of the other irst growths. Also known as premiers crus, these are the top ive wines in a famous 1855 classiication that ranked estates in quality from ifth to irst “growths.” For centuries merchant ships sailed from Bordeaux laden with casks of red wine for Britain, then spread the region’s prestige throughout the globe. At the end of the 14th century, the area sent the
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equivalent of 1 million bottles to London for the wedding of King Edward II, and by the 18th century, prosperous French aristocrats began to build turreted châteaux. Laite was already renowned in 1868 when wealthy French banker Baron James de Rothschild bought it for just under 5 million francs (about $54 million today), and since then it’s been vulnerable to vine blights, wars, changing tastes, and price booms and busts. Still, the mystique of its elegant, long-lived red wines has been relected in prices that are consistently higher than those for other irst growths. Top vintages can last 50, even 100 years. Internationally, current vintages hover at about $700 a bottle; the much-soughtafter 1982 is $4,000. If you are lucky enough to ever taste that legendary wine, you’ll experience a haunting cedary black trufle fragrance and complex lavors that unroll with the light silkiness that is Laite’s hallmark. At the height of the Asian boom in interest in 2011, the estate’s value was an estimated €3.7 billion ($4.3 billion), according to the London International Vintners Exchange, a trading house for investment-grade wines. Its value is still at least €1 billion. Michael Baynes of Maxwell-Baynes Real Estate in Bordeaux puts the collective value of DBR (Laite)’s other châteaux at about €790 million, based on recent sales, and its Languedoc and Chilean estates at €70 million. “Rarity and status play more of a role than the underlying economics of the business,” says Alex Hall of Vineyard Intelligence. “Laite Rothschild itself is like a famous painting. Until it is sold, it’s diicult to know what it’s actually worth.” De Rothschild has two brothers and a number of cousins who might’ve taken on the top role. But she had the primary requirement: She actually wanted the job. Fascinated by the estate from an early age, de Rothschild groomed herself by interning at Château L’Evangile in Pomerol at age 19 and joining the group that selects Laite’s assemblage (the inal blend of wines that ends up in bottles) at 20. She also obtained an MBA from HEC Paris and a master’s degree in journalism at Columbia and worked for the New York Times in Paris. In 2015 she began full time at the family company. Unlike other irst-growth château owners, who started out with no formal training in wine, de Rothschild has been taking courses in viticulture and oenology at agricultural school CNEAC in Argentonsur-Creuse for a national diploma and is writing a thesis on cold maceration in winemaking. In the process, she convinced the DBR (Laite) board that she has the ambition, drive, and passion to head a company with 430 employees and 1,200 hectares of vineyards worldwide. I meet with de Rothschild in a lightilled drawing room in Château Laite, parts of which date to the 16th century. We’re sitting in antique chairs
PHOTOGRAPH COURTESY F. POINCET
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upholstered in red silk brocade; gilt-framed portraits of her ancestors hang on the walls. Carrying a red notebook stufed with papers, she talks about Laite with thoughtful passion, sharing memories of childhood summers here. “My father taught me to taste wine,” she says. “He told me to close my eyes when sipping, to memorize it.” She emphasizes how even this famous estate must ind ways to speak to the new generation of wine drinkers. But it’s not long before we get to one of her irst challenges: namely, China. Laite has had a complicated relationship with the Chinese market. It was one of the irst great Bordeaux to be sold in China, and it quickly emerged as a desired gift for government
