Tuesday, September 26, 2017

Yield Curves And The Economy

At first blush, it may appear that an inverted yield curve is desirable. After all, this is a possible indication of expected lower inflation in the future. However, the the past six recessions in the U.S. dating back to the 1960s have been preceded by an inverted yield curve. Recent Fed actions have led to a change in the interpretation of yield curve as Fed actions have flattened the yield curve by taking risk out of the system, reducing the term premium, or extra return for taking the risk associated with longer term bonds. Instead, the term premium between other financial instruments such as high-yield bonds may be more indicative of future economic stability. As this article highlights, even though the term premium for Treasury bonds has flattened, the term premium for high-yield bonds (Actually credit default swaps on those bonds: Think of it as insurance that only pays out if those bonds default.) has increased.

Zuckerberg Loses New Votes

Even though Mark Zuckerberg currently controls the majority of Facebook's voting shares, it appears that even that has limits. Facebook recently announced that it would not seek approval of Class C shares that would effectively allow Zuckerberg voting control forever. Market sentiment on dual class shares has shifted, as indicated by the announcements that no new companies with dual voting share classes would be admitted into the S&P 500 or any FTSE Russell indices. Additionally, the approval of Class C stock with super-voting power would probably have prompted a shareholder lawsuit in which Mark Zuckerberg would have been for a deposition or as a witness, something he would likely wish to avoid.

Buybacks Fall

In the second quarter of 2017, S&P 500 companies repurchased $120.1 billion worth of stock, down 9.8 percent from the first quarter and a 5.8 percent decrease from the second quarter of 2016. Only 66 of the 500 companies reduced the number of shares outstanding by 4 percent, while more than 20 percent repurchased more than 4 percent of shares outstanding the the second quarter of 2016. Apple and Boeing led the way, repurchasing $7.1 billion and $2.5 billion in shares, respectively. The S&P 500 companies did set a dividend record, paying out $104 billion during the quarter, up from $100.9 billion in the first quarter.

Wednesday, September 20, 2017

Corporate Underinvestment

A recent article indicates that financial managers may not be following good capital budgeting techniques. The median hurdle rate used to value new projects is 12.0 percent, with an average rate of 13.6 percent. Meanwhile, the same survey notes that the median WACC is 9.8 percent, with a mean of 10.6 percent. While that article infers that these numbers should be the same, we differ on this assumption. If new projects are riskier than the company, which would likely be the case, then the cost of capital for new projects would necessarily be greater than the WACC since the required return on a project depends on the use of funds, not the source of funds.

Underinvestment still does occur, as 67 percent of respondents answers “No” when asked if their company undertook all projects that create value. Common reasons given for not pursuing value creating projects were:

Shortage of management time and expertise (51%)
The project is not consistent with the company’s core strategy (41%)
The risk of the project is too high (39%)
Shortage of funds (38%)
Shortage of employees (32%)

Tuesday, September 19, 2017

Toys R Us Joins Retailers In Bankruptcy

With $5 billion in debt, Toys R Us becomes the second largest retailer in U.S. history to file bankruptcy, following only KMart. The bankruptcy filing is at the worst possible time for the company as it is ramping up inventory for the fourth quarter, which typically accounts for about 40 percent of the company's revenue. Overall, 2017 has been a bad year for retailers as 35 retailers have filed for bankruptcy, including Wet Seal and Radio Shack, who filed Chapter 22 bankruptcies.

An IPO Set To Fly Or Crash

Finnish mobile game maker Rovio has set the price for the company's IPO. The maker of Angry Birds will have a value of about $1 billion based on the IPO price. The company will sell about 55 percent of its shares, with current owner Trema International retaining about 37 percent ownership. The IPO price of 10.25 to 11.50 euros values the company about the same as peers, but does include an expectation for profit growth.

Monday, September 11, 2017

Hurricane Irma And Cat Bonds

Our thoughts and prayers go out to those affected by Hurricane Irma. Fortunately, Irma weakened as it approached the U.S. and property damage estimates dropped from $200 billion to $49 billion, although the final tally won't be known for months. As you can imagine, large natural disasters such as this affect financial markets. Last week, the stock market fell and the dollar weakened based on the dire projections, although both have rebounded today, in part because of the storm's weakening. However, no financial instrument was hit as hard as cat bonds based on hurricane damage in Florida. In fact, one cat bond that was recently issued by Heritage Insurance Holdings fell to 50 cents on the dollar. The cat bond market has reached $90 billion, and almost one-half is tied to Florida hurricane damage.