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.

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.

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.

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.

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.

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.

Sirius Board Sued

The City of Miami (Florida) Police Relief and Pension Fund is suing the Board of Directors of Sirius for not fighting a takeover by Liberty Media Corp. With Sirius facing bankruptcy three years ago, Liberty loaned Sirius $530 million with a caveat that Sirius not adopt a poison pill or any other defense measures that would stop Liberty from acquiring Sirius after three years from the date of the loan. Liberty has acquired more than 50 percent of the stock in Sirius without paying a premium on the shares, which is typical in an acquisition. The pension fund states that the Board's agreement not to fight a takeover by Liberty Media was a violation of the Board's fiduciary duty to stockholders.

Should Facebook Fire Peter Thiel?

We are not proponents of Facebook co-founder Peter Thiel's plan to pay students $100,000 to drop out of college, an offer that made a big splash. Thiel is back in the news again when it was announced that he had sold 90 percent of his stake in Facebook. Since Thiel sits on Facebook's Board of Directors, some have called for his resignation, citing the sale as a lack of conviction in Facebook's future. Others have argued that Thiel was an early investor, has made his profit, and it is time for him to move on. Thiel invested $500,000 in 2004. His original investment had grown to over $1 billion, an annual return of more than 159 percent. In either case, it is likely that potential agency problems have increased since Thiel's wealth is now less aligned with that of other Facebook investors.

Best Buy Fights Back

Best Buy announced that it was hiring turnaround specialist Hubert Joly. The hiring occurred shortly after the company's Board of Directors stone-walled founder Richard Schulze's cash offer of $24 to $26 per share. The hiring of Joly is an indication that the Board does not believe that Schulze's offer is in the best interest of the company's shareholders and may lead to a protracted proxy battle for the company.

Municipal Bond Default Rates

Between 1970 and 2011, Moody's reported that there were 71 municipal bond defaults. Similarly, S&P said that there were 47 municipal defaults from 1986 to 2011. These default numbers are over two different periods but appear similar, so we should be able to believe both numbers. But the Federal Reserve reports there were 2,521 and 2,366 defaults over the same periods! So now who do we believe? It depends on how you count. Both Moody's and S&P reported only defaults for rated bonds, while the Fed included defaults for unrated municipal bond issues, most definitely a riskier class of municipal bonds. The data also shows that general obligation bonds are unlikely to have defaulted, while revenue bonds and industrial development bonds were much more likely to have defaulted.

Poway's Time Value of Money

Recently, the Poway Unified School District in California issued a very interesting bond. The bond issue was for $105 million. No payments will be made for 20 years, then the first payment of $30 million will be made. The next year, $47 will be due, then $50 million a year for the next 18 years. Check for yourself that the interest rate on this debt is 7.84 percent. While we think this is a relatively high interest rate in the current environment (although California municipal bonds are likely a very risky investment), assume that the interest rate is correct for this investment. If Poway had taken out an amortized loan with equal payment, the payments would have been for about $8.659 million per year, or a total of $346.4 million over 40 years. A normal bond issue with interest payments and a repayment of principal at the end of the loan would have annual interest payments of $8.237 million, for a total repayment of $442.7 million. Under the current bond terms, the total repayment will be $977 million. The multi-million dollar question: From a pure time value of money perspective, which of these bond terms is preferable? Answer: They are all the same! Why?

Capital Structure: U.S Versus Europe

A major difference in the capital structure of U.S and European companies' balance sheets is the source of debt. European companies have traditionally relied heavily on bank debt rather than publicly traded debt. The total publicly traded debt of European companies is just 7 percent of GDP, compared to 35 percent in the U.S. With the recent banking turmoil in Europe, European banks have been deleveraging balance sheets. As a result, European companies have been issuing bonds in large amounts. For example, AB InBev issued $7.5 billion worth of bonds and Unilever issued $1 billion in bonds. Because of new banking regulations and economic problems, European banks are expected to shed $2 trillion over the next several years, which will likely increase corporate bond issues in Europe even further.

A Positive: Smaller Free Cash Flows

Free cash flows available to companies to pay dividends or buy back stock fell in the first quarter of 2012, but that is not necessarily a bad thing. While free cash flow fell slightly, selling, general and administrative expenses rose, as did capital spending. Longer cash cycles during the quarter also slowed free cash flows. Because of the generally positive reasons for the decreased free cash flows, indications are that this is positive news.

Hostess' Chapter 22

While bankruptcy is very often a difficult process for many companies, the second bankruptcy for Hostess this decade is definitely not a piece of cake. A recent article outlines how the original bankruptcy process looked like it would allow Hostess to move forward as a going, profitable concern. However, the recent recession coupled with Hostess' high labor costs and high leverage have forced the company back into bankruptcy court. The company pension plan is underfunded by about $2 billion and labor relations are stained. If the pension liability is eliminated by the bankruptcy court, the Teamsters Union has already had a strike by its members ratified. And while it is difficult to liquidate a Twinkie, the manufacturer of this iconic yellow treat may be headed for such a fate.

Best Buy Goes Private?

Former Best Buy CEO Richard Schulze announced that he would like to take the company private. Mr. Schulze already owns slightly more than 20 percent of Best Buy stock. Best Buy stock is down around 50 percent over the past 5 years as the company's sales and profits have declined. The share price range offered by Schulze is $24 to $26 and represents a premium of 36 to 47 percent on Friday's closing price. The offer will be funded through Schulze's equity investment, private equity investments, and debt. All told, the offer values Best Buy at about $8.8 billion. While no one knows the exact financing for the proposed LBO at this time, one possible scenario is explained here.

Social Impact Bonds

Bonds come in a variety of exotic types and one of the newest is a social impact bond. Through Goldman Sachs, New York City just offered a $9.6 million social impact bond to help Rikers Island inmates from returning to jail after they are released. Social impact bonds provide money upfront to nonprofits to provide social services. If the nonprofit doesn't meet its goal, the government doesn't lose money...and the investors won't get paid in full.  

Strong Dollar, Weak Earnings

A common message from U.S. based multinational companies during recent earnings announcements is the pain of the strong dollar. While most multinationals use various hedging procedures to protect against currency fluctuations, the fact that the dollar has appreciated by about 5 percent against the euro in the most recent quarter has caught many by surprise. A strong dollar makes U.S. products more expensive overseas and the foreign sales are worth less when they are converted back to dollars. To give a couple of examples, currency losses reduced Tupperware's sales by about 10 percent and reduced Colgate-Palmolive's profits by about 10 percent as well.

Pay Your Debt

Berlin, Germany has close to €63 billion in debt, but that amount may grow if Mittenwalde, Germany has its way. An archivist recently found a certificate of debt that indicated Mittenwalde had loaned Berlin 400 guilders on May 28, 1562 at an interest rate of 6 percent per year. It was reported that the debt would now be at 11,200 guilders, or €112 million ($136.79 million). In fuzzy reporting, how this amount was calculated is not given. A quick time value of money calculation indicates that the actual amount owed by Berlin is about 97.66 trillion guilders, or about €976.6 quadrillion!