Posts filed under ‘Themes – Trends’
Listening for Dinner Bell or Penalty Whistle?
Excerpt from my monthly newsletter (sign-up on the right of page)…
Investors are eagerly waiting on the sidelines wondering whether to listen for a dinner bell signaling the time to sink their teeth into traditional equity investments, or respond to a penalty whistle by nervously maintaining money in depleted, inflation-losing CDs. A large swath of investors are still scarred from the losses experienced from the 2008-2009 financial crisis and are trying to rationalize the recent +80% move in equity markets (S&P 500 index) over the last 18 months. Eating saltine crackers and drinking water in CDs and money market accounts yielding < 1% feels OK when the world is collapsing around you, but eventually people realize retirement goals are tough to achieve with the money stuffed under the mattress.
Here are some recent bells and whistles we are listening to:
Mid-Term Elections: Regardless of your politics, Republicans are forecasted to regain control of the House of Representatives, while expectations for a narrow Democrat Senate majority remains the consensus. Currently, Democrat Jerry Brown is a handful of points in the lead over Meg Whitman for the California governor’s race. Another issue voters are closely monitoring is the likelihood of Bush tax-cut extensions.
Printing Press Part II: The Federal Reserve has strongly hinted of another round at the printing press in an effort to stimulate the economy by keeping interest rates low (e.g., record low 30-year fixed mortgage rates around 4.2%). The Fed accomplishes this so-called Quantitative Easing (or QE2) by purchasing Treasuries and mortgage backed securities – pumping more dollars into the financial system to expand credit and loans. In addition, QE2 is structured to stimulate the meager 0.8% core inflation experienced over the last 12 months (Bloomberg) to a Goldilocks level – not too hot and not too cold. QE2 asset purchase estimates are all over the map, but estimates generally stand at the low end of the original $200 billion to $2 trillion range.
Growth Continues: Although companies are sitting on record piles of cash ($1.8 trillion for all non-financial companies), chief executive officers continue to have short arms with their deep pockets when it comes to spending on new hires. Persistent growth for five consecutive quarters (2% GDP expansion in Q2), coupled with tight cost controls, is resulting in 46% estimated growth in 2010 corporate profits as measured by the average of S&P 500 companies. For the time being, “double dip” worries have been put on hold for this jobless recovery.
Unemployment Hypochondria: As I wrote in an earlier Investing Caffeine article (READ HERE), there is an almost obsessive focus on the unemployment rate, which although moving in the right direction, remains at a stubbornly high 9.6% rate nationally. Fresh new employment data will be released this Friday.
Foreclosure-gate: As foreclosures have increased and the decline in the housing market has matured, investors have grown more impatient with collections from mortgage backed securities originators. Banks and other mortgage lenders could face more than $100 billion in losses (CNBC) in mortgage “putbacks” related to improper packaging and terms disclosed to investors. Lawyers are salivating at the opportunity of litigating the thousands of potential cases across the country.
Create Your Own Blueprint – Block Noise
In reality, there is no dinner bell or penalty whistle when it comes to investing. Sure, we hear dinner bells and whistles every day on TV from strategists and economists, but in this sordid, cacophony of daily noise, the long line-up of soothsayers are constantly switching back and forth between optimistic bells and pessimistic whistles. The consistent onslaught of this indiscernible noise serves no constructive purpose for the average investor. I strongly believe the correct plan of attack is to create a customized investment plan that meets your long-term objectives, constraints, and risk tolerance. By creating a diversified portfolio of low-cost tax-efficient products and strategies, I believe investors will be more securely positioned for a more comfortable and less stressful retirement.
I have my own opinions on the economic environment, which I detail in excruciating detail through my InvestingCaffeine.com writings. These macro-economic opinions are stimulating but have little to no bearing on the construction of my investment portfolios. More important is focusing on the investment areas with the best fundamental prospects, while balancing risk and return for each client.
