Friday, December 28, 2012

Do Buybacks Create Value?

There are several reasons a company would buy back its stock. A buyback could be used in lieu of a dividend, the company could be altering its debt-equity ratio, or the company could feel that its stock is the best investment possible. So do buybacks increase shareholder value? In a recent interview, Greg Milano, CEO of Fortuna Advisors, argues that buybacks result in a temporary stock price pop when the buyback is announced, but over the long-term, companies that buy back more stock tend to perform worse than other stocks. Further, the bigger the increase in the EPS due to buybacks, the lower the PE ratio falls.

Thursday, December 20, 2012

NYSE No More

The Intercontinental Exchange (ICE) announced that it would purchase the NYSE for $33.12 a share, a 38 percent premium over its market value. ICE, which operates commodities and derivatives markets around the world, was formed in 2000 yet has a larger market value than the NYSE. ICE intends to spin off many of the European operations into a separate company. Although the particulars of the spinoff were not announced, it appears that much of the spinoff will include assets acquired in the Euronext acquisition made by the NYSE only five years ago. NYSE shareholders will own 36 percent of the combined company after the acquisition.

Tuesday, December 11, 2012

LIBOR Arrests

The recent LIBOR scandal has resulted in three arrests. British police arrested three men after searching their homes. LIBOR affects an estimated $300 trillion in derivatives and about $10 trillion in loans worldwide are tied to LIBOR.

Convertible Bond Issuance Near Record

New convertible bond bond issues have a chance to reach last year's record of $20.7 billion, while at the same there has been more than $1 trillion in high-grade bonds issued during 2012. One downside of convertible bond issuance is evidence that the announcement of a convertible bond generally has a negative effect on the stock price. When electronics company Sony announced its recent convertible issue, the stock price dropped 10 percent. And anecdotal evidence suggests that some stockholders sold stock and purchased the bonds even though the bonds were zero coupon bonds.

Sunday, December 9, 2012

The 2012 Stock Market: Early Returns

Year-to-date, the S&P 500 is up around 12 percent, an average return for the market since 1926. Both the Nikkei Index in Japan and Euro Stoxx 600 are up around 13 percent. Given the problems in Greece and other European countries' sovereign debt and the recent threat of a fiscal cliff, an average market return seems pretty good. Surprisingly, the VIX, a measure of stock market volatility, is also down by 40 percent since the beginning of the year. 

Tuesday, December 4, 2012

Does Apple Really Have $121 Billion In Cash?

At the end of September, Apple reported a cash balance of $121.25 billion. But does Apple really have a savings account with that balance? Yes and no. While Apple's worldwide cash balance is $121.25 billion, the company only has $38.65 billion in the U.S. For the 600 U.S. multinationals that report cash balances held overseas, about 60 percent of the cash is overseas. Johnson and Johnson reported a cash balance of $24.5 billion, but the company holds essentially no cash in the U.S. The reason companies have not repatriated overseas earnings is that these funds would be subject to a 35 percent tax rate. The effect is to reduce a company's liquidity and ability to pay dividends or repurchase shares. For example, Emerson Electric recently borrowed money in order to pay dividends, repurchase shares, and make debt payments and pension contributions in spite of the fact that the company reported a cash balance of $2 billion.

The Average Investor

Even with our discussion of the Efficient Markets Hypothesis (EMH), we often get the feeling that many students still believe that when they leave our class they will become superstar investors and greatly outperform the market. So, how have investors done on average? In the chart of the week at BlackRock, it appears that the answer is poorly. Over the past 20 years, oil has averaged 8.6 percent, stocks have averaged 7.8 percent, and bonds 6.6 percent. Inflation has been a relatively mild 2.6 percent. Yet, over this period, the average investor has returned only 2.1 percent per year! The reason given by BlackRock is that the average investor allows emotion to rule their decisions, moving into and out of different investment classes at the most inopportune times.

Sunday, December 2, 2012

Inflation As Measured By The CPI

The Consumer Price Index (CPI) is  a common measure of inflation, however a more interesting CPI is the Christmas Price Index, calculated each year by PNC Bank. This CPI calculates the cost of all of the gifts mentioned in the Twelve Days of Christmas, from a partridge in a pear tree to 12 drummers drumming. This year, uncovering the cost of the CPI requires you to take a virtual journey around the world. Over the past year, the CPI increased 4.8 percent to $25,431.18, a fairly expensive Christmas! The biggest price jump was the 29.6 percent increase in the six geese-a-laying. Six items remained unchanged, including the partridge, turtle doves, and lords-a-leaping. And for the really interested individual, the website has prices for each of the items back to 1986, the beginning of the CPI.

Friday, November 30, 2012

Maximize Shareholder Wealth

The goal of a corporation should be to maximize shareholder wealth. Why? Since shareholders have a residual claim, if they are happy, everyone in line before them such as creditors and employees have been financially rewarded. In a new book, Lynn Stout argues that increasing shareholder value is not the goal of a corporation. In fact, her argument extends to the notion that shareholders do not own a corporation, a strange argument from a law professor. She states "No human being can own a corporation-they are independent legal entities," which makes little sense since ownership of stock confers a legal ownership of a corporation. Our response is best summed up by Charles Elson: “What [Professor Stout] is saying is nothing new and is actually quite silly.”

Another argument we disagree with is that corporations sacrifice long-term goals for short-term profit. While we don't disagree that this happens, sacrificing long-term shareholder wealth maximization does not fit with the goal of maximizing shareholder wealth. Choosing short-term results over long-term results is an agency problem that needs correction if it occurs, but not at the expense of shareholder wealth maximization.

Finally, we would like to address the statement made by Professor Stout that companies "...drain out cash through stock repurchases and dividends - all for the purpose of pumping up the share price temporarily." The relevance of dividends and stock repurchases is discussed in the text, but if the company has no positive NPV investments, excess cash should be paid to shareholders. Additionally, given that the S&P 500 companies (excluding financials) have a near record level of cash, we would argue that if anything, companies have not paid out enough to shareholders in the form of dividends and share repurchases.

Tuesday, November 27, 2012

What Are The Odds?

With the Powerball jackpot reaching $500 million, lottery ticket sales are very brisk. So what are the odds of winning? 1 in 175 million. You would have a better chance of randomly predicting the name of a female in the United States (1 in 157 million). While the jackpot is announced at $500 million, it is actually paid over 30 payments with the first payment being made today. If the winner selects the cash option, they will receive "only" $327 million. So, with equal annual payments, what interest rate is being offered? Check for yourself that it is about 3.24 percent. Of course, Powerball payments actually increase at 4 percent per year to keep pace with inflation. Given this growth rate in the payments, what is the nominal interest rate offered on the payments now? Check for yourself that the rate is about 9.82 percent.

Tuesday, November 20, 2012

HP Write-Off

HP announced an $8.8 billion write-off associated with the company's purchase of Autonomy, a British software company HP purchased for $11 billion last year. The reason for the write-off is that HP discovered Autonomy misrepresented not only its past performance but its prospects going forward. The fraud was evidently well hidden as the purchase was audited by Deloitte, which itself was audited by KPMG. HP has filed a complaint with the SEC as well as British securities regulators, with the hope that criminal charges will be filed. Civil charges against the officers of Autonomy also appear to be forthcoming.

Monday, November 19, 2012

A Christmas Present From Walmart

Walmart announced that it was moving its next dividend payment to December so that investors could enjoy the lower dividend tax rate of 15 percent, rather than face a tax rate of up to 43.4 percent (including the healthcare dividend tax) beginning in January. Walmart's total dividend payment is $1.34 billion, so investors will likely save millions of dollars in taxes, a nice package under the Christmas tree.

Friday, November 16, 2012

Twinkies Disappear

In a sad day for junk food lovers everywhere, Twinkies maker Hostess Brands has asked the bankruptcy court judge for permission to liquidate its assets. The company blamed a strike by the Bakery, Confectionary, Tobacco Workers and Grain Millers International Union (BCTGM). The company will continue to ship products until inventory runs out. Of course, Twinkies will likely make a comeback. It is likely that another bakery or private equity firm will purchase the Twinkie name in bankruptcy and bring back the familiar yellow treat.

Thursday, November 15, 2012

Stock Certificates Damaged

The flooding in New York from Superstorm Sandy hit the vault of the Depository Trust & Clearing Corporation (DTCC). While the DTCC is relatively unknown, it holds $35.6 trillion in securities and settled nearly $1.66 quadrillion in trades during 2010. The DTCC is the primary clearinghouse for securities in the U.S. The job of the DTCC is to keep track of the trades made in stocks, bonds, and other securities and track who owns those securities after each trade. Many financial instruments, such as Treasury bonds, are book entry only. This means that ownership of a particular Treasury bond is electronically recorded, often at the DTCC. Physical stock and bond certificates have been rapidly declining in favor of the book entry system, although as the damage from this flooding shows, there are still a significant number of physical financial certificates.

Monday, November 12, 2012

Dividends Jump Before January?

With the impending dividend tax increase from 15 percent to 43 percent, at least some companies are paying special dividends before January 1, 2013 to allow shareholders to be taxed at the lower rate. For example, The Buckle announced a special dividend of $4.50, more than 10 percent of its stock price and Commerce Bancshares announced a $1.50 special dividend.

Eugene Fama Interview

Professor Eugene Fama from the University of Chicago is regarded as a financial leader, with some of the most cited research in Finance. In a recent interview, Fama discusses a wide range of financial topics, including the ability of portfolio managers to beat the stock market, the equity risk premium, CAPM, and a discussion of underfunded pensions, among other topics. As for the equity risk premium, Fama argues that because of an increase in PE ratios, the equity risk premium going forward is about 4 percent, significantly lower than the approximately 7.5 percent historic risk premium since 1926. In the discussion of underfunded pension liabilities, Fama argues that "The sponsor should be discounting the liabilities at the expected return implied by the risk of the liabilities, not the expected return of the assets." To show the link between different areas of Finance, consider that while the interview discusses capital markets, this statement is a fundamental tenant of capital budgeting, that is, the cost of capital depends on the use of funds, not the source of funds.  

Saturday, November 10, 2012

Interest Rate Swaps Go Standardized

Historically, interest rate swaps have been over-the-counter and had counterparty default risk. The Dodd-Frank Wall Street Reform and Protection Act requires that most derivatives go through a clearinghouse. In December, the CME (formerly the Chicago Mercantile Exchange) is debuting interest rate swap futures. Initially, the contracts will have 2, 5, 10, and 30 year maturities. At maturity, the contract converts into an interest rate swap. But, the purchaser or seller can reverse the position prior to maturity, which will allow for interest rate change hedging prior to maturity as well. While trading these futures will require participants to post margin. The advantages of these swap futures are a highly transparent market, the elimination of counterparty risk, and the access to liquidity to exit the contract at virtually any time.

Currency Risks

If your company has operations, sales, or production in different countries, hedging is a necessity. With the recent rise of the U.S. dollar, some companies have become complacent about hedging. While U.S. companies can benefit from a rise in the dollar, it is difficult to predict future exchange rate movements. Hedging should be an ongoing process, even if the company feels exchange rate moves might be favorable. As the article notes, the business of most companies is not to take currency risk, but rather buy or sell a product. Unfortunately, some CFOs try to use currency markets to generate additional revenue. And while this may sound appealing, as with any investment, it is very hard to beat the currency market.

Tuesday, November 6, 2012

Which EPS?

One problem with using financial ratios is that the calculation of these numbers is done differently by different people. You would think that EPS would be calculated the same all over, but in fact there are two common EPS numbers, the basic EPS and the diluted EPS. The basic EPS is calculated as we have done in the textbook, that is, net income divided by shares outstanding. The diluted EPS is the net income divided by the total potential shares outstanding. Many companies use stock options to motivate employees, especially upper management. If there are a large number of employee stock options issued by the company and not yet exercised by employees the number of shares outstanding could grow rather quickly if the options are exercised. The diluted EPS uses the number of shares as if all employee stock options were exercised. This gives a lower EPS, which is a more conservative estimate of the company's EPS.

Luck Or Skill?

The efficient markets hypothesis may be the most bitterly debated topics in Finance. Portfolio managers believe that the market is not semistrong form efficient, otherwise their contribution is negligible. However, many proponents argue that beating the market is nearly impossible. Michael Mauboussin, the chief investment strategist at Legg Mason Capital Management, argues that on the skill/luck continuum, stock picking requires just abount as much luck as roulette or slot machines. In part, he argues that the number of intelligent people in the investment industry means that the distinction between the best and the worst narrows. And, as people become more skillful, luck becomes a more important component of performance.

Friday, November 2, 2012

A Prospectus Is Meant To Be Read

One cause that some have given for the recent financial problems is that the underwriters and sellers of the securities misled investors. With the discussion of various financial regulations, and passage of others, the government agrees. While we have no stance on whether investors were misled in verbal communications, it appears that these claims may be overstated. For example, in the famous Abacus CDO prospectus, Goldman Sachs stated they "..shall not have a fiduciary relationship with any investor," and that the firm "may have conflicts of interest." Even more directly in another deal, Citigroup and Credit Suisse stated that the firms may have conflicts, but also that the firms’ “actions may be inconsistent with or adverse to the interests of the Noteholders.” As an investor, you must remember that just because the SEC approves a prospectus does not mean that the SEC feels the investment is a good idea, but rather that all relevant information is disclosed. It is up to the individual to research the investment and decide for themselves.

Swaps Collateral

One of the major risks with swap contracts is counterparty risk, that is, default by the party on the other side of the contract. Even though the loss from an interest swap contract in the event of default is only the difference between the two payments, this can still result in a negative impact on the remaining party. The Dodd-Frank Act requires that the CME Group and other swap clearinghouses must now require collateral from both swap parties similar to the collateral provided in futures trading. The intent of the collateral is to reduce the risk of default and limit the impact in the event of a default. In order to allow the industry more time to resolve technology problems, the implementation of the collateral rule has been delayed until January 14, 2013.

Thursday, November 1, 2012

Apple Cannabilization

One key consideration in calculating the cash flows from a new project is side effects, including cannibalization, or erosion, of existing product sales. When Apple announced its new iPad Mini, one of the key considerations for Apple should have been the potential cannibalization of sales of the regular iPad. However, as the article points out, not all of the cannibalization is relevant. If Apple hadn't cannibalized some of its iPad sales, Amazon or Google would have taken these sales from Apple with their smaller tablets.

Using Time Value Of Money

Recently, GM decided to remove future pension liabilities from its balance sheet. To accomplish this, GM gave its salaried employees a choice: keep the pension payments as promised, although the pension payments would be made by Prudential, not GM, or take a lump sum payment now. So what information is necessary to make a decision such as this? The main components are the interest rate offered by the pension payments, the rate of return an employee could earn on the lump sum, and the difference in the risk between these two options, including the likelihood of default on the pension payments. While we doubt many GM employees made such a comprehensive analysis, 30 percent of the salaried employees took the lump sum option.

Sunday, October 28, 2012

PE Ratios and Dividends Around The World

According to FactSet, the country with the lowest PE ratio is Russia at 5.22 times, while Mexico has the highest PE at 26.90 times. The PE ratio in the U.S. is about 15.20 times. In addition to Russia, Italy and New Zealand are the only countries with single digit PE ratios, while Mexico has the only PE ratio above 20. India's stock market has a dividend yield of 1.33 percent, while Spain's average dividend yield is 8.43 percent. By way of comparison, the average dividend yield on U.S. stocks is 2.18 percent.

Saturday, October 27, 2012

No Greek Haircut

German Finance Minister Wolfgang Schaeuble announced that a "haircut", or restructuring, of Greek debt would not be possible. The Greek government had asked for a haircut on the country's debt, in this case a by reducing in the coupon rate and extending the maturity of Greece's debt. Schaeuble stated that refunding, or buying back outstanding bonds and replacing them with new debt, was a possibility.

Friday, October 26, 2012

Microsoft Wins Treasury Award

Microsoft has more than $1 billion in cash flowing through the company each day, so working capital management is a very important task. Recently, the company was awarded the Alexander Hamilton award by Treasury and Risk. Microsoft's working capital team worked on ways to improve cash forecasting. The team was able to reduce forecasting variances by 50 to 70 percent each month, resulting in a drop of over $200 million in the cash balances of subsidiaries.

Thursday, October 25, 2012

Crowdfunding A Startup

A new potential source of financing for small businesses seems to be growing closer to reality. Crowdfunding, or small investments by many individuals, was part of the JOBS Act, which was enacted in April 2012. The new law will allow individual investors to invest in startups through the Internet. Although crowdfunding has been passed into law, the SEC must still set the rules and regulations for these new "exchanges". Investors in crowfunding must be accredited. For an individual, this means more than $1 million in net worth or more than $200,000 in income for two of the past three years. A recent article for small business owners explains some of the rules, drawbacks, and taxes for crowdfunding.

Wednesday, October 24, 2012

M&A Down, Insurance Coverage Up

In the first half of 2012, mergers totaled $929.4 billion, down about 22 percent from the same period in 2011. At the same time, M&A insurance has increased. Policy limits for M&A insurance rose to $2.3 billion, a 35 percent increase. M&A insurance typically pays off if a seller misrepresents the position of the company. Such misrepresentations can include financial statement errors, errors about the customers of the company, or lying about the status of lawsuits or potential lawsuits. The buyer then may be able to file a M&A insurance claim for up to two years after the transaction.

The Board Versus The CEO

At one time, a company's Board of Directors was viewed as a rubber stamp for the CEO. Recently, Boards have become more active in the management and control of the company. Citi CEO Vikram Pandit resigned last week after a clash with Citi's Board and in 2011 Yahoo's Board fired CEO Carol Bartz. Other companies that have lost CEOs or Board Chairman leaving because of discord include American International Group and Hewlett-Packard. A recent survey indicates that 21 percent of Board Chairman in 2011 were independent, up from only 10 percent in 2006. Other factors cited which may be leading to the increased activism of Boards includes the recent financial crisis, increased regulation, and fear of investor lawsuits.

Tuesday, October 23, 2012

Cash Balances

When things get risky and uncertain, cash is king. Many companies seem to be following this advice. In fact, the cash balance for the S&P 500 companies is approaching $1.5 trillion. CNBC recently compiled a list of 10 cash rich companies. For example, Priceline has $2.4 billion in cash, which is 63 percent of the company's assets, compared to an industry average of about 20 percent. And Altera Corp. has $3.44 billion in cash, which is 80 percent of assets, compared to an industry average of 27 percent.

Monday, October 22, 2012

The NPV Of A College Degree

While there has been debate about the cost of a college education, any analysis of cost should include both all outflows and all inflows. A recent article from Brookings discusses both the cost and financial benefits of a college degree. The Hamilton Project found that the return on a college degree doubled the stock market return since 1950 and is more than five times the return on corporate bonds, long-term government bonds, gold, or home ownership. The average IRR of a college education since 1950 was 15.2 percent. Since 1976, the IRR has fluctuated between 14 and 18 percent. In 1980, the NPV of a college degree was about $260,000 at a 5 percent rate and the NPV grew to more than $450,000 for someone starting college in 2010. Although the text deals with capital budgeting in a corporate context, remember that capital budgeting techniques can actually be applied any time a financial decision is being made.

Wednesday, October 17, 2012

Share Repurchases Set To Rise?

With the potential tax increase on dividends, the potential for smaller dividend increases offset by increases in share repurchases exists. If capital gains are taxed at a lower rate than dividends, capital gains should be preferred by investors. Another interesting point in the article is the reference to the performance of stocks in companies that follow through with share repurchases. Such companies have outperformed the market as a whole, which may indicate that share repurchases, when completed, give a similar signal as dividend payments.

Tuesday, October 16, 2012

Dividends Are Here To Stay

Why do companies pay dividends? According to finance theory, investors should be indifferent to dividends or capital gains assuming equal taxation. And when dividends are tax disadvantaged, investors should prefer no dividends and the subsequent increase in capital gains. Professor Douglas Skinner, an accounting professor at the University of Chicago, discusses the dividend puzzle. As is noted in DeAngelo, DeAngelo, and Skinner (2004), the top 25 dividend payers account for more than one-half of all dividend payments. Skinner points to continued dividend payments as a result of: 1) The signalling power of dividends. That is, dividends are a strong signal that the firm will continue to be able to pay dividends. 2) Dividends reduce the ability of managers to squander cash. 3) Widows, orphans, and regulations that force large institutions to invest in dividend paying stocks. As Dr. Skinner points out "Although we haven’t yet established the reason, the data are very clear: Dividends, even though they remain a puzzle, are here to stay."

Presidential Capital Budgeting

In September 2010, President Barack Obama spoke to A123 Systems Inc. CEO David Vieau and Michigan Governor Jennifer Graham about the opening of a new electric car battery plant in Livonia, Michigan. President Obama proclaimed that “This is about the birth of an entire new industry in America -- an industry that’s going to be central to the next generation of cars.” Unfortunately, the results from a new project can be wildly different from capital budgeting projections. Today, A123 filed for bankruptcy protection. Part of the reason for A123’s bankruptcy lies in the fact that the government targeted sales of 1 million electric vehicles by 2015, but as of September 2012, only 50,000 electric cars have been sold in the U.S. A potential suitor for A123 is Wanxiang Group Corp., China’s largest auto-parts maker. Such a bid would likely result in car batteries made in China, not the U.S., a stated goal of U.S. government support of A123.

Monday, October 15, 2012

Starbucks And U.K. Taxes

A common criticism of the U.S. tax code is that corporations do not pay a fair share of taxes on income. But this is more widespread than just the U.S. Since 1998, Starbucks has earned over £3 billion ($4.8 billion) in revenue in the U.K. yet has paid only £8.6 million pounds ($13.44 million) pounds in taxes. There is no indication that Starbucks has done anything illegal, but it has used the U.K. tax code to its advantage. Overall, Starbucks has paid 13 percent tax on its international operations. One way companies as diverse as Starbucks and Google avoid taxes is to charge subsidiaries for intellectual property from a business that is domiciled in a tax haven country. The second method used is that the coffee sold in the U.K. is roasted at a subsidiary in Amsterdam, which sets the price it charges U.K. Starbucks. A final method is inter-company loans. A subsidiary in a low or no tax country makes a loan to a subsidiary in a high tax country. The borrower can deduct the interest payments, but the low tax subsidiary pays little or no tax on the interest income.

Saturday, October 13, 2012

Mutual Funds Underperform The Market

Although many professional money managers and investors would like to think that they can beat the market, the evidence is against this belief. New research shows that for the 12 months preceeding June 2012, the S&P Composite 1500 outperformed 89.84 percent of all actively managed U.S stock funds. For the prior three years and five years, the percentages were 73.24 percent and 67.72 percent, respectively. Mutual fund performance is even worse for bonds funds with 93.62 percent of actively managed long-term government bond funds trailing the Barclays Long Government index. These percentages lend support for the stock (and bond) market being semistrong form efficient.

Thursday, October 11, 2012

Porsche Sued Over VW Acquisition

Back in 2008, Porsche made a failed acquisition bid for Volkswagen. Although two lawsuits have recently been dismissed, a new lawsuit has been filed by the family of industrialist Adolf Merckle. Merckle committed suicide after several of his investments, including a short position in VW, turned sour. Merckle's family is arguing that Porsche camouflaged its potential acquisition of VW and secretly purchased VW shares. When the potential acquisition was announced, VW shares shot up, forcing Merckle and other short sellers to scramble to cover the short positions.

Tuesday, October 9, 2012

Net Income Is Fiction, Cash Flow Is Fact

With all of the regulation regarding regarding financial reporting, including Sarbox, you might conclude that the earnings reported by a company would be precise and correct. However, recent research indicates that 20 percent of companies manage earnings. Managing earnings in this context means that companies may under-report earnings in one quarter to offset potential down earnings in future quarters. In a recent interview, Dr. John Graham discusses the results of his research and suggests that a more important measure of corporate performance is cash flows. While earnings can be manipulated through accounting choices, cash flow is much more difficult to manipulate.

30-Year Bond Issuance Rises

Companies are issuing 30-year bonds at a frenetic pace. So far in 2012, about $92 billion worth of 30-year bonds have been issued, more than in any full year since 1995. Companies are issuing long-term bonds because investors are willing to buy because of the almost non-existent short-term yields, and companies are locking in the low long-term yield. The investment grade YTM for 30-year bonds is at 2.77 percent, down from over 7 percent four years ago. Comcast recently sold $1 billion in 30-year bonds at 4.45 percent, compared to the 6.5 to 7 percent range the company had paid a couple of years ago. This resulted in a $20 million annual savings on interest payments. Even General Electric, which hadn't sold 30-year bonds for five years, issued $2 billion in 30-year bonds.

Friday, October 5, 2012


For the year, 105 IPOs have been priced, more than the 96 that were priced in the same period in 2011. IPOs have raised $36.1 billion, 23.4 percent more than in 2011. On the downside, 50 IPOs have been cancelled during the year, the most recent by Dave & Buster's. Over the past nine years, an average of 55 IPOs have been cancelled each year, with 2008 seeing 103 cancellations.

Thursday, October 4, 2012

Sprint Down And Down

Yesterday Deutsche Telekom, parent of T-Mobile, announced that it was entering negotiations to purchase MetroPCS. The stock price of telecom rival Sprint, which backed out of the acquisition of MetroPCS earlier this year, fell on the news. Today, a report by Bloomberg announced that Sprint was considering a counter-bid for MetroPCS. So what would you expect happened to Sprint shares on this announcement? The stock fell by an additional 3 percent. One interpretation is that the market views a T-Moblile/MetroPCS merger as a negative for Sprint, but a Sprint purchase of MetroPCS as even more negative, possibly because Sprint may be forced to overpay for MetroPCS in a bidding war.

Wednesday, October 3, 2012

U.K. Department of Transport Fails Finance

Sir Richard Branson's Virgin Trains, which has been operating a British railway line since 1997, recently lost on a bid to continue operating the line until 2027. So Virgin Trains sued over the decision. In the buildup to the court case, the U.K. Department of Transport (UKDT) retracted the offer to run the line by rival FirstGroup. So why the the UKDT back down? While the reason given was vague, it is probable that the UKDT did not properly evaluate the cash flows it would receive from the winning bid. As the article states, it seems likely that the UKDT did not discount the back-end loaded payments which made FirstGroup's bid appear larger than Virgin Trains.

Sunday, September 30, 2012

It's September, Time To Buy

At the beginning of the month, we referenced an article which suggested that investors should sell in September. And we are happy we didn't follow the advice in the article. For the record, the S&P 500 increased by about 2.4 percent in September, from 1,406.58 to 1,440.67. We would be happy with that return in any month.

Friday, September 28, 2012

Duke Energy Coup, Part Deux

Back in July, we posted about the two hour CEO job that William Johnson held for with the merged Duke Energy/Progress Energy. As with many complicated stories, time allows for more information to be disseminated. For example, in an interview, old/ex/new CEO Jim Rogers said that he had only given up his position as a CEO of Duke Energy in order to pay a lower premium for Progress Energy. This implies that William Johnson helped aid the sale of Progress at a discount in order to be the CEO of the combined company, an accusation he vehemently denies.

Thursday, September 27, 2012

Investors Happy About RIM Loss

Research In Motion (RIMM), the manufacturer of the Blackberry, announced a loss of $235 million or 45 cents per share for the second quarter compared to a profit of $329 million or 63 cents per share in the second quarter last year. The loss per share excluding one-time expenses was 27 cents per share. While this would seem to be bad news, RIMM shot up 14 percent after the announcement. So why the big jump in the stock price? Analysts had expected a loss of 46 cents per share. As one analyst stated: "It's still bad, but it's a much smaller disaster than expected."

Student Loans Climb

The average student loan debt has climbed to $26,682. Currently, unsubsidized Stafford loans have an interest rate of 6.8 percent. So, if you graduate with an average student loan debt and pay off your loan over the next 20 years, what are your monthly payments? See if you don't agree that it will be $203.67 per month.

Tuesday, September 25, 2012

IPO Doubles Stock Market Size

Morgan Stanley has withdrawn as the lead underwriter for the Asiacell IPO, which is set to take place on the Iraqi bourse. It will be the first major IPO on the Iraqi market since 2003. One interesting fact about the IPO is the large size relative to the Iraqi bourse. The Iraq Stock Exchange has a market capitalization of about $3.4 billion and trades an average of $3 million per day. Asiacell is expected to have a market capitalization of about $4.4 billion on its own.

Monday, September 24, 2012

GM Looks For A Revolver

GM is seeking a new revolver, or revolving credit line, for between $8 and $10 billion. The revolver will be used to replace an existing revolver of $5 billion, pay down other debt, and to provide liquidity. The commitments from individual banks will start at $600 million and go down to $350 million for the second tier. The upfront fees are 35 to 50bp (bp is a basis point, or 1/100th of a percent. One basis point is equal to .01%) depending on the amount committed by the bank. The interest rate on the loan is expected to be 250bp over LIBOR, and GM will pay 37.5bp on the unused amount of the revolvers.

Friday, September 21, 2012

Option Straddles

So now that you have learned about options, maybe you think you are ready to buy and sell options. A popular option trading strategy is a straddle. With a straddle, you buy a call and a put with the same exercise price and expiration date. You are betting on the volatility of the underlying stock. That is, you make money with a big price movement either up or down. However, as with any investing strategy there are risks. With a straddle, you will lose if the stock price doesn't move enough to offset the price of both options. For more on straddles, check out this article.

Thursday, September 20, 2012

IPO Bump?

It is well documented that there are cycles in IPOs. Recently, the IPO market has been relatively slow, but some analysts believe that the time may be right for an increase in the number of IPOS. The stock markets have experienced good returns over the past year, recent IPOs have performed relatively well, and the VIX, the market's "fear gauge," is low.  Additionally, the JOBS Act, which allows companies to file a confidential first draft of its registration documents, may increase the number of publicly traded companies.

Should FX Exposure Always Be Hedged?

For a company with an exposure to currency risk, hedging with derivatives is one way to reduce or eliminate that risk. However, a risk manager at one bank argues that companies should not automatically hedge exchange rate risk. For example, if a U.S. company is going to receive euros at a future date, it will lose if the dollar weakens. If the company expects the dollar to strengthen, a good hedging strategy may not involve a hedge at the current exchange rate, but to allow a small risk in order to give the market time to move in the expected direction. While we are not endorsing or condemning the particular strategy used in the article, we definitely agree that hedging is not a one size fits all activity and should be fit to the particular company and situation.

Wednesday, September 19, 2012

Turkey Issues Sukuk

Turkey announced that it was issuing its first sukuk, or bonds compliant with Islamic law. Turkey expects that it will sell $1 billion of the dollar-denominated bonds. Turkey will sell certificates to investors, who then lease them back at a fee. The offer is oversubscribed, with about $6 billion in orders for the bonds. The sukuk will pay an interest rate about the same as comparable Turkish government bonds. Overall, about $13 billion of the $24.3 billion worth of bonds issued in the Middle East in the first half of 2012 have been sukuk.

Tuesday, September 18, 2012

Cash They Can't Spend

Companies seem to have a lot of cash on hand recently. For example, Google has about $44 billion in cash and short-term investments and Apple has about $28 billion on its balance sheet. But the tech giant with perhaps the biggest cash horde is Microsoft, with about $63 billion in cash on its balance sheet. So why doesn't Microsoft spend some of this cash? One reason is that of the $63 billion in cash, $54 billion is held by the company's overseas subsidiaries. In order to spend this cash, Microsoft would need to repatriate it, resulting in taxes being paid on the overseas profits.

Saturday, September 15, 2012

Twinkie Goes Stale?

According to the urban legend, a Twinkie never goes stale, but its parent has gone stale. Hostess, in the middle of bankruptcy filing, has asked the bankruptcy judge to force a new contract on one of its employees' unions. Hostess is in its second bankruptcy since 2004 and has argued that without a new labor contract it will be unable to continue operations. Fortunately for junk foodies, even if Hostess does not emerge from bankruptcy it is likely that most of the company's iconic brands such as Twinkies, Ding Dongs, and Cupcakes will be sold to another company.

Friday, September 14, 2012

Early Release for Lockups

Lockups, agreements that restrict the ability of insiders to sell stock in an IPO, have traditionally lasted for 180 days after the IPO. Recently, lockup provisions have been shortened for many IPOs. In fact, the lockup period for ExactTarget was only 7 days after the IPO. One reason may be an increase in fees for the underwriter. The lead IPO underwriter is almost always the underwriter on the secondary offering from the lockup shares if the secondary offering is less than 180 days from the IPO. After 180 days, the underwriter for the secondary offering is up for grabs.

Wednesday, September 12, 2012

I'll Take That Negative YTM Treasury

Recently the U.S. Treasury sold new bonds at a record low YTM of negative 1.286 percent over five years. The reason investors were willing to a take a negative YTM is that the bonds are TIPS. With TIPS, the government increases the par value each year by the inflation rate. Given that regular Treasuries with the same maturity had a YTM of .71 percent, buyers of the TIPS are expecting inflation to average about 2 percent over the next five years in order to break even. The expected break even inflation rate is 2.376 percent over 10 years and 2.39 percent over 30 years, all well below the average inflation rate of 3.1 percent since 1926.

Tuesday, September 11, 2012

Moody's May Downgrade U.S. Debt

In August 2011, S&P downgraded U.S. Treasury debt from its vaunted AAA credit rating. Over a year later, Moody's announced that it may also downgrade U.S. Treasury debt from its current Aaa rating. Moody's blamed the the possible downgrade on the "fiscal cliff". In January 2013, government spending cuts and tax increases are set to take place, which analysts believe may lead to another recession.

Monday, September 10, 2012

Chevrolet Volt: Bad Capital Budgeting

By most accounts, the Chevrolet Volt has been a dismal failure. Year-to-date, Chevrolet has sold just 13,500 Volts, well below the 40,000 cars that GM had projected for 2012. The car's $39,995 base price, along with long charge time, has not helped sales. Of course, reporting on the Volt's financial results can be as weak as the car's sales. For example, as the article notes, it currently costs GM between $75,000 and $88,000 to build each car, including development costs. GM spent between $1 billion and $1.2 billion in development and tooling costs, or just under $56,000 per car sold since the model's introduction. In any capital budgeting analysis, such calculation are meaningless for several reasons. One notable reason is the shaky analysis in the first line of the article that implies it isn't a good thing for GM to sell more Volts. The actual cost to build a Volt is estimated to be $20,000 to $32,000, so any sale above that variable cost increases the NPV of the project. One thing the article does point out is that the development of the of the Volt does provide technology that can be applied to future vehicles, a strategic option in green technology.

Sunday, September 9, 2012

Profit Margin = Net Income / Sales?

When you are examining ratios, you must be careful that you know how that ratio is calculated. For example, the profit margin for private companies in 2012 has reached 9.1 percent over the past three months, about triple the profit margin in late 2009 and early 2010. You would think that everyone would calculate a ratio as basic as the profit margin in the same manner, but that isn't true. If you read the last paragraph carefully, you will find that the profit margin for private companies often excludes taxes and includes owner compensation in excess of market-rate salaries. In this case, we can't compare the profit margin for a private company and a public company even if they are in the same industry since the calculation of the profit margin is different.

Why Take This Class?

Based on our experience, many students have a negative view of Finance at the beginning of the class. So why take this class? A recent study found that most retail investors “have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.” Only 14 states currently have a required personal finance class. While we do not believe that this class will make you an informed investor by itself, many of the concepts are applicable to basic investment decisions and can serve as a foundation for your future financial literacy.

Wednesday, September 5, 2012

Sell In September?

"Sell in May and go away," an old stock market adage, advises investors to sell stocks in May and not reinvest until the fall, typically around Halloween. Since 1896, September has been the Dow Jones Industrial Average's worst month with an average loss of about 1 percent. And since 2000, September has seen an average loss of 2.12 percent. On the bright side, 5 of the last 7 Septembers have had positive returns.  Whether or not September 2012 has another negative return remains to be seen, but technical analysts should have already left the stock market.

Tuesday, September 4, 2012

EU Warned About Credit Problems

Moody's cut the European Union's creditworthiness from "stable" to "negative". In July, Moody's revised the outlook downward for Germany and the Netherlands. Moody's stated that it believed that member countries would likely back their sovereign debt rather than EU debt. The EU recently announced a bond buyback for the sovereign debt of Spain and Italy, two countries that have large deficits and borrowings, leading to very high sovereign debt interest rates.

Monday, September 3, 2012

Dividend Tax Expires, Stock Unaffected?

A recent opinion article in CFO argues that allowing the Bush dividend tax cut to expire will not affect stock prices. In other words, the author argues that tax rates on dividends do not affect stock prices for four reasons: 1) Dividends are critical to returns and smart investors do not turn their backs on dividends. 2) Dividend paying stocks remain in high demand, the widows and orphans argument. 3) Institutional investors will not be impacted, a rephrasing of the widows and orphans argument. 4) There is no evidence that companies adjust dividends based on shareholder taxation, an argument that DeAngelo, DeAngelo, and Skinner (2008) might disagree with (Figure 19.8).

Sunday, September 2, 2012

The Bonds They Are A Changin'

Goldman Sachs recently pulled its Dylan bonds from the market. Goldman had originally expected to sell $300 million worth of the bonds, backed by the royalties received from songs written by Bob Dylan. The bonds were expected to be issued with a BBB- rating, but Goldman pulled the bonds to separate the cash flows into two classes, or "tranches". The senior tranche will carry a higher credit rating, while the subordinated, or junior, tranche will have a lower credit rating and bear more default risk than the senior tranche.

Samurai Bonds Issuance Rises

Samurai bond issuance is rising due to low Japanese interest rates and demand from Japanese investors. About $7.2 billion worth of Samurai bonds have been issued this year by Asia-Pacific borrowers. While this is down from the $8.2 billion issued over the same period the previous year, it is up 20 percent from 2010. Japanese investors are eager for the samurai bonds after the 2011 tsunami revealed the problems with too much domestic debt exposure, resulting in "reverse roadshows". Typically, a lender will have a roadshow to attract potential investors, but demand for samurai bonds is so high that borrowers are running reverse roadshows in which they search for potential lenders to offer samurai bonds.

Saturday, September 1, 2012

Economists Learn Finance

One of the central tenets in Finance is the importance of market values and this is true when managing risks. When the recent financial crisis began in 2007, the models used by Federal Reserve economists were unable to explain the problems occurring in the economy. So, Finance came to the rescue. The Federal Reserve had always believed itself better informed than the market, but investors can provide important information about the risk a particular bank poses to the rest of the financial system. One of the new models being used by the Fed is the Marginal Expected Shortfall Approach, developed by professors at NYU's Stern School of Business.

Friday, August 31, 2012

Corporate Bond Sales Record

Corporate bond sales in August reached a record $237.6 billion. A major reason was likely low interest rates, which reached 3.72 percent according to the Bank of America Merrill Lynch index. Siemens issued 13 year bonds at 2.75 percent and 30 year bonds at 3.75 percent. JP Morgan issued 5 year bonds at a 2 percent yield and perpetual preferred shares at 5.5 percent, an especially low rate considering the preferred stock was rated as junk.

Wednesday, August 29, 2012

A Cheap Stock Market

Compared to five years ago, the S&P 500 is 15 percent cheaper. The PE for the S&P 500 based on forward earnings is currently 12.7 times, down from 15.1 times at its peak in 2007.

Mergers Down...And Up

From June until today, the dollar amount of mergers was only $191.9 billion, the second lowest number in the past six years. But the 3,400 mergers were also the second highest number of mergers over the same period. Recent mergers and acquisitions have generally been "bolt-on" mergers, that is adding to an existing division, rather than "transformational" mergers which add an entirely new division or product line.

Yelp Up After Lockup Expiration

Generally when lockups expire 180 days after an IPO, the stock price falls. Contrary to expectations, Yelp was up as much as 22 percent on the day of its lockup expiration. About 52.7 million shares were freed up today, or seven times the current number of shares available for trading. The fact that no large sales were made by insiders is likely the cause. A large number of Yelp shares had been short sold, and with the lack of a price drop, short sellers could be buying to cover their position.

Tuesday, August 28, 2012

LIBOR Lawsuits

Lawsuits over LIBOR manipulation are growing, from individual and institutional investors who argue that their bond returns were artificially lowered to cities and hedge funds who argue that their financial contracts cost more because of trader actions. The size of the potential payouts by banks varies dramatically from $7.8 billion to $176 billion. Many of the lawsuits will be class action, especially for individual investors. For example, the lead plaintiff on one case lost about $100 in interest over a 34 month period. As with many lawsuits, it will likely take years in the courts to be resolved.

Monday, August 27, 2012

You Spent How Much?

Energy companies have been under scrutiny for their large net incomes in recent years, but as the saying goes, "It takes money to make money." In our discussion of capital budgeting, we note that good estimates are necessary because of the large sums involved. So how large is large? You would think the $28 billion price tag for the Three Gorges Dam in China is fairly large, and indeed it is. But compared to the $116 billion Kashagan project in Kazakhstan, it is relatively small.

Death Annuities

Like many terms in Finance, annuity has several different meanings. In the textbook, we define an annuity as a stream of payments over some specific period. In the insurance industry, an annuity is a tax-deferred account that allows for savings and investment. The investment vehicles can vary from a fixed rate investment to a variable annuity that allows for investments in the stock market. The insurance annuity is similar to our textbook definition of an annuity since unless it is terminated early, at some point the annuity will be annuitized, that is, a stream of payments will be made from the balance of the account. Since they are sold by insurance companies, an annuity also has a death benefit. However, a loophole in annuity contracts has allowed Joseph Caramadre to make upwards of $15 million from the death of annuitants. For an audio version, listen here.

Bring On The Noise

One problem raised in the Facebook IPO was that relevant information about the company was disclosed to a group of select investors but not to the general public. However, under the current quiet period rules, it appears that nothing wrong was done. In part because of this, the SEC has decided to review quiet period rules in light of technology improvements. The existing quiet period rules allow for the underwriter to communicate with its clients but not the general public. Although current SEC chairman Mary Shapiro said the current rules offer "real benefits", Representative Darrell Issa has requested that the SEC reevaulate the quiet period.

Hertz Buys A Dollar

After three years of negotiation, Hertz has agreed to buy Dollar Thrifty for $2.3 billion. The original offer made two years ago was for $41 per share, or about $1.2 billion. By holding out for two years, Dollar Thrifty doubled the price it received for shareholders. During the merger talks, competitor Avis was drawn into acquisition talks, but withdrew from the bidding in large part due to antitrust concerns. As part of the deal, Hertz agreed to sell its Advantage Rent A Car unit.

Best Buy Changes Mind...Again

In a surprising move, Best Buy has given founder Richard Schulze the go-ahead to pursue his potential acquisition of the company. Just last week, Best Buy rebuked Schulze's initial offer and hired turnaround specialist Hubert Joly as its new CEO. Schulze has been given access to the company's financial information and is allowed to recruit partners for the potential acquisition. Schulze has 60 days to make an offer. If rejected, he would have to wait until January to make another offer.

Sunday, August 26, 2012

The Downside To A Fast Cash Cycle

As PC sales have slowed industry wide, Dell's sales have slipped as well. One of Dell's claims to fame and a reason for its profitability is a fast cash cycle. In fact, during many years, Dell had a negative cash cycle. But Dell's slowing sales and cash cycle have caused a problem. When sales are increasing, the company is getting paid to make products faster than it is making them. When sales slow, the cash needed to pay for old orders can become greater than the cash received from new orders.

Wednesday, August 22, 2012

Option Volatility

In the Black-Scholes option pricing model, the only variable that is not directly observable is the volatility of the stock. In practice, an implied volatility is often calculated. To do this, we take all of the observable variables including the option price, plug them into Black-Scholes, and solve for the standard deviation that gives us the current option price. Doing this calculation directly is not possible. You must use trial and error, or a computer program.

As you can imagine, when company specific news is expected in the future, the implied volatility rises. One announcement that can cause a large swing in the stock price is earnings. It is fairly common for the implied volatility to rise when a company's earnings announcement draws near. In this video, Dan Passarelli discusses the implied volatility of HP's options near the company's earnings announcement, as well as option trading strategies for HP stock. Note, the option trading strategies he discusses are fairly advanced.