DraftKings Goes Public

Daily sports wagering company DraftKings will be going public in 2020 in an unusual way. DraftKings will complete a merger with the publicly traded blank check company Diamond Eagle. Since Diamond Eagle is already publicly traded, DraftKings will become publicly traded after the merger without having to file all of the necessary SEC paperwork associated with a traditional IPO. DraftKings will also purchase sports betting technology company SBTech for $300 million, with the financing for this acquisition from institutional investors.

Bill.com's Partial Adjustment

When Bill.com filed for it's IPO in November, the indicated price range was $16-$18. Earlier this week, the company raised the range to $19-$21, before settling on $22. When the IPO hit the market yesterday, the price jumped 61 percent. The company raised $215.6 million, but apparently left about $131 million on the table. Whether that comes back to haunt the company is yet to be seen: Sales increased about 60 percent from the previous year, but losses have also increased.

Grade Time!

As many of you are aware, it is that time of year for grades. And while we hope you earned an A, it appears that many companies haven't. The inaugural American Corporate Governance Index was released and only 16 percent of companies received an A- or better. Ten percent of companies failed. The worst average grade was a C- for Principle 8, which requires a company to regularly evaluate its system of corporate governance and commit to addressing deficiencies. The next lowest grade was given for Principle 4, which requires companies to maintain strategies focuses in long-term performance and value. Looks like more studying is needed.

TIme Value Of Money And Baseball

In case you missed it, two days ago, Steven Strasburg signed a record 7-year, $245 million contract to pitch for the Washington Nationals. One day later, Gerrit Cole signed a 9-year, $324 million contract to pitch for the New York Yankees. As we discuss in the textbook, many sports contracts are actually paid out longer than is stated. You need the time value of money to properly evaluate such contracts. For example, Bruce Sutter signed a then record 6-year, $9.1 million contract with the Atlanta Braves in 1984. While this works out to a little over $1.5 million per year, Sutter was actually paid only $750,000 per year in interest for the six years of the contract. The rest of the money was paid as a deferred annuity. Sutter last pitched in 1988, but, in 2022, he will receive his last annuity payment. Importantly, note that it was believed at the time that a one-time payment of $1.7 million would have funded the annuity.

Schwab Breaks And Buys Ameritrade

Charles Schwab is nearing a deal to buy fellow broker Ameritrade for $26 billion, a premium on Ameritrade's $22.4 billion market cap. But what makes this really interesting is that Ameritrade was valued at $25.3 billion in October before Schwab helped to drop Ameritrade's price! Schwab makes more money from commissions than Ameritrade does. When Schwab announced that it was eliminating commissions, Ameritrade was forced to follow suit. Naturally, Ameritrade's price dropped more than Schwab's, so when Schwab announced the purchase of Ameritrade, the price was much less than it would have been a month earlier before commissions were eliminated. 

TVM And Max Scherzer

The time value of money is everywhere and when you see large cash flows over many years, you need to be careful about the reported values. Consider the analysis of Max Scherzer’s contract, which was stated as having a $210 million value. Even though Scherzer would pitch for only seven years under the contract, he would receive $15 million per year for 14 years. At a 7 percent discount rate, the present value of the contract is only $131 million. A more typical contract, with the salary increasing over seven years, would result in a present value of $158 million, and an equal annual salary of $30 million would result in a present value of $162 million. That’s quite a disparity in values. And, while we agree with the calculations, we aren’t convinced that the seven percent rate being used as a proxy for the long-term return on the stock market isn’t a bit low.

A Fantastic NPV

One thing you should always consider is the reasonableness of any estimate. For example, Hycroft Mining recently announced that a gold mine the company on which the company has begun work has an NPV of $2.1 billion with an initial investment of $61 million! The project has an IRR of 147 percent and a profitability index of more than 34 times. While this certainly seems to be a fantastic project, we have some doubts about the extremely high NPV and IRR estimates. We would also mention that the discount rate of 5 percent, which was used by the company, seems low for a project of this risk. The stock market doesn’t believe the NPV of this mine is anywhere near $2.1 billion: The company’s current market capitalization is about $5 million.