Despite what I just said, if you are still determined to know my opinions on the market direction, then follow me to the dinner table; I just heard the dinner bell ring.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GE, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
From Merger Wedding to eHarmony
Source: Photobucket
“Keep your eyes wide open before marriage, and half-shut afterwards.”
– Benjamin Franklin
Stocks share a lot of the same dynamics with dating and marriage. Some may choose to play the field through partnerships and joint ventures, while others may choose to remain independent as eternal bachelors/bachelorettes. Others, however, are willing to take the plunge. Unfortunately some marriages don’t last. But if things don’t work out, there is no need to worry because eHarmony.com (or resident investment bank) will always be there to help find your next perfect match.
Unlucky in Love
An example of a bloody divorce is the mega-merger between AOL Inc. and Time Warner (TWX) in 2000. The relationship was so destructive that investors witnessed AOL’s peak value of $222 billion in December 1999 (Fortune) plummet to around $3 billion today…ooooph!
Compared to some relationships, AOL lasted much longer. In fact Yahoo! Inc. (YHOO) didn’t even get to celebrate a honeymoon with Microsoft Corp. (MSFT) in February 2008 when the behemoth software company offered a +62% premium ($31 per share) for the gigantic portal. Microsoft’s $45 billion cash and stock offer was ruled unworthy by Yahoo’s board, so the company decided to leave Microsoft at the altar. Even after considering Yahoo’s latest price spike on acquisition rumors, Microsoft’s original bid is still almost double Yahoo’s current stock price of $16 per share.
Merger Scuttlebutt
As I discussed in my earlier mergers and acquisitions article (M&A) conditions are ripening with large corporate cash piles, a continued economic recovery, improved capital markets availability, and cheap credit costs (at least for those that qualify). With the clouds slowly lifting in the M&A world, suitors are shaking the trees for more potential opportunities.
While some acquirers may have altruistic intentions in combining companies, some marriages are done for pure gold-digging purposes. Private equity firms Blackstone Group (BX) and Silver Lake are rumored to be circling the Yahoo wagons and courting AOL as a potential partner in a joint bid. Whatever the expectations, if private equity plays a role in a Yahoo bid, the internet company should not become disillusioned with romantic warm and fuzzies – private equity firms like to get straight down to dirty business. Yahoo owns a 35% stake in Yahoo Japan and a 43% interest in leading Chinese e-commerce company, Alibaba Group. If a joint private equity bid were ever to win, I believe there would be a strong impetus to realize shareholder value by carving up these non-operating stakes. Consolidating overhead and streamlining expenses would likely be a top priority as well.
The Perfect Marriage
A “perfect marriage” could almost be called an oxymoron because like any relationship, there is significant work required by both parties. The divorce rate is estimated at around 40-50% in North America (Europe around the same), however mergers even fail at a higher 70% rate, according to Bain and Company study. I would argue successfully integrating larger deals are even more difficult, hampering the success rate even further. Merging two poorly managed companies purely for cost purposes is probably not the best way to go. Crashing two garbage trucks together is not going to create a Ferrari. I wouldn’t go as far as to say Yahoo and AOL are garbage trucks, but they face numerous, substantial challenges. Maybe these two companies are more akin to Mazdas transforming into a Toyota Camry (TM).
From my perspective, if companies really are dead set on engaging in acquisitions, then I urge management teams to focus on smaller digestible deals. Specifically, concentrate on those deals with experienced senior management teams who understand and respect the unique culture of the acquirer. Mergers also often fail due to excessive optimism and overly optimistic assumptions. This is an area in which Warren Buffett excels. Rarely do you observe the Oracle of Omaha overpaying for an acquisition, but rather he patiently waits for his fat pitch, and when it floats over the plate, Buffett is quick to throw out a lowball offer that will dramatically increase the probabilities of long-term merger success (think Geico, Sees Candy, Burlington Northern, etc.).
