Friday, November 9, 2018

Spotify's Reverse IPO

Spotify went public on April 3, 2018 in a direct listing. Bypassing the traditional underwriting process, Spotify basically said that its stock could now be publicly traded. Because Spotify did a direct listing, the company raised no additional money from outside investors. And Spotify could have sold shares on the market without worrying about the underpricing that often occurs in an IPO. Now, about seven months later, Spotify just announced a $1 billion share buyback. The stock has fallen about $8 billion since it went public and the buyback is a signal of management’s confidence in the stock. More interestingly, it also means that Spotify has never raised public capital and is using the stock market only as a means to return capital to investors. As this article points out, because of the new reliance on private investors, we could possibly see a day when a company undertakes an IPO for the purpose of initiating a buyback.

Thursday, October 25, 2018

Sears' Financial Distress Costs

We mentioned in the textbook that there are indirect financial distress costs, which, unfortunately, Sears is experiencing. Because of Sears' financial problems, suppliers are not willing to sell to Sears, or are tightening credit terms. Part of the reason is that suppliers continued to sell to Toys R Us, but then only received 20 cents on the dollar. A poll indicates that 66 percent of suppliers are demanding cash payment or payment on delivery and 26 percent were on regular terms, but not longer than 30 days. In fact, more than 200 suppliers have quit selling to Sears at all. This can create a "death spiral" as Sears cannot order goods to sell at a time when sales are already low, meaning fewer customers even go to Sears' stores. 

Tuesday, October 23, 2018

Netflix's Capital Structure

As we discussed in the text, the optimal capital structure for a company is the result of many interacting factors. And while we can observe capital structures in practice, it is less frequent for a company to state its target capital structure. Recently, Netflix announced that was issuing $2 billion in debt to help the company reach its optimal capital structure, which the company said should be 20 to 25 percent debt-to-market capitalization. At the current market value of equity, the company would need to issue between $22 and $30 billion of debt. What makes this debt issue really interesting is that though company is burning through cash, the announced purpose of the bond is to increase leverage.  

Market Quiz

CFO.com has a seven question quiz on current capital markets. There are some interesting questions, including the relative size of the venture capital market compared to IPOs, the issuance size of the preferred stock market (keep in mind that Apple's market capitalization is over $1 trillion), and the slope of the Treasury yield curve.

Thursday, October 11, 2018

Bond Ratings And Mergers

A recent article in Bloomberg highlights a potential threat to the bond market. Recent years have seen a number of high-priced acquisitions funded by debt. As a result, many of these companies have dramatically increased leverage as measured by Debt/EBITDA. This has caused a drop in credit ratings, with $2.47 trillion worth of debt now rated as BBB, more than three times the 2008 level of BBB debt. Even though many of the deals are funded through debt, a common assumption is that synergies and the improved cash flow would allow the company to quickly pay down debt. But a hiccup in the economy or synergies not materializing could limit debt pay down. In the last three recessions, from 7 to 15 percent of investment grades bonds were downgraded to junk status. Given the higher amount of debt with lower credit ratings, a recession in the next couple of years could push a massive amount of corporate debt into junk territory.

Sears Bankruptcy

It appears that Sears, once the world’s largest retailer, may file for bankruptcy as soon as this weekend. One alternative being explored is a Section 363, or stalking horse, filing. In a Section 363 filing, the company would sell some of its assets, but the sale would still have to be approved by the bankruptcy court. For example, CEO Eddie Lampert has already offered $480 million for the company’s Kenmore appliance and home improvement division. If successful, the company would exit the bankruptcy with fewer assets, but less debt as well.

Wednesday, October 10, 2018

Michael's Bond Losses

As Hurricane Michael hits the Gulf Coast, pension funds, endowments, and other large investors are getting nervous.  About $15.7 billion wort of CAT bonds are exposed to a Florida hurricane. Large investors have been drawn into CAT bonds because of higher potential returns and the diversification these bonds can provide. The total CAT bond market is currently at $30 billion. For a major catastrophe, an insurance company typically cover the first part of its loss, then relies on reinsurance or securities to help cover the rest. If the trigger is hit on a CAT bond, often the bond is cancelled, meaning the bondholder receives no further coupon payments and no par value upon redemption. 

Tuesday, October 9, 2018

Papa John's Extra Cheese

Papa John's stock has been battered this year after comments made by founder John Schnatter on a conference call. Schnatter resigned as chairman in July, but still owns about 30 percent of the company's stock. In a nod to the bidding wars that can occur in a takeover battle, the stock jumped nearly 8 percent today when it was announced that Trian Fund Management is considering a bid to buy the company and take it private.

Interest Rates And Bond Prices

As we noted in the textbook, an increase in interest rates will decrease the price of a bond. And recently, interest rates have been rising. U.S. high-grade debt is down 2.53 percent this year and the 10-year U.S. Treasury bond has lost 3.23 percent this year as well. To give you an idea of the magnitude of losses worldwide, the Barclays Multiverse Index, which includes investment grade and high yield bonds from around the globe, has lost about $916 billion in market value this year.

Inflation Expectations


One thing to keep in mind with present value calculations, if you calculate the present value using real cash flows and the real interest rate or nominal cash flows and the nominal interest rate, the present value will be unaffected. This is true for capital budgeting as well So where can you get expectations of future inflation? One place is the New York Federal Reserve, which publishes microeconomic data, including expectations of consumer inflation. We should warn you, these are expectations, and like any expectations, are not exact.

New Lease Accounting Standards

Beginning January 1, 2019, public companies have to begin disclosing the present value of lease of future lease payments as a liability on the balance sheet. Previously, many leases were kept off the balance sheet. The result will be that for companies that rely heavily on leases, the debt may increase dramatically. However, we would like to make an important point in that while the balance sheet debt will increase because of the new leasing accounting standards, it will only have a minimal, if any, effect on leasing cash flows, meaning that he NAL calculation we discuss is still the correct analysis to determine whether to lease or buy.

Wednesday, October 3, 2018

Comcast Bonds

In order to finance the $39 billion acquisition of Sky Plc, Comcast sold $27 billion worth of unsecured bonds. This is the second largest bond offering of the year and the fourth largest all-time. The company sold 12 different bonds, ranging from a 2-year maturity to a 40-year maturity in the offer. Investors jumped at the bonds, putting in orders for $88 billion, which allowed Comcast to issue the 40-year maturity at a yield spread of 1.75 percent above Treasuries. The bond issue will increase Comcast's leverage from 2.2 times EBITDA to 3.6 times EBITDA. The bonds are rated A with a negative outlook, which means there may be a downgrade in the future.

Friday, September 28, 2018

2018 Working Capital Survey

The Hackett Group has released the 2018 US Working Capital Survey. Overall, working capital management has improved, with the cash conversion cycle dropping to 33.8 days, a 4 percent improvement. Day's payable has increased from 53.5 days in 2016 to 56.7 days in 2017, while days' payables outstanding increased from 37.8 days to 39.5 days. The inventory period also increased slightly, from 50.7 days to 51 days.

Monday, September 24, 2018

And The Winner Loses

In a nod to the winner's curse, Comcast stock fell 8 percent today when it was announced that the company outbid rival Fox in the three round auction of British broadcaster Sky. Comcast's winning bid was for $40 billion. The price was about 27 percent higher than Comcast's initial bid. In any auction, the winner ultimately is the bidder willing to pay more than any other bidder, increasing the likelihood that the winner overbid, resulting in a a negative NPV.

2018 Alexander Hamilton Awards


The 2018 Alexander Hamilton Awards from Treasury & Risk have been announced. The gold award went to Herc Rentals, which set up a treasury group to sales for a billion-dollar company less than six months after its divestiture from Hertz. The silver award went to Avery Dennison which centralized its European treasury functions, resulting in significant savings, and improved foreign exchange processes. Finally, OpenText was awarded the bronze award for streamlining its treasury and setting up processes for the integration of future acquisitions.

Slow Earnings Repatriation


One goal of the Tax Cuts and Jobs Act of 2017 was to increase repatriation of overseas earnings. Broadly speaking, new repatriated earnings are not subject to additional taxes that were in force under the previous tax system. A common misconception is that most of the $3 trillion in foreign earnings earned held abroad by U.S. companies was sitting in stockpiles of cash. In the second quarter of 2018, companies repatriated $169.5 billion, which is up significantly from the $34.9 billion in the second quarter of 2017, but down from the $294.9 billion repatriated in the first quarter of 2018. Several factors have reduced the expected tax windfall, including a company’s desire to leave cash overseas for investment to foreign laws that limit a company’s ability to repatriate cash to the U.S.