oicials. Its appearance as the only wine worth drinking in Hong Kong gangster movies, such as Exiled, and a famous Chinese television soap opera helped cement its fame. During the Asia-led wine boom, Laite became a superbrand, and its prices skyrocketed. All this led to wine speculation and a lood of counterfeits. But in 2011 the bubble began to burst; there was economic uncertainty and a crackdown on gifting by the government. Wine prices for Laite and other irst growths plummeted. Only in 2016 did they begin to rebound. But the Chinese market can’t be ignored: Almost 80 million bottles of Bordeaux are exported annually to China and Hong Kong, and prices have been creeping up. Meanwhile, Chinese moguls, including Jack Ma, have bought more than 100 châteaux in Bordeaux since 2010. “One of the immediate priorities is the launch of our Chinese estate,” she concedes. That’s the company’s early, daring 10-year-old winery project on the hilly Shandong Peninsula in eastern China, roughly equidistant from Beijing and Shanghai. It was started in a partnership with China’s Citic Group Ltd., formerly the China International Trust & Investment Corp., a state-owned investment company. The goal was to gain a foothold in a growing domestic market with millions of potential customers, building on Laite’s reputation. In 2011 the company planted 25 hectares of vines on the property, with the intention of producing a cabernet-based red blend. Then in January, Citic, as part of its retrenching to its core inancial business, wanted out of the partnership. DBR (Laite) plans to buy out Citic’s 30 percent share for more than $5 million and intends to open the winery next year. At many top châteaux, it’s typical for the owner (or a family member) to be the face of the brand, with a savvy wine professional as the day-to-day actor behind the scenes. De Rothschild will team with DBR (Laite)’s recently appointed chief executive oicer, Jean-Guillaume Prats, the former president and
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CEO of LVMH Moët Hennessy Louis Vuitton SE’s wine division. Helpfully, he oversaw the creation and introduction of LVMH’s Chinese wine, Ao Yun. “Saskia de Rothschild combines ierce intelligence with great imagination,” says Sarah Kemp, an adviser to the London wine club 67 Pall Mall. “Like her father, she is a listener, but she is her own woman and will bring an exciting new chapter to Laite.” But keeping Laite in its top spot as the most expensive and sought-after Bordeaux is no easy task. According to a recent Sotheby’s market report, Bordeaux, which dominated the auction scene for decades, represented only 40 percent of its worldwide sales in 2017. That’s a record low. Part of that decline comes from collector tastes—rarer Burgundies are more in vogue at the moment, and interest is spreading in ine wines made in other parts of the world. At the same time, new wine enthusiasts tend to be more environmentally conscious than those from the era of de Rothschild’s father. Thomas Duroux, CEO of Bordeaux’s Château Palmer, which was recently certiied biodynamic, says that in the next 10 years, all serious classiied growths will go in this direction. “It’s what consumers want,” he says. Château PontetCanet, which has also gone biodynamic, has seen a meteoric rise in the critical opinion of its wine and its prices. Most of Laite’s vineyard is organic, and it now has nine experimental biodynamic hectares. The company’s Château L’Evangile is almost 100 percent organic. “We are speeding up,” de Rothschild says. “Our mission is the conversion to a more natural, sustainable way of doing agriculture.” Future sales also depend on bringing her millennial generation back to Bordeaux and connecting more directly with consumers. “We have to create a more friendly, more humble approach,” she says. “My friends in Paris don’t drink Bordeaux. You can’t ind it in certain restaurants. They drink Loire whites, Châteauneuf from the Rhône, and wines from the Jura and Languedoc.” It’s a long list of challenges. De Rothschild can’t tackle them all herself. For now, her father will be co-chairman of Château Laite with her, but she is in charge of DBR (Laite). “Before I was interested in wine, I was fascinated by Laite as a place,” de Rothschild relects as I’m leaving. We can see the tower of the charming château, and a herd of rare wild cows wanders 50 hectares of marshland. Long rows of green vines give the estate an idyllic, peaceful atmosphere and the sense of mystery that lies behind all truly great wines. “It’s not a regular business, it has this vulnerable quality,” de Rothschild says. “And with climate change, that sensation is growing. That’s why I’ve always wanted to protect it.” Long term, de Rothschild hopes to add more wineries to the portfolio—in the Loire, deinitely in Napa, and even farther aield, perhaps in Ethiopia. “But we won’t buy shiny shoes,” she says with a smile. “We like to ind a raw stone and polish it.”