In the end, a joint relationship may not be forged between Yahoo, AOL and private equity firms, but if talks disintegrate, no need to worry – alternative partnerships can be explored on eHarmony.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in YHOO, MSFT, TWX, BX, BRKA, TM, Alibaba, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Microsoft Makes Dividend Splash
Source: ActingLikeAnimals.com
I’ve talked about growing profits and cash piles for a while now (read more), but at some point investors and board members get restless and demand action (Steve Jobs has not yet). The most recent blue-chip company to make a splash, when it comes to capital management, is Microsoft Corp. (MSFT), which just announced a significant +23% increase in its dividend in conjunction with $4.75 billion in debt offerings. These capital structure changes still leave plenty of room for additional share repurchases and acquisitions.
Debt Offering – Are You Sure?
Huh? What in the heck is Microsoft doing borrowing money? I mean, does a company with $44 billion in cash and investments, generating a whopping additional $22 billion in free cash flow in fiscal 2010 (ended in June), really need access to additional capital? The short answer is “NO.” But a company like Microsoft borrowing $4.75 billion is like Donald Trump borrowing $50 on his credit card. Well wait, “The Donald” has actually had some hair and Chapter 11 problems, so the more appropriate analogy would be Bill Gates borrowing $20 on his credit card. Not only is it a rounding error, but it’s a good financial management practice for corporations to take advantage of the debt tax shield (read definition).
What makes Microsoft’s debt issuance that much more incredible is the astonishingly low rates the company is paying investors on the debt. According to Dealogic, Microsoft set a record low for yield paid on corporate unsecured debt. For the separate maturities ranging from 2013 to 2040, Microsoft paid a stunningly low 25-83 basis point spread over Treasuries. I don’t want to get into government credit worthiness today, but who knows, maybe Microsoft will pay lower debt rates than the U.S. Treasury, in the not too distant future?!
Regardless of the array of capital structure management strategies used by other companies, Microsoft is not alone in dealing with its cash hoarding problems. Cisco Systems Inc. (CSCO), another blue-chip cash printing press, just announced the initiation of a 1-2% dividend to be paid by the end of their fiscal year ending in July 2011 (read more about dividend cash “un-hoarding”).
But Who Cares?
Who cares about Microsoft’s wimpy 2.62% yield anyway? Well, for one, I sure care! A 10-year Treasury Note is yielding a measly, static 2.55%. If Microsoft continued on the same dividend path growth over the next five years as it did over the last five years, investors could potentially be talking about a 5.2% yield on our initial investment, and this excludes any potential stock price appreciation. With only roughly a 25% payout ratio on Microsoft’s fiscal 2010 free cash flow, the company has a lot of freedom to hike future dividends, even if earnings don’t grow. Microsoft has also enhanced shareholder value by putting its money where its mouth is by purchasing over $30 billion of company stock over the last three years.
Nice trend in dividend growth.
The extreme case of dividend growth is Wal-Mart Stores (WMT), which if purchased in 1972 would provide a +2,300% yield on the original investment, excluding any benefit from the massive price appreciation ($.05 split-adjusted per share to $53.65). Microsoft is no young chick like Wal-Mart 40 years ago, but you get the gist (read Dividend Sapling to Fruit Tree).
So while strategists and economists fret about the possibilities of a “double dip” recession, in the interim there have been 179 companies in the S&P 500 index that have hiked dividends in 2010 (versus only 3 companies that have cut). Microsoft has been no slouch either, growing revenues by +22% and EPS (Earnings Per Share) by +50% in their most recent fiscal fourth quarter. Although Microsoft’s stock is down -20% for 2010, the capital management and dividend splash recently announced by Microsoft (and other companies) should eventually capture the eye of investors currently earning squat on overpriced bonds and almost worthless Certificates of Deposit.
