Friday, August 29, 2014

Hortons' Poison Put Covenant

When Burger King announced its acquisition of Tom Hortons Inc. this week, Hortons' bondholders felt the effect as bond prices fell from 106 to 101 because of the lowered credit rating for the combined company. However, when the expected downgrade is announced, analysts believe the bond value will drop to 90 percent of par. Most of the bonds will likely be redeemed by Hortons as the bonds have a put provision that allows the bondholders to force Hortons to buy back the bonds at 101 percent of face value in the event of a takeover. While the put does protect bondholders from absorbing the full loss in value, bondholders will still experience the 5 percent drop in bond value. In Europe, Spens clauses force the company to buy back bonds closer to the market value of the bond prior to the acquisition.

Monday, August 18, 2014

Credit-Ratings Agency Regulations

It appears that the SEC is close to increasing the regulations on credit-ratings agencies. Traditionally, credit ratings for bond issues have followed the "issuer pays" model, that is, the bond issuer pays the ratings agency fee. This arrangement can lead to a conflict of interest as a credit-ratings agency that awards low ratings could lose business in the future. The new rules are designed  to "take additional steps to ensure that the firms’ interest in winning business doesn’t affect ratings analysis." Additionally, the new regulations require more disclosures to investors, never a bad outcome.

More Than A Dollar

In what will likely become a bidding war, Dollar General offered $9.7 billion for Family Dollar Stores, topping the $9.2 billion offer from Dollar Tree. The offer by Dollar General is for $78.50 per share, but Family Dollar stock reached about $81 today, and indication that investors are expecting the bidding to continue. Dollar General is expecting annual synergies of $550 to $600 million beginning in the third year of the merger. Assuming perpetual synergies and a zero NPV acquisition, the company appears to be using a required return from 5.1 to 5.6 percent.

Tuesday, August 5, 2014

Be Careful Of Numbers

Last week we published a post about recent share buybacks. In that post, the article we referenced noted that the 100 stocks with the biggest buybacks had outperformed the S&P 500 by 10 percentage points in 2013, but trailed the S&P 500 by about 1 percent in the first quarter of 2014. As we like to caution our students - Be careful of numbers. A more recent article about share buybacks notes that the top 100 repurchasers have outperformed the S&P 500 by about 1 percent so far this year, a reversal from the previous article. So, while the companies with the largest buybacks didn't outperform the S&P 500 in the first quarter of 2014, they did in the second quarter.

While this is interesting, the more important point for you going forward is to critically examine  historical numbers. Just because something happened in the past does not mean that it will occur in the future, or, in this case, just because a past relationship doesn't hold during a specific time period doesn't mean that that relationship won't continue in the future. In short, a sense of skepticism is a healthy thing when dealing with historical numbers.

Friday, August 1, 2014

Diversification And Rebalancing

By now you are aware of the benefits of diversification. As this article states "you don’t diversify to gain the highest returns. You do so to ensure you don’t get the lowest." An important part of diversification that you should be aware of is rebalancing. Suppose that you decide you want a portfolio that has 70 percent stocks and 30 percent bonds. Since stocks generally have a higher return than bonds, over time, your portfolio weights will gradually shift more heavily toward stocks. Because of this, you should rebalance your portfolio periodically. In other words, you should sell some of the better performing asset and buy the other asset in order to return the portfolio weights to 70/30, your original allocation.

Thursday, July 31, 2014

Share Buybacks

In the first quarter of 2014, S&P 500 companies repurchased about $160 billion of their own shares. Companies may be motivated to repurchase shares because of slow domestic growth, which can make share repurchases an attractive alternative for corporations. Another motivation mentioned in the article  is that share repurchases may be used to readjust a company's capital structure. In the past several years, the stock market has increased in value, which has likely increased the equity weight of a company's capital structure. As a result, a company's capital structure may be too heavily tilted toward equity. A share repurchase can reduce the equity, thus restoring the capital structure to the optimal level.

A point about share repurchases addressed in the article that is particularly near and dear to us is research that finds companies are not particularly good investors. In fact, companies tend to undertake repurchases when company stock valuation is at a peak instead of when company stock is undervalued. One reason for this contradiction may be that as company performance increases, cash held by the company increases, as well as the stock price. As a result, companies have cash available when its stock price is high, which is the worst time to buy stock. 

The Value Of Stock Splits

In the textbook, we argued that stock splits appear to have no value to either shareholders or corporations. However, it appears that our analysis may be incorrect and there could well be an important advantage from stock splits that accrues to management.