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CARS
Bloomberg Pursuits
June 11, 2018
The Koenigsegg Agera RS currently holds the top-speed record of 277 mph
Hennessey’s Venom F5 will challenge it as early as next year
The Bugatti Chiron is relatively untested—oficially, it’s electronically limited to 261 mph
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The Race to 300 mph According to the cliché, records are meant to be broken. But given the limits of human ability or physics, there are some that may never be. Currently, Nike Inc. is on a campaign to break the two-hour mark for the marathon—but in a highly controlled test a year ago in Milan with optimal conditions, the fastest runner could manage only 2:00:25. In the world of hypercars, there’s a similar dream threshold. “Achieving 300 mph is the goal,” says John Hennessey, founder of Hennessey Performance in Sealy, Texas, which builds fewer than a dozen supercars a year. The top speed notched by a production car, 277 mph, was reached by a Koenigsegg Agera RS on a closed course in Nevada last year. That beat Bugatti Automobiles SAS’s long-held 267.8 mph mark and inspired a slew of challengers, most promisingly Hennessey, which vows to erase that mark with its forthcoming Venom F5. (Other vehicles, rocket ships on land not made for sale, have gone faster.) “Three hundred mph is an important discussion for the car companies, to validate their product and for the potential
owners to validate their purchase,” says David Lee, who owns more than 30 six- and seven-igure cars and has 732,000 Instagram followers. Buyers in that rareied air do seem to care deeply about top speeds—just scroll through the social media feeds of a few hypercar owners and observe how much swagger is attached to each new car, each fastest run. On Instagram, California collector @dan_am_i recently bragged about joining the 210 mph club at the track at Spring Mountain Motorsports Ranch in Nevada and received more than 6,000 likes. As his cars get faster, Hennessey says, “our team becomes better, our engineers become better.” Records “are important for our company, our family, and our customers.” They’re not just about bragging. “The top-speed title was part of the package with the Bugatti Veyron—the fastest, most powerful, most expensive sports car you could buy at the time,” says Ian Fletcher, an automotive industry analyst for IHS Markit. “It has also helped with the visibility of a company like Koenigsegg.”
ILLUSTRATION BY BRATISLAV MILENKOVIC
Supercar brands such as Bugatti, Koenigsegg, and Hennessey are nearing a legendary threshold. At stake is more than glory. By Hannah Elliott
CARS
June 11, 2018
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Bugatti, Hennessey, and Koenigsegg Automotive AB are joined by a myriad of more obscure competitors that are also making cars gunning for 300 mph: Dubai-based Devel Motors, TranStar Racing LLC and its Dagger GT, and Croatiaâ&#x20AC;&#x2122;s Rimac Automobili. One other thing that binds them all: the need for world-class tires. â&#x20AC;&#x153;Itâ&#x20AC;&#x2122;s a big game, with ierce competition, and itâ&#x20AC;&#x2122;s very fast-moving,â&#x20AC;? says Eric Schmedding, Michelinâ&#x20AC;&#x2122;s product manager for original equipment. Michelin, based in France, made the record-breaking tires used by Koenigsegg and Bugatti. Those tires are crucial, because the real limiter to 300 mph isnâ&#x20AC;&#x2122;t actually engine power; 1,200 or 1,500 horsepower can be done. It often comes down to downforce and frictionâ&#x20AC;&#x201D;mostly, where the wheels meet the road. And even at below-record speeds, if anything goes wrong with a tire, the situation could turn fatal. The challenge is to mitigate heat, pressure, and wear. The tires on a 300 mph attempt would need to be able to repeatedly withstand high speeds for minutes at a time, because the oicial record is awarded after taking the average speed of several runs over a set course. According to Schmedding, â&#x20AC;&#x153;We are knocking on the door of 300 mph.â&#x20AC;? Which is exciting, to be sure. But how much does it matter? Most modern car buyers are obsessed with luxury SUVs and the prospect of autonomous driving, not the idea of an obscure car hitting a speed thatâ&#x20AC;&#x2122;s almost theoretical. And the quest to break records costs a lot: Each Bugatti can take years and a billion dollars or more to develop.