The Power Of Compounding

We hope you have learned about the power of compounding by now. If not, consider your future retirement. How much of your salary do you need to save in order to replace your pre-retirement income? Somewhere between 4 and 44 percent of your salary! If you start saving at 25 and retire at 70, you only need to save 4 percent of your salary, but if you wait to start saving until you are 45 and want to retire at 62, you will have to save 44 percent of your salary. That is quit a big difference and shows the power of compounding.

Beer Bonds

Bonds do not necessarily have to pay cash coupons. A bond by Scottish brewery BrewDog highlights this point. BrewDog is considering a new bond issue that would have a 6 percent coupon, paid out as 3 percent in cash and 3 percent in craft beer. If you have buy one of these bonds, you would get a cash payment, a coupon for £20 in BrewBucks redeemable at the company's bars, a free book, and a free beer on your birthday each year you are a bondholder. Cheers! 

The Popularity of BBB Bonds

S&P, one of the major bonds rating agencies, has categorized bonds by credit ratings, and BBB bonds compose the largest chunk of corporate bonds. BBB bonds account for $3.2 trillion, or 53 percent of the outstanding investment grade bonds. Total BBB corporate debt, including term loans and revolving credit facilities, tops $7 trillion. One risk with this much debt just above the junk level is that an economic downturn could result in a large part of this debt being downgraded to junk status.

A Southwest Acquisition?

Southwest, which is known for its all 737 fleet, reportedly lost out on $175 million in income during the second quarter due to the continued grounding of the 737 Max. So how is Southwest to grow? There is speculation that the way to growth may be the acquisition of another airline such as Spirit or JetBlue. This would allow Southwest to rapidly increase fleet size and diversification as other airlines' fleets include Airbus jets. So what does one analyst think about this possibility? A Stifel analyst downgraded Southwest stock on speculation of an acquisition, an indication that any possible acquisition will be over-priced.

Fiat Chrysler/Peugeot Synergies

Fiat Chrysler and Peugeot have announced a 50/50 merger, with sales of $190 billion for the combined company. A key reason for the merger is an annual cost savings of $4.1 billion from “a more efficient allocation of resources for large-scale investments in vehicle platforms, powertrain, and technology and from the enhanced purchasing capability inherent in the combined group’s new scale.” As with most mergers or acquisitions, whether they synergies are realized will be an important determinant of whether the merger is successful.

Corning Wins Cash Gold

Corning recently won the Gold Award in liquidity management from Treasury & Risk. In 2015, the company announced its Capital Allocation Framework, designed to reduce its $5.5 billion in cash by one-half. The company generates one-third of its revenue in Asia, which is where much of the cash was tied up. Thanks to the formation of the Shanghai Free Trade Zone, Corning was able to pool its cash, allowing for more flexibility in cash management. Better cash management practices have allowed Corning to reduce its cash balance to about $1.2 billion as of June 2019.

M&A Checklist

In the textbook, we discuss how to value an acquisition. But what are the some considerations in the valuation of the target? The recent acquisition of Wells Fargo's retirement and trust business by Principal can give you some insight. For example, Principal had to consider whether recent problems at Wells Fargo had extended into the retirement area. Additionally, future revenues from the acquisition depend on how many of the current customers stay when the acquisition is complete. In this case, a payment will be made in two years contingent on the percentage of current customers of Wells Fargo remain at that time.

Finally, an important consideration is the cultural fit between the two companies. The value of the synergies, as well as the continuation of the current cash flows of the target company into the future, often depend on culture. If employees of the target company are thrust into a new culture, it may lead to an exodus of employees, resulting in a decrease in ongoing cash flows as well as reducing expected synergies. A culture clash was allegedly a major cause of why the AOL-Time Warner merger flopped so badly.

WeWork's Neumann Ousted

Last week, we mentioned that WeWork had pulled its IPO, and now, CEO Adam Neumann appears to be paying the price. WeWork's biggest investor, SoftBank, called for his ouster this past weekend, and today, Neumann announced he would be stepping down as CEO. Even though Neumann co-founded WeWork in 2010, investors apparently lost faith in him to lead the company going forward.

A Stock Up In Smoke

As we discussed in the textbook, an unsystematic risk affects a small number of companies, often only one company. Investors in cannabis producer CannTrust learned about systematic risk today as the stock fell 14 percent when the company's license to grow marijuana was suspended. The stock has fallen since July, when it was discovered the company was growing plants in an unlicensed room, resulting in the destruction of thousands of pounds of plants. Investors received a bigger shock in in July when the unlicensed plants were discovered: The stock fell about 22 percent that day. The company's CEO has been fired, but whether the license will be reinstated is unknown.

WeWork Postpones IPO

Shared workspace company WeWork has apparently delayed its IPO. The company was expected to go public at the end of the month, but low investor demand apparently halted this plan. It was reported last week that the company might value its stock between $10 and $12 billion, lower than the $12.8 billion in equity already invested in the company, and dramatically lower than the $47 billion valuation in January when SoftBank invested $2 billion.

A Digitized Athlete

Brooklyn Nets sixth man Spencer Dinwiddie signed a contract for $34 million over three years. Now, Dinwiddie hopes to digitize his contract into a digital token. The plan is to pay back investors principal plus interest from his future salary. For investors, an advantage is that the tokens will have little correlation with other financial assets. There are numerous examples of securitizing cash flow from future earnings, from Bowie bonds, physicians who sell part of the future revenue in their practice, to fledgling golfers, who get money from backers in exchange for future winnings. However, these assets are not without risk. In November 2015, Fantex pulled an IPO that planned to sell future earnings for running back Arian Foster. Foster retired from the NFL less than a year later after several injuries.

Century Bond Issues Increase

Interest rates continue to be at or near historic lows, which presents a unique opportunity for borrowers. And universities are beginning to realize the opportunity. Rutgers University announced that it would sell $330 million worth of 100-year bonds, and the University of Virginia recently sold 100-year bonds at a YTM of 3.23 percent. So far this year, $1.3 billion in century bonds have been issued. Corporate bond issuers Walt Disney and Coca-Cola have also issued century bonds. Demand for these bonds is being driven by low interest rates, causing investors to seek out yield in riskier investments.

Ford: A Fallen Angel

Moody's downgraded Ford's bonds to Ba1, into junk bond territory. The downgrade was due to lower operating margins, weak earnings, and lower cash flow creation. Some of the increased costs are due to Ford's restucturing plan, designed to improve performance in the future. S&P and Fitch did not downgrade Ford's debt to junk territory, indicating a split-rating in the company's bonds.

Oil And Gas Bankruptcies

As we discussed in the textbook, financial leverage is a double-edged sword, increasing shareholder returns in good times, but causing financial distress in downturns. Since companies in an industry tend to have similar leverage ratios, a wave of bankruptcies can occur in that industry. The high leverage in the oil and gas industry appears to be reaching a tipping point as 26 oil and gas producers have filed for bankruptcy this year, almost matching the 28 for all of 2018. There is still a way to go to match the 70 bankruptcy filings in 2016, which was caused by low oil and gas prices.

Germany's Negative Yield Bond Sale

With about $15 trillion in value worldwide, the amount of bonds outstanding with negative yields is astonishing. And a recent bond sale by the German government added to this number. Germany sold million worth of 30-year, zero coupon bond €824 million worth of these bonds that will pay back €795 million in 2050. The bonds originally had a YTM of negative .11 percent, but fell even further to negative .153 percent.

An ICO Bubble?

A couple of years ago, coins or tokens, were the new frontier of investing. Now, it appears that the fantastic returns offered in this investment were often only temporary, as are most fantastic returns. A recent Twitter post post notes that the median ICO return in U.S. dollars is negative 87 percent and continues to go lower. Although several ICOs have outperformed bitcoin, most have not. Of course, many of these ICOs were likely destined to be poor performers and sold by being hyped to uninformed investors. 

A Flight To Cash

We have discussed risk and return in the textbook, so by now you should have a grasp on the concept of financial risk. A recent article notes that ultra-wealthy individuals have been moving assets into cash or cash alternatives. In the first quarter of 2019, high-net worth individuals held nearly 28 percent of investable assets in cash. And while cash itself is desirable for liquidity and diversification, this number appears high. There is one sentence in particular we would like to point out:

“Yet perception of risk is an emotional thing.”

We can measure an asset’s total risk by standard deviation, or an asset’s market risk by beta. However we measure risk, it is unemotional. But there can be behavioral factors, such as the fear of risk, that can affect an individual’s decisions.  

As a final point, the article discusses a family that moved money into gold bars and buried them and implies this is moving assets into cash. While gold is a physical asset and often performs well in a bad economy, the volatility of gold prices can often be quite high.