Read complete Microsoft dividend story
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, CSCO, nd WMT, but at the time of publishing SCM had no direct position in MSFT, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Questioning the Death of Buy & Hold Investing
In the midst of the so-called “Lost Decade,” pundits continue to talk about the death of “buy and hold” (B&H) investing. I guess it probably makes sense to define B&H first before discussing it, but like most amorphous financial concepts, there is no clear cut definition. According to some strict B&H interpreters, B&H means buy and hold forever (i.e., buy today and carry to your grave). For other more forgiving Wall Street lexicon analysts, B&H could mean a multi-year timeframe. However, with the advent of high frequency trading (HFT) and supercomputers, the speed of trading has only accelerated further to milliseconds, microseconds, and even nanoseconds. Pretty soon B&H will be considered buying a stock and holding it for a day! Average mutual fund turnover (holding periods) has already declined from about 6 years in the 1950s to about 11 months in the 2000s according to John Bogle.
Technology and the lower costs associated with trading advancements is obviously a key driver to shortened investment horizons, but even after these developments, professionals success in beating the market is less clear. Passive gurus Burton Malkiel and John Bogle have consistently asserted that 75% or more of professional money managers underperform benchmarks and passive investment vehicles (e.g., index funds and exchange traded funds).
This is not the first time that B&H has been held for dead. For example, BusinessWeek ran an article in August 1979 entitled The Death of Equities (see Magazine Cover article), which aimed to eradicate any stock market believers off the face of the planet. Sure enough, just a few years later, the market went on to advance on one of the greatest, if not the greatest, multi-decade bull market run in history. People repudiated themselves from B&H back then, and while B&H was in vogue during the 1980s and 1990s it is back to becoming the whipping boy today.
Excuse Me, But What About Bonds?
With all this talk about the demise of B&H and the rise of the HFT machines, I can’t help but wonder why B&H is dead in equities but alive and screaming in the bond market? Am I not mistaken, but has this not been the largest (or darn near largest) thirty year bull market in bonds? The Federal Funds Rate has gone from 20% in 1981 to 0% thirty years later. Not a bad period to buy and hold, but I’m going to go out on a limb and say the Fed Funds won’t go from 0% to a negative -20% over the next thirty years.
Better Looking Corpse
There’s no denying the fact that equities have been a lousy place to be for the last ten years, and I have no clue what stocks will do for the next twelve months, but what I do know is that stocks offer a completely different value proposition today. At the beginning of the 2000, the market P/E (Price Earnings) valued earnings at a 29x multiple with the 10-year Treasury Note trading with a yield of about 6%. Today, the market trades at 13.5 x’s 2010 earnings estimates (12x’s 2011) and the 10-Year is trading at a level less than half the 2000 rate (2.75% today). Maybe stocks go nowhere for a while, but it’s difficult to dispute now that equities are at least much more attractive (less ugly) than the prices ten years ago. If B&H is dead, at least the corpse is looking a little better now.
As is usually the case, most generalizations are too simplistic in making a point. So in fully reviewing B&H, perhaps it’s not a bad idea of clarifying the two core beliefs underpinning the diehard buy and holders:
1) Buying and holding stocks is only wise if you are buying and holding good stocks.
2) Buying and holding stocks is not wise if you are buying and holding bad stocks.
Even in the face of a disastrous market environment, here are a few stocks that have met B&H rule #1:
Maybe buy and hold is not dead after all? Certainly there have been plenty of stinking losing stocks to offset these winners. Regardless of the environment, if proper homework is completed, there is plenty of room to profitably resurrect stocks that are left for a buy and hold death by the so-called pundits.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, AMZN, ARMH, and NFLX, but at the time of publishing SCM had no direct position in GGP, APKT, KRO, AKAM, FFIV, OPEN, RVBD, BIDU, PCLN, CRM, FLS, GMCR, HANS, BYI, SWN (*2,901% is correct %), CTSH, CMI, ISRG, ESRX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Curious Case of Gen Y and Benjamin Button
If a current Gen Y-er aged backwards like Benjamin Button, he would feel right at home when it comes to investing, because acute conservatism and risk aversion have struck older and younger generations alike. The Curious Case of Benjamin Button is a story that follows the critical peaks and valleys of a boy born in his eighties, who immediately begins to reverse the aging process. Investors of all ages have suffered their peaks and valleys over the last decade, and these experiences have impacted investing attitudes and perceptions heavily during the prime earning years. For retirees, it’s virtually impossible for extreme events like the Great Depression, World War II, Vietnam, Kennedy’s assassination, and Nixon’s impeachment to NOT have had an influence on individuals’ investing behavior.