Brett David, the owner of Prestige Imports in Miami, which sells all the top-brand supercars, says many clients who buy Paganis, Bugattis, and Lamborghinis care about plenty of other things besides top speed. â&#x20AC;&#x153;The race to 300 mph is very, very real,â&#x20AC;? he says. â&#x20AC;&#x153;But when you think of a supercar you also think of things like zero to 60 mph. You think of braking speed. Are we thinking of a vehicle with hybrid technology? Are we talking about a car that is aesthetically beautiful and has tons of sex appeal?â&#x20AC;? Bugatti, too, downplays the signiicance of the record, which the brand previously set with its Veyron Super Sport in 2010. â&#x20AC;&#x153;Itâ&#x20AC;&#x2122;s not on the top of my agenda,â&#x20AC;? says Stephan Winkelmann, Bugattiâ&#x20AC;&#x2122;s chief executive oicer. â&#x20AC;&#x153;Itâ&#x20AC;&#x2122;s something [my engineers] ask me about internally, but I think that Bugatti is much more than this.â&#x20AC;? (Lee, the collector, warns: â&#x20AC;&#x153;Bugatti will tank in value, because their top speed was the only thing they had.â&#x20AC;?) And yet, Winkelmann also points out that the technology in the companyâ&#x20AC;&#x2122;s 1,479-horsepower Chiron has been automatically limited to run no faster than 261 mph, â&#x20AC;&#x153;so we donâ&#x20AC;&#x2122;t even know how fast this car is going to go.â&#x20AC;? Itâ&#x20AC;&#x2122;s a swiftly shifting ield, and the current record may topple as soon as 2019â&#x20AC;&#x201D;by another Koenigsegg. â&#x20AC;&#x153;The Agera RS will be replaced with a new vehicle, most likely at the Geneva show next year,â&#x20AC;? says Steven Wade, Koenigseggâ&#x20AC;&#x2122;s head of communications. â&#x20AC;&#x153;Will that car hit 300 mph? Weâ&#x20AC;&#x2122;ll all have to wait and see.â&#x20AC;?
TRAVEL
Bloomberg Pursuits
What Do Kids Do on Private Jets? In the race to court customers, VistaJet offers young travelers a fantasy at 45,000 feet By Adrien Glover Photographs by Annie Schlechter
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“Go ahead, try some,” urges the Mad Hatter, a jovial redhead in a tall feathered hat and tails. He gestures toward a small apothecary bottle labeled “Drink Me.” It takes little persuading for Oona, my 7-year-old daughter, to grab it and gingerly sip, being careful not to spill any on her blue dress and white pinafore. Moments earlier her little brother, Zane, devoured a frosted sugar cookie that turned his mouth Cookie Monster blue. Soon, both are eagerly sampling other delights the
June 11, 2018
be-hatted actor, Fergus Adamson, sets out on a little table before them. Like everything else staged in the back eight seats of the Global 5000 Bombardier business jet—including games of dominoes and croquet—it’s part of an extravagant (and expensive) tea party produced at a turbulence-free 45,000 feet. Up in the front section of the plane, three adults sip Ruinart Blanc de Blanc Champagne while checking email, completely undisturbed by the action a few rows back. They can’t even hear the children’s squeals of delight when it comes time to eat the chocolate trules they made themselves by hand. Welcome to the world’s irst oicial Alice in Wonderland adventure in the sky. For many kids on terra irma, playing dress-up and having a performer isn’t outlandish at a themed birthday party, but at cruising altitude, entertainment options are usually limited to a screen and headphones. Not so with VistaJet Group Holding Ltd., the subscription-based global aviation company that launched its Adventures in the Sky program on June 1. For a starting price of $4,000—not including the minimum $12,000 hourly cost of chartering the jet—travelers on the company’s 70 silver-and-red planes can retain Sharky & George, an exclusive London-based children’s party creator with an almost cultlike following, to devise enough antics to keep their kids happily busy from New York to Dubai. Actors irst meet the children out of costume, to avoid any sky-high freakouts. And the activities, which include eating sugary snacks and playing active games, are all vetted for safety on a narrow plane. (They’re also messproof;
June 11, 2018
Adamson, aka the Mad Hatter, delights tomorrow’s 1 Percent
when experimenting with colorful stickers, the company tested 17 variants to ind ones that wouldn’t ruin the jets’ $65,000 leather seats.) Parties are adapted for diferent ages and interests, but they all start with a handful of themes: a moviemaking option complete with green screen; a spy adventure promising international intrigue; and, of course, Alice in Wonderland. Matteo Atti, executive vice president for marketing and innovation at VistaJet, believes an audience exists for concepts like these. “Given that one in every four VistaJet lights has a child on board, we saw the opportunity to build something incredibly special for our younger passengers,” he says. Researching and creating the product was a yearlong process. But it’s worth the efort to keep parents and children happy, he says, and to attract new lying families. “If you can trust us with your family, you can trust us with anything,” he says. According to luxury-travel network Virtuoso, the number of jet charter trips grew 10 percent from 2014 to 2016. PrivateFly, a global charter-booking broker that works with 250 operators worldwide, said in its irst-quarter 2018 report that 15 percent of its passengers were younger than 16, up 50 percent from a year ago. In a market that Atti estimates has an addressable population in the mid-ive igures globally, catering to—and retaining—each client is crucial, even if that client is 5 years old. “I ly privately because it makes it possible to do something special with my son and his friends in a single day, like going to the Grand Canyon to hike caverns,” says Eric Crown, co-founder and former chief executive officer of Insight Enterprises Inc., a Fortune 500 company. “He’s been
“If you can trust us with your family, you can trust us with anything”
on everything from prop planes to Gulfstreams since the age of 2.” For most parents who frequent private jets, it isn’t lavishness that makes it worthwhile but practical concerns— legroom, flexible scheduling, reliable Wi-Fi, and not having to worry about your kids’ behavior in front of 150 strangers. “Private terminal access at smaller airports makes traveling with children much easier to manage,” says David McCown, U.S. president and CEO of Air Partner Plc, a charter service and fractional-jet-ownership program. “Parents and kids avoid the hassle of long airport lines and TSA screenings.” The typical requests for lights with kids rarely go beyond asking for a particular board game or brand of pizza, McCown says. But most private jet companies need to go all-out to meet client expectations every now and then. Air Partner, for example, recently decorated a plane with balloons, presents, and cake for the 10th birthday of a client’s granddaughter—and then proceeded to make multiple stops to pick up family members across the U.S. before lying to Europe. NetJets Inc. makes a standard practice of providing coloring books and teddy bears for young travelers—who make up 10 percent of its passengers. If asked, the company will go further; it’s created Disney-themed lights for families and once put together an in-light laboratory for a client’s science-minded granddaughter who was turning 8. “We have quite a few requests but don’t need to explicitly ofer this as a service,” says Tom Ville, marketing manager for NetJets. Formalizing Adventures in the Sky is certainly a marketing play for VistaJet, but it also allows the company to be nimbler in responding to extravagant asks. And yet its most crucial kid-relating tools are subtler: Since only 10 percent of its clients ly with nannies, VistaJet’s Cabin Hostesses have all taken coursework in family-based psychology and age-based care at Norland College, an institute for early-childhood education in Bath, England. They’re trained to calm nervous little lyers and even bottle-feed. For parents who want something more special than a coloring book and less expensive than a full-blown party, the company will create activity hampers and backpacks—stufed with treasure maps and stop-motion Lego moviemaking kits—to get kids excited. VistaJet lyers tend to have the means to indulge in such treats or spring for an Adventures in the Sky party, which can carry a six-igure price tag. Private jet “members” have an average net worth from $670 million to $1.1 billion. Of course, the best judges of whether it’s all worth it are the kids themselves. After her VistaJet tea party on a threehour light from New Jersey’s Teterboro Airport, Oona was so enchanted, she wondered aloud to me if she’d dreamed it all up. “Alice went down a rabbit hole, but I went up high in the sky,” she says. “It was so cool.”
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Bloomberg Pursuits
MANA GERâ&#x20AC;&#x2122;S SPECIA L
Take My Diamond, Please! 82
In Oceanâ&#x20AC;&#x2122;s 8, an all-female crew sets out to steal a $150 million necklace. Bad idea, say jewelry dealers By James Tarmy The Oceanâ&#x20AC;&#x2122;s movie franchise, which began with Oceanâ&#x20AC;&#x2122;s Eleven in 2001, then breezed through numbers Twelve (2004) and Thirteen (2007), had followed the same formula: George Clooney, Brad Pitt, and a clique of colorful conidence men band together, then steal something. The dialogue is easy, the characters are charming, and the plots are totally incomprehensible. Oceanâ&#x20AC;&#x2122;s 8, which is directed by Gary Ross and opens in theaters on June 8, picks up where its predecessors left of. This time, though, thereâ&#x20AC;&#x2122;s a twist: Instead of an all-male cast of criminals, now itâ&#x20AC;&#x2122;s women who commit the grand larceny. (The irst movies managed to stuf Julia Roberts into an almost silent supporting roleâ&#x20AC;&#x201D;no small feat.) The ringleader of this crew is Danny Oceanâ&#x20AC;&#x2122;s sister, Debbie (Sandra Bullock), a grifter with expensive taste. She spends the irst part of the movie pulling cons at the traditional signiiers of New York Cityâ&#x20AC;&#x2122;s upper crustâ&#x20AC;&#x201D;the Plaza Hotel, Bergdorf Goodmanâ&#x20AC;&#x201D;while assembling a crackerjack team that includes Cate Blanchett, Helena Bonham Carter, Mindy Kaling, Sarah Paulson, Awkwaina, and Rihanna.
June 11, 2018
And what do these accomplished, fast-talking women want? For a movie that purports to upend gender norms, the somewhat disappointing answer is: jewelry! But not just any jewelry. They want the biggest, most expensive, heaviest necklace imaginable. The object of Debbieâ&#x20AC;&#x2122;s desire is a Cartier bauble that weighs 6 pounds, is worth $150 million, and is worn at the Met Gala by an obnoxious starlet, played by Anne Hathaway, who eventually becomes the inal piece in this gang of eight. On the face of it, a diamond necklace seems like a perfectly reasonable thing to steal. But talk to anyone in the diamond industry, and heâ&#x20AC;&#x2122;ll tell you the idea that a $150 million necklace will still be worth $150 million after itâ&#x20AC;&#x2122;s stolen is a bigger fantasy than The Lord of the Rings. â&#x20AC;&#x153;Youâ&#x20AC;&#x2122;d be lucky to get 10¢ on the dollar,â&#x20AC;? says Howard Rothauser, a former diamond wholesaler and the founder of the jewelry website Dacarli. â&#x20AC;&#x153;It would be unsalable as a necklace.â&#x20AC;? Diamonds may be forever, but their market is finite. Thereâ&#x20AC;&#x2122;s a limited buyer pool for giant stones, and any diamond of value will be laser-etched with a registry number from the Gemological Institute of America Inc., so buyers would know if itâ&#x20AC;&#x2122;s been lifted. â&#x20AC;&#x153;Thereâ&#x20AC;&#x2122;s legitimate and illegitimate markets,â&#x20AC;? says Martin Rapaport, founder of the Rapaport Group, a diamond-market company that includes an online trading network for gems. â&#x20AC;&#x153;The spreadâ&#x20AC;?â&#x20AC;&#x201D;read: proit marginâ&#x20AC;&#x201D;â&#x20AC;&#x153;in the thievesâ&#x20AC;&#x2122; market is really low,â&#x20AC;? he says. â&#x20AC;&#x153;The buyer knows theyâ&#x20AC;&#x2122;ve got you by the balls. Who are you going to sell it to? And if they rip it of, who are you going to complain to?â&#x20AC;? That market narrows further as the price rises. â&#x20AC;&#x153;If itâ&#x20AC;&#x2122;s a very expensive piece, it almost doesnâ&#x20AC;&#x2122;t pay to steal one of these suckers, because everyone knows whatâ&#x20AC;&#x2122;s going on,â&#x20AC;? Rapaport says. â&#x20AC;&#x153;Not only will you have fewer buyers, youâ&#x20AC;&#x2122;ll also have to hold on to it or recut it.â&#x20AC;? And recutting such a precious stone will inevitably reduce its value. â&#x20AC;&#x153;Itâ&#x20AC;&#x2122;s like a painting,â&#x20AC;? Rapaport continues. â&#x20AC;&#x153;You canâ&#x20AC;&#x2122;t just rip it in half.â&#x20AC;? Rothauser points to another problem: the diamond cutter. â&#x20AC;&#x153;Heâ&#x20AC;&#x2122;s going to look at you and know exactly what youâ&#x20AC;&#x2122;re doing, and then think of how much youâ&#x20AC;&#x2122;d have to pay him.â&#x20AC;? So how much could the women of Oceanâ&#x20AC;&#x2122;s 8 conceivably hope to get for their necklace? Assuming it retails for $150 million, it probably cost the jeweler $50 million wholesale (thatâ&#x20AC;&#x2122;s right, ladies and gentlemen, youâ&#x20AC;&#x2122;re paying a 200 percent markup), â&#x20AC;&#x153;so one guy with really deep pockets might say, â&#x20AC;&#x2DC;Iâ&#x20AC;&#x2122;ll give you $10 million,â&#x20AC;&#x2122;â&#x20AC;? Rothauser says. â&#x20AC;&#x153;That would be about right, because he might double the valueâ&#x20AC;? when he sells it. Rothauser recommends that thievesâ&#x20AC;&#x201D;fictional or otherwiseâ&#x20AC;&#x201D;stick with gold. â&#x20AC;&#x153;You steal gold bars, and no one knows anything,â&#x20AC;? he says. â&#x20AC;&#x153;Itâ&#x20AC;&#x2122;s a commodity. Itâ&#x20AC;&#x2122;s like stealing truckloads of water. But diamonds? If someone gives me a necklace and claims itâ&#x20AC;&#x2122;s worth $150 million and I try to sell itâ&#x20AC;&#x201D;or even just a couple of its stonesâ&#x20AC;&#x201D;everyone would know. Theyâ&#x20AC;&#x2122;d turn me in just for the PR value alone.â&#x20AC;?
ILLUSTRATION BY 731, PHOTOGRAPH: GETTY IMAGES
CRITIC
Bloomberg Pursuits
Embrace the Patio Shoe Not quite a slipper, not quite a sneaker. Just what Dad really wants. Photograph by Stephen Lewis
The key to a good Father’s Day gift is finding something he’ll enjoy when he’s around you. May we suggest durable, comfortable footwear that’s equally sensible for
June 11, 2018
walking the dog, watching the game, or manning the grill? This $120 pair from Mahabis Ltd., which former London lawyer Ankur Shah launched in 2014, have a durable rubber sole and a “collapsible heel” sculpted from stretchy neoprene. Crucially, the hidden lining is soft, fuzzy wool. THE COMPETITION • L.L. Bean Inc.’s Wicked Good slippers ($89) come with a soft sheepskin suede exterior and an even
softer shearling lining. There’s not much support for wearing them all day long, but they’re great for a weekend at the cabin. • Glerups’s Open Heel shoes ($95) are made of felt and come in eight colors, including navy and fire-engine red. They slip of and on with delightful ease. • At $120, the Ugg Ascot slippers occupy the high end of the slip-on segment. The suede exterior has a loaferlike look, while the brand’s trademark flufy lining keeps feet warm in winter and dry in summer. THE BOTTOM LINE Although the Ugg Ascots feel like walking on a cloud, the sensation, in reality, isn’t for everybody. Shoes from the Mahabis Outdoor collection, on the other hand, almost disappear on your feet. This year the company has introduced new colors, kode slate and arden bronze. $120; mahabis.com
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PROP STYLIST: SONIA RENTSCH
THE ONE
Bloomberg Pursuits
June 11, 2018
José Quiñonez The force behind a finance technology that gives immigrants one simple but powerful tool: a credit score. By Arianne Cohen
ILLUSTRATION BY SAM KERR
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For generations, those without access to banks and credit Control Act of 1986 and, as a graduate student at Princeton’s cards have depended on one another for loans and fund- Woodrow Wilson School, discovered how legitimizing ing. As a result, millions of immigrants don’t have a credit inances in the developing world, such as giving land ownscore, even though they have plenty of credit history. ers the title to their property, held enormous potential. “People were involved in very informal lending circles,” A decade ago, San Francisco community leaders used a says José Quiñonez, chief executive oicer of Mission Asset $1 million gift from Levi Strauss & Co. to start the Mission Fund. “We thought we could create a process to formalize Asset Fund, which aims to help low-income families build that lending so that we could report it to the credit bureaus.” inancial security. “I saw the mission statement, and I was Without a credit score, it’s hard to obtain a credit card, like, ‘I love it! But how do you do that?’ ” Quiñonez says. let alone lease a car, fund a child’s education, or buy a “I didn’t want to just provide another inancial education home—all hallmarks of successful American life. Under class in Spanish with a glossy brochure.” He was hired in Quiñonez, MAF began tracking these of-the-books loan 2007 and built a pilot program to test his lending circle payments and reporting them to credit bureaus. “He’s inlu- idea. As the program grew, MAF developed a technolenced an entire ield by making the parts visible that create ogy platform on Salesforce.com that creates promissory inancial identity and track records,” says Ida Rademacher, notes and services loans. The platform is now licensed by a vice president at the Aspen Institute, which hosts a inan- 50 nonproits in 17 states. cial technology group Quiñonez has attended. MAF was unique in ofering loans with the “Lending circles have been around forever, but b. 1971, Durango, Mexico expectation that customers would succeed and his innovation was to broker the relationship pay them of on time. “A lot of the business Currently training models for low-income loans are predicated with credit bureaus.” for a half-marathon on a certain percentage of people defaulting,” Known as tandas in Latin America or susus Won a MacArthur in West Africa, these informal loans come in a Rademacher says. MAF now ofers other modest “genius” grant in 2016 variety of forms across cultures. Quiñonez’s loans—many $1,000 or less—to address common Listens to audiobooks awareness of these shadows of the banking secpain points among the poor. The fee to ile natuon chipmunk speed ralization papers, for example, is $725. It’s small tor began in 1980, when he entered the U.S. as an and eats Flamin’ Hot Cheetos with undocumented 9-year-old. He received amnesty hurdles like these that can prove huge barriers chopsticks to keep his under Ronald Reagan’s Immigration Reform and for immigrants. fingers clean
Bloomberg Businessweek (USPS 080 900) June 11, 2018 (ISSN 0007-7135) H Issue no. 4572 Published weekly, except one week in January, February, April, June, July, September, and December, by Bloomberg L.P. Periodicals postage paid at New York, N.Y., and at additional mailing offices. Executive, Editorial, Circulation, and Advertising Offices: Bloomberg Businessweek, 731 Lexington Avenue, New York, NY 10022. POSTMASTER: Send address changes to Bloomberg Businessweek, P.O. Box 37528, Boone, IA 50037-0528. Canada Post Publication Mail Agreement Number 41989020. Return undeliverable Canadian addresses to DHL Global Mail, 355 Admiral Blvd., Unit 4, Mississauga, ON L5T 2N1. E-mail: bwkcustserv@cdsfulfillment.com. QST#1008327064. Registered for GST as Bloomberg L .P. GST #12829 9898 RT0001. Copyright 2018 Bloomberg L .P. All rights reserved. Title registered in the U.S. Patent Office. Single Copy Sales: Call 800 298-9867 or e-mail: busweek@nrmsinc.com. Educational Permissions: Copyright Clearance Center at info@copyright.com. Printed in the U.S.A. CPPAP NUMBER 0414N68830
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