Hortons' Poison Put Covenant

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

Credit-Ratings Agency Regulations

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

More Than A Dollar

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

Be Careful Of Numbers

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

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

Diversification And Rebalancing

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