Investing Consequences on Younger Investors
If a younger Mr. Button were still alive today, there is no doubt the disheartening events experienced in his 80s would only become reinforced by the bleak occurrences in 2008-2009. His reverse aging would not only have allowed him to witness the collapse of Lehman Brothers, but also behold the demise and bailout of other gargantuan financial institutions. Today, if Benjamin wasn’t busy watching the MTV Video Music Awards, he would most likely be diligently managing his bullet-proof portfolio of cash, CDs (Certificates of Deposit), Treasury bills, and maybe some tax-free municipals if he was feeling a little spunky.
The cautious stance of youthful savers was confirmed in a recent study conducted by Merrill Lynch Global Wealth Management. The report demonstrates how the recent financial crisis has had a severe dampening impact on the risk appetites of 18-34 year old “Millennials.” So dramatic an effect was the recession, the nervous conservatism experienced by the 30-somethings was only rivaled by fear from 65 year olds. In fact, the 56% of young investors, who were more cautious today than a year ago, was the highest percentage registered by any age group.
Here’s what Christopher Geczy adjunct associate professor of finance at University of Pennsylvania’s Wharton School had to say about younger Millennials:
“We’re coming off a series of financial crises that hit this young generation at points in their lives where external events shape strong opinions…Many of them have witnessed a decline in the wealth of their families and seen their parents delay retirement or even return to the workforce.”
Beyond witnessing the challenges faced by their parents, the Millennials are encountering their own obstacles – such as joblessness. For those workers under age 35, the unemployment rate in August stood at more than 13% – significantly higher than the 9.6% national rate.
Note to Youths: Stocks for the Long Haul
In the typical life cycle of investing, investors flaunt a higher risk tolerance in their younger years and exhibit more risk aversion as they approach or enter retirement. Historically, this makes perfect sense because workers earlier in their careers have plenty of time to ride out the fluctuations associated with owning equities. Jeremy Siegel, professor at the Wharton University Professor, says stocks significantly outperform bonds by 6% per year over longer timeframes (see Siegel Digs in Heels).
For Gen Y-ers the larger risk is being too conservative, not too aggressive. Barry Nalebuff, a strategy professor at Yale’s School of Management agrees:
“The biggest risk for this generation is that they’ll live too long. With medical breakthroughs, the reality is that many of them will live beyond 100…The only way they have enough assets to last them is to invest in stocks. If they don’t, a lot of people will have to keep working way past when they want to because they won’t have enough money saved up.”
Even for those downbeat on the domestic equity markets – rightfully so with no price gains achieved over the last decade – younger investors should not lose sight of the tremendous equity opportunities available internationally (see the Blowing the Perfect Investment Game).
For many people, reverse aging may be fun for a while, but for Benjamin Button, living through the Great Depression and multiple wars as an adult would likely dampen the mood and increase risk aversion dramatically. Millennials have persevered through difficult times too. Generation Y has survived two recessionary bubbles caused by excessive technology spending and consumer credit binging, both over a short timeframe. Becoming too conservative for these investors will feel comfortable in the short-run if uncertainty continues to prevail. But investing now with adequate, diversified equity exposure is the prudent course of action. Even a wrinkly Benjamin Button could agree, wisely investing in some equities during your earlier career sure beats working as a Wal-Mart (WMT) greeter into your 80s.
Read the full Money-CNN and Newsweek articles on the subject
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and WMT, but at the time of publishing SCM had no direct position in BAC/Merrill, Lehman, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
M&A: Top or Bottom?
James Stewart at Smart Money recently wrote a piece attempting to debunk the consensus view, which holds the belief that increased mergers and acquisitions (M&A) activities is a leading indicator of positive market returns. There is no doubt, in the desert of positive news headlines, the bulls are searching for signs of an oasis to rescue them. Temporarily quenching the thirst of the bulls were $90 billion of proposed deals last week, including the hefty $40 billion hostile takeover offer of Potash Corp. (POT) by BHP Billiton Ltd. (BHP).
Is this uptick in deal announcements the sign of greener pastures, or is it what Stewart calls a “reverse indicator” of the market’s direction?
Stewart buttresses his argument by showing how record deal activity occurs at peaks of the market. For example, global M&A activity crested at $4.3 trillion in 2007, right before the market cratered in 2008. This peak can be compared to the previous trough of $1.3 trillion in M&A transactions in 2002, just as the economy was freshly recovering out of the recession. The trough to peak period for this M&A cycle lasted about five years (2002-2007), so I’m having a little trouble understanding how Stewart is claiming a peak is imminent after less than 1 year into the new M&A cycle (the recent M&A trough occurred in 2009 at $1.3 trillion)? Wouldn’t his analysis imply a gradual increase in deals until 2014? Well, for now, let’s just go with his rapid orgasm thesis and move onto his next points.
Stewart proceeds to rationalize the spate of new deal announcements with the following reasons:
- Higher Prices Perk Up Previously Reluctant Sellers: The general price rebound in the market from the nadir in March 2009 is one major contributing factor to why previously reluctant targets are now warming up to fresh overtures.
- Suitors More Comfortable: In 2009, buyers weren’t in the mood for paying top dollar for companies experiencing deteriorating fundamentals. Prices may be higher in 2010, but the Armageddon scenarios of early 2009 have momentarily been put on hold.
- Money Can’t Get Any Tighter: The cheap, loosey-goosy lending standards in the pre-2008 M&A golden era no longer exist, but conditions can’t get much worse than the log-jammed lending standards practiced in 2009.
The Real Reason for Deals Rising
Source: The Wall Street Journal
One word…cash. About $1.8 trillion of it is just piling up on the non-financial balance sheets of domestic companies (Financial Times). The tribes are getting restless with the obscene amounts of money earning 1% or less (read Steve Jobs: Gluttonous Hog article) and shareholders want to see more productive strategies applied to their capital. Frankly, I much prefer organic investment (e.g., R&D and marketing), share buybacks, and dividends over large destructive acquisitions any day. Just ask the executives at AOL/Time Warner, Mercedes Benz/Chrysler, and Sprint/Nextel how those large deals worked out for them. For some reason, many men like driving big macho trucks, just as many CEOs like controlling big companies.
One Reason to Buy and Many Reasons to Sell
I can’t disagree with James’s thesis that M&A markets get overheated near market tops, but I think there is a lot of room in deal announcements between the $90 billion in deals announced last week and the $4.3 trillion peak. I also agree that one good week of M&A announcements should not be extrapolated into eternity.
Worth noting as well, I believe there is a substantial difference in the financing market today versus the prior peak. In the BHP/Potash deal for example, BHP offered $40 billion in cash…not stock. BHP is putting its money where its mouth is, particularly its $18 billion in annual cash flow and its healthy balance sheet. Internal financing wasn’t the main priority in the mid-2000s, when companies (including private equity) were more cavalier with OPM (other people’s money), specifically with the endless pools of cheap bank financing.
Currently, companies have deep pockets, but very short arms, and as a result, companies have been very stingy with their capital. However, if we continue to see more internally financed cash deals, I will view that trend as a tremendously positive signal of longer-term fundamental confidence, a characteristic which was absent last year.
On the topic of insider buying, Peter Lynch pointed out “there is only one reason to buy and many reasons to sell” – the only real reason to purchase is the belief stock prices will move higher. Since the availability of cheap capital has been severely hampered, a wide swath of companies will have to rely on their own cash generation – not OPM. Since outside capital is scarce, the companies with cash flexibility will be more prudent in their M&A due diligence.
Overall, James Stewart may be right about the sustainability of M&A going into next year. However, in the short-run, as the gargantuan corporate cash piles get put to use through more M&A, and share buybacks, simple supply-demand economics indicate a shrinking equity base should bode well for market prices, all else equal. Uncertainty is available in large quantities right now, so time will tell if deal making will diminish into a market top, or gain momentum into a bull market. With all that cash sitting on the sidelines, my guess is we are closer to the trough of the M&A wave versus the top. If I’m wrong, don’t hold your breath for a Microsoft-Google (MSFT/GOOG) or Exxon-Chevron (XOM/CVX) merger anytime soon.
Read Full Smart Money M&A Article Here (Hat-Tip Josh Brown TRB)
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, GOOG, and AAPL, but at the time of publishing SCM had no direct position in BHP, POT, MSFT, XOM, CVX, AOL/Time Warner (TWX), Mercedes Benz/Chrysler, and Sprint/Nextel (S) or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Private Equity: Hitting Maturity Cliff
Photo source: 1Funny.com
Wow, those were the days when money was as cheap and available as that fragile, sandpaper-like toilet paper you find at gas stations. Private equity took advantage of this near-free, pervasive capital and used it to the greatest extent possible. The firms proceeded to lever up and gorge themselves on a never-ending list of target companies with reckless abandon (see also Private Equity Shooting Blanks). Now the glory days of abundant, ultra-cheap capital are history.
Rather than rely on low-cost bank debt, private equity firms are now turning to the fixed income markets – specifically the high yield market (a.k.a. junk bonds). As The Financial Times points out, more than $170 billion of junk bonds have been issued this year, in large part to refinance debt issued in the mid-2000s that has gone sour due to overoptimistic projections and a flailing U.S. economy. In special instances, private equity owners are fattening their own wallets by declaring special dividends for themselves.
Even though some of these over-levered, private equity portfolio companies have received a temporary reprieve from facing the harsh economic realities thanks to these refinancings, the cliff of maturing debt in 2012 is fast approaching. Some have estimated that $1 trillion in maturing debt will roll through the market in the 2012-2014 timeframe. Either the economy (or operating performance) improves enough for these companies to service their debt, or these companies will find themselves falling off these maturity cliffs into bankruptcy.
Junk is Not Risk-Free
Driving this trend of loan recycling is risk aversion to stocks and a voracious appetite for yield in a yield desert. Stuffing the money under the mattress, earning next to nothing on CDs (Certificates of Deposit) and money market accounts, will not help in meeting many investors’ long-term objectives. The “uncertain uncertainty” swirling around global equity markets has nervous investors flocking to bonds. The opening of liquidity in the high yield markets has served as a life preserver for these levered companies desperate to refinance their impending debt. This high-yield debt refinancing window is also an opportunity for companies to lower their interest expense burden because of the current, near record-low interest rates.
But as the name implies, these “junk bonds” are not risk free. For starters, embedded in these bonds is interest rate risk – with a Federal Funds rate at effectively zero, there is only one upward direction for interest rates to go (bad for bond prices). In addition, credit risk is a concern as well. In the midst of the financial crisis, many of these high-yield bonds corrected by more than -40% from their highs in 2008 until the bottom achieved in early 2009. If the economy regresses back into a double-dip recession, many of these bonds stand to get pummeled as default rates escalate (see also, bond risks).
Pace Not Slowing
Source: Dealogic via WSJ
Does the appetite for high yield appear to be slowing? Au contraire. In the most recent week, Dealogic noted $15.4 billion in junk bonds were sold. The FT sees the pace of junk deals handily outpacing the record of $185.4 billion set in 2006.
The Wall Street Journal used the following deals to provide a flavor of how companies are using high-yield debt in the present market:
“First Data Corp. sold $510 million of 10-year notes this week, at 9.125%, to pay down bank debt due in 2014. Peabody Energy sold $650 million of 6.5%, 10-year notes to pay off the same amount of higher-priced debt due in three years. MultiPlan Inc., a health-care cost-management provider, sold $675 million of notes this week, at 9.875%, to help fund a buyout of the company. Cott Corp., a maker of store-branded soft drinks, sold $375 million of debt at 8.125% to fund its purchase of another company, Cliffstar Corp.”
The roads on the junk bond highway appear to be pothole free at the moment, however a cliff of debt is rapidly approaching over the next few years, so high-yield investors should travel carefully as conditions in the junk market potentially worsen. As we witnessed in 2008-2009, it can take a while to hit rock bottom in the riskier areas of the credit spectrum.
Read full Financial Times and Wall Street Journal articles on the high yield market.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including HYG and JNK), but at the time of publishing SCM had no direct position in First Data Corp., Peabody Energy (BTU), MultiPlan Inc., Cott Corp. (COT), Cliffstar Corp., or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Cindy Crawford Economy
Photo source: http://www.joyyoga.blogspot.com
I remember intently examining a few magazine covers that former supermodel Cindy Crawford adorned in my prime high school and collegiate years. Like our economy, the resultant recovery in 2009-2010 feels a little like a more mature version of Cindy Crawford (now 43 years old). Things look pretty good on the surface, but somehow people are more focused on pointing out the prominent mole, rather than appreciating the more attractive features. Many market commentators feel to be making similar judgments about the economy – we’re seeing nice-looking growth (albeit at a slowing pace) and corporations are registering exceptional results (but are not hiring). Even Ben Bernanke, our money-man superhero at the Federal Reserve, has underscored the “unusually uncertain” environment we are currently experiencing.
Certainly, the economy (and Cindy) may not be as sexy as we remember in the 1990s, but nonetheless constant improvement should be our main goal, regardless of the age or stage of recovery. Sure, Cindy chose cosmetic surgery while our government chose a stimulus (along with healthcare and financial regulatory reform) for its economic facelift. But the government must walk a fine line because if it continues to make poor decisions, our country could walk away looking like a scary, cosmetically altered version of Heidi Montag.
Our government in many ways is like Cindy Crawford’s former husband Richard Gere – if the Obama administration doesn’t play its cards right, the Democrats risk a swift divorce from their Congressional majority come this November – the same fate Richard suffered after a four year marriage with Cindy. Like a married couple, we need the federal government like a partner or spouse. Fortunately, our government has a system of checks and balances – if voters think Congress is ugly, they can always decide to break-up the relationship. Voters will make that decision in three months, just like Cindy and Richard voted to separate.
The Superpower Not Completely Washed Up
We may not have the hottest economy, but a few factors still make the equity markets look desirable:
- Corporate profit, margins, and cash levels at or near record levels. S&P profits are estimated to rise +46% in 2010.
- Interest rates are at or near record lows (Fed Funds effectively at 0% and the 10-Year Treasury Note at 2.74%).
- The stock market (as measured by the S&P 500 index) is priced at a reasonably alluring level of 13x’s 2010 profit forecasts and 12x’s 2011 earnings estimates.
Multiple Assets & Swapping
I don’t have anything against the institution of marriage (I’ve been happily married for thirteen years), but one advantage to the financial markets is that it affords you the ability to trade and own multiple assets. If a more mature Cindy Crawford doesn’t fit your needs, you can always swap or add to your current holding(s). For example, you could take more risk with a less established name (asset), for example Karolina Kurkova, or in the case of global emerging markets, Brazil. Foreign markets can be less stable and unpredictable (like Kