Monday, July 30, 2012

Excess Euros

Apparently European companies could do a much better job of managing working capital. According to recent research, European companies could free up €886 billion ($1.09 trillion) in cash by improving working capital. The report found that the best performing companies collect 16 days faster, pay 16 days slower, and have about one-half of the working capital of a typical company. And very few companies appear to be stellar working capital managers. Of the 925 companies examined, only 99 improved working capital every year for three years and no company managed to improve the receivables period, inventory period, and payables period each year.

Sunday, July 29, 2012

An Olympic Capital Budget

While it may come as a surprise, even the Olympics can be viewed as a capital budgeting project. And the London Olympics could have had better financial planning. The 2012 Summer Olympics cost London nearly $15 billion, or about five times the original estimate. London gets repaid with broadcast dollars, and the broadcasters get repaid with sponsors' advertisements. Whether the sponsors actually receive a return on investment is more difficult to calculate.

Happy Birthday Sarbox!

Ten years ago, Sarbanes-Oxley, better known as Sarbox, was enacted into law. Experts say that for the most part, Sarbox is working. The law has strengthened accounting and helped reduce the likelihood of another Enron-sized book-cooking meltdown. Although Sarbox requires financial statement certification by executives, only a handful of criminal charges have been filed for violations, but over 200 civil cases have been filed under the law. Another indication of Sarbox's success is that restatement of financial reports has dropped from 1,790 in 2006 to around 790 for the past two years.

Saturday, July 28, 2012

Cash, Taxes, And Dividends

More than a few companies are sitting on piles of cash. For example, Apple has more than $117 billion in cash, Microsoft has more than $60 billion, and Google has more than $43 billion. Since these companies are in relatively saturated markets, there is less room for capital investment. So why don't these companies pay larger dividends? One argument is the repatriation of foreign income. Many of the cash piles are in foreign subsidiaries. If the cash is repatriated to the parent, the company must pay a 35 percent tax rate (less any foreign taxes paid) on the repatriated funds. Then shareholders are forced to pay a further 15 percent on the dividend income, a combined tax rate of nearly 50 percent.

How Much Is That Degree?

The average cost for a year of college is $15,100 at a public university and $32,900 at a private university. Over the last 10 years, the cost of a year of education at a public university has increased 6.5 percent per year. As a result of the (unfortunate in this case) exponential effect of compounding, this means that in 2030 the average cost per year of a public college will be $44,047.

Wednesday, July 25, 2012

Share Repurchases Slow In Being Fulfilled

Over the last 12 months, 565 companies have announced share repurchases for $185.9 billion, but to date only about $68.8 billion in stock has been repurchased. However, in July 2010, a similar report found that only one-half of the companies that announced share repurchases had actually begun buying shares. All 565 companies that have announced share repurchases have made at least minimal buybacks. Further, some evidence suggests that only one-third of share repurchase announcements are ever fully completed.

Monday, July 23, 2012

Apple Cashes In On Cash

By any account, the performance of Apple's stock has been fantastic in recent years and at least part of that performance can be traced back to its management of fixed assets and net working capital. Apple manufactures nothing, but instead contracts out production of iPhones, iPads, and Macs to someone else. These manufacturers are then forced to make large capital investments necessary for production, reducing Apple's need for fixed assets. And many of these suppliers produce products only for Apple, meaning that Apple has leverage in negotiations with its suppliers. Apple pays it payables 83 days on average after receiving the invoice. On the receivables side, Apple collects in 18 days on average and has just 4 days of inventory on hand. As a result, Apple's cash conversion cycle is an incredible negative 61 days!

Credit Rating Falls, YTM Declines?

One year ago, S&P dropped the credit rating on U.S. government debt from AAA to AA. Normally a decline in the credit rating results in an increase in the YTM of the debt. However, in the year since the credit rating drop, interest rates on 10-year U.S Treasury notes have fallen from 2.56 percent to 1.51 percent. Additionally, mortgage rates have fallen, the dollar has strengthened against an index of major currencies, and the  DJIA has risen 12 percent. The contrarian drop in interest rates is largely attributable to the size and resilience of the U.S. economy and the fact that the U.S. dollar is still the world's currency.

Sunday, July 22, 2012

Who Is Your Landlord?

Securitized bonds are bonds backed by a financial asset. Practically any financial asset can be securitized and many have been. For example, mortgage backed securities (MBSs) were widely attributed as a cause of the recent recession. Other financial assets such as song catalog royalties, credit card balances, car loans, and life insurance have been securitized as well. A recent addition to the securitized bond market are rental-backed bonds. Financial firms are buying foreclosed homes and renting them out. They then sell bonds whose interest payments are made from the rental cash flows from these houses. Whether the model of selling rental bonds will work remains to be seen, but it appears that there are several investment banks prepared to make the plunge.

Spain's Default Risk Premium

Spain sold about €3 billion ($3.68 billion) of sovereign debt recently. Unfortunately for the Spanish government and taxpayers, the YTM of its 10-year bonds was about 7.02 percent, dramatically higher than the 1.22 percent for comparable German government bonds. Evidence of the financial problems in the Spanish government is seen by the government's request for a €100 billion bailout. Perhaps even more worrisome for Spain is that the YTM on its 2-year bonds was 5.20 percent.

Saturday, July 21, 2012

Google's Newest "Acqui-Hire"

Google announced that it was buying the popular iPhone and Macintosh email app company Sparrow for less than $25 million. While Google plans to keep the app up and running, don't expect any updates in the future. Instead, Google has assigned the company's five employees to "new projects" for Gmail. Last month Google acquired Meebo for $100 million and then shifted all of that company's employees to Google+. With a service company, the talent of the employees can be the major asset of that company and an acqui-hire can be a quick and efficient way to acquire that talent. Of course, the assets in this case can leave much more easily than a physical asset. In 2005, Google purchased Dodgeball, but the company's founders left Google in 2007 when they felt that Google failed to support the service.

Fender Dented

On Friday, Fender, the manufacturer of guitars played by such legends as Eric Clapton and Jimi Hendrix, withdrew its IPO. The company had planned to raise about $150 million and use about $90 million of that amount to pay down debt. Fender has lost money every year since 2007. Many investors felt that the industry and company were both risky at this time. Other IPOs this week have performed much better. Both Palo Alto Networks and Kayak jumped about 30 percent in the first day, and Five Below jumped about than 55 percent

Thursday, July 19, 2012

Managing Earnings

A recent academic survey indicates that companies manage earnings and disagree with the direction that accounting standards are heading. As the authors state in the abstract: "Our key findings include (i) high-quality earnings are sustainable and are backed by actual cash flows; they also reflect consistent reporting choices over time and avoid long-term estimates; (ii) about 50% of earnings quality is driven by innate factors; (iii) about 20% of firms manage earnings to misrepresent economic performance, and for such firms 10% of EPS is typically managed; (iv) CFOs believe that earnings manipulation is hard to unravel from the outside but suggest a number of red flags to identify managed earnings; and (v) CFOs disagree with the direction the FASB is headed on a number of issues including the sheer number of promulgated rules, the top-down approach to rule making, the curtailed reporting discretion, the de-emphasis of the matching principle, and the over-emphasis on fair value accounting."

Will They Ever Be Comfortable?

A recent survey indicates that 52 percent of investors under the age of 31 say that they will never be comfortable investing in stocks. While the majority of the experience by young investors is the recent bear market, historically equities have outperformed bonds and savings accounts. The fear of equities is evidenced by one investor who has not even set up her 401k to receive the company match. One rule of thumb for investments is that you should be able to go to sleep at night and not worry about your investments. While we can agree with this statement, many people worry only about potential losses. Never forget that if you are saving for retirement that you will need sufficient funds available for retirement and we doubt that a one percent return will allow you to achieve your retirement goals and be comfortable in retirement.

Wednesday, July 18, 2012

It's All In The Diversification

Diversification is a powerful tool to help reduce the risk of a portfolio. Unfortunately, it seems that many people on Wall Street seem to ignore the benefits of diversification. During 2011, employees at the five largest Wall Street banks lost a combined $2 billion in their 401k accounts, mainly due to the falling stock prices of their employers. For example, Morgan Stanley employees hold an average of 24 percent of their 401k balance in Morgan Stanley company stock. During 2011, these employees lost a combined $570 million on the investment. Since an employee is already relying on their employer for income and benefits, buying company stock as well results in a concentrated portfolio. Experts recommend that an employee invest no more than 5 percent in company stock.

Losses Not Caused By Greed

Former Wall Street trader and behavioral finance expert John Coates argues that recent billion dollar losses at JPMorgan, UBS, and Societe Generale are not necessarily the result of greed, but rather the "winner effect". A winner becomes more confident and seeks more risk after each win. As Coates notes, each billion dollar loss he has examined has come at the hands of a trader who is at the end of a multi-year winning streak.

Monday, July 16, 2012

LIE-BOR Scandal Grows

The investigation into the apparent LIBOR raet fixing by Barclays and other banks is growing. Apparently, the New York Federal Reserve knew of potential LIBOR rate fixing as early as 2007, but no action was taken. The Justice Department's criminal division is investigating several banks and their employees, building a criminal case. Charges are expected to be filed against at least one bank by the end of the year. While most regulators can only pursue civil action and levy fines, the Justice Department investigation could lead to fraud charges and possible jail sentences for traders and other employees. The Attorneys General in New York, Connecticut and Massachusetts are also investigating LIBOR manipulation to determine the effects on states' investments and borrowings. And the Commodities Futures Trading Commission is pursuing a civil case against UBS. 

Thursday, July 12, 2012

Your Favorite Publisher Gets Divorced

McGraw-Hill Companies, which operates in four distinct segments, a credit rating service, an investment research area, a corporate information segment, and McGraw-Hill Education (MHE), announced that it planned to spin-off MHE into a separate company that would trade on the NYSE. Shareholders in McGraw-Hill would receive one share of the new company for every three shares of stock held in the parent company. Although an exact date was not given for the spin-off, the company said it would be completed before the end of the year.

Financial Reintermediation

In the 1970s, financial disintermediation occurred  when investors left the safety of bank deposits for higher yielding money market mutual funds (MMMFs). Recently, the SEC has been in discussions about possible changes to the structure and regulation of MMMFs, which has helped lead to financial reintermediation, that is the increased use of bank deposits. In the recent 2012 AFP Liquidity Survey, 74 percent of corporate short-term assets are in bank deposits, MMMFs, and U.S. Treasury bills. Interestingly, since 2006, the percentage of short-term assets in bank deposits has increased from 23 percent of short-term investments to 51 percent.

Wednesday, July 11, 2012

A Coup At Duke

What would it be like to be CEO for a day? Former Duke Energy/Progress Energy CEO Bill Johnson found out. Eighteen months ago, Duke and Progress announced that when the merger took place, Progress CEO Mr. Johnson would be the CEO of the combined company. The merger closed on July 2, 2012 and Mr. Johnson retired at 12:01 AM on July 3rd, forced out by the Board of Directors of the new company. Most of the Board consisted of old Board members from Duke Energy. The action has caused a controversy since the merger had to pass through the North Carolina Utilities Commission, and an investigation has been launched by the North Carolina Attorney General's Office.

Monday, July 9, 2012

Free Insurance

Recently, the term "too big to fail" has become popularly known. Too big to fail refers to those institutions that, if they failed, would have dramatic and rippling effects on the economy. Five large banks, JPMorgan, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs, fit this label. The assumption by most is that if any of these banks were to fail, they would be bailed out by the U.S. government to avoid a widespread panic. The implication for lenders is that any loans would be repaid by the government even in the event of a bankruptcy. This means that the lenders have an implicit put option on the debt and the borrowers can borrow at a lower interest rate than would be possible without the implicit guarantee. So how much is this bond insurance worth? One estimate puts the savings for the banks at $120 billion between 2007 and 2010.

Buy Stock Or Another Company?

Recent research suggests that business-service companies would better serve shareholders by acquiring other companies than share repurchases. In two periods, 2002 through 2006 and 2007 through 2011, business-service companies that acquired other companies had much better performance than comparable companies that had stock repurchases. Whether this applies to other industries is unclear. Business-service companies have a strong cash return and require little capital to grow internally. For industries with different operating characteristics, this may not hold true.

Sunday, July 8, 2012

Employee Stock Options And Diversification

In the 1970s, CEO compensation consisted of about 16 percent in stock options, but in 2011 that percentage had risen to 60 percent options and other equity awards. Similarly, many other employees have been awarded employed stock options (ESOs) in recent years. While it is possible to get rich by holding all of your ESOs, it is also risky. As a recent article in The Wall Street Journal points out, not only are you exposed to the risk of the company with the options, but through your salary as well. One strategy to consider is selling ESOs and buying a diversified portfolio or mutual fund. So when to sell ESOs? One investment adviser argues that they should be sold when the time value of the option is less than one-third of the total value. The argument for this trading trigger is at that point there is not a lot left to gain, but a significant amount to lose.

Thursday, July 5, 2012

Illwill Toward Goodwill

Microsoft recently took a $6.2 billion goodwill impairment charge related to the $6.3 billion purchase of aQuantive, implying that the entire deal was a bust. But Microsoft was not alone: Rio Tinto wrote-off $8 billion for its purchase of Alcan, the NYSE wrote-off $1.6 billion of its Euronext purchase, and Proctor & Gamble wrote-off $1.5 billion of its Gillette purchase. In this article, Peter Atwater, president of a financial consulting firm, argues that the current accounting method for acquisitions is a free option. If things go well in an acquisition, there is never an accounting cost.  While we would not disagree with Mr. Atwater on the accounting interpretation, we would argue that is it irrelevant (except for taxes). Accounting methods almost never represent the true value of an investment or acquisition. If a company overpays for a target, the cost is the stock price decline associated with the overpayment. Similarly, any increase or decrease in value after the acquisition shows up in the stock price, a much more important determinant of the success of any management decision. As he says, "Who wouldn't want to live in an accounting world like that." We would always prefer to live in a market value world, something the accounting world has never been able to capture.

Dump This, Abandon That

While most people are familiar with Android devices, Gmail, and Google maps, failures at Google are less often remembered. Today, Google announced that it would close iGoogle in November 2013. iGoogle allowed users to personalize a home page with applications such as news feeds, stock quotes, and weather. This is the 30th product scrapped by Google since Larry Page became CEO 15 months ago. Apparently, Google realizes that there is an option to abandon an unsuccessful product.

Wednesday, July 4, 2012

How To Get Rich In Bankruptcy

Alvarez & Marsal, advisers for Lehman Brothers during the current three and one-half years of bankruptcy have requested a $31.5 million incentive fee for work already done and $59.2 million in incentive fees for work it will continue to do. If granted, the incentive fees will bring the total billed by Alvarez & Marsal to more than $620 million. The lead attorneys in the Lehman case have received nearly $390 million to date.

Let's Stay Home, The Currency is Falling

One of the major determinants of international travel is the exchange rate. The decrease in the value of the Indian rupee has caused Indians to experience an increase of 30-40 percent in international travel costs over the past six months. One Indian travel agency reported a drop of 25 percent in travel volume this year.

Monday, July 2, 2012

LIBOR Manipulation

In the wake of Barclays £290 million ($453 million) fine for manipulating LIBOR rates, the British government ordered a review of how LIBOR rates are determined. Currently, Thomson Reuters determines the interest rate based on the average of the interbank interest rate offered by contributor banks. Barclays underreported the interest rate at which it could borrow, thereby lowering the average interest rate for all banks. A proposed method for the new calculation of LIBOR rates to use actual quotes to calculate the interest rate.

And in what may be the first of several resignations/firings due to the scandal, Barclays' Chairman Marcus Agius resigned.

Why Is There No Corporate Investment?

During the recent financial crisis, blame has been placed on corporations for a lack of new investments. While corporate cash balances have been climbing, new investments have stalled. One reason may be an increasing equity risk premium, or market risk premium (MRP), as we call it in the text. An increase in the MRP premium increases the cost of capital for any project, making the NPV less favorable. A recent article in CFO argues that an increase in the MRP is a factor behind the slowdown in capital investments. This may be part of the problem, but we would like you to consider a couple of things.

While the MRP may have increased, the cost of debt has decreased, so the overall cost of capital could have remained the same, or even decreased.  As the article points out, calculating the MRP is not an exact science. An increase in the MRP may be a factor, but the impact is unknown at this time.

While we hope your education is teaching you to critically examine arguments you hear or read, we would also like to point out a glaring error in the logic of the argument presented in this article. The article states that "stock investors are questioning the very integrity of the markets, and the perceived risk of holding an equity portfolio has increased." One reason given for this is the Facebook IPO debacle. And while the Facebook IPO problems may have affected investors' beliefs about risk and market integrity, the Facebook IPO occurred about six weeks ago, much too recently to have had any effect on the MRP during most of the period in question.’t-investing

Sunday, July 1, 2012

The Global IPO Slowdown

In the second quarter of 2012, there were 201 IPOs worldwide, less than one-half of the 428 IPOs during the second quarter of 2011. The dollar value of new IPOs fell from $62.4 billion to $40.1 billion for the same period. The U.S. was the sole bright spot, with deals of $22.5 billion during the quarter, although $16 billion of that amount was raised by Facebook. However, in part because of the problems with the Facebook IPO, no IPOs occurred in the U.S. for a five-week stretch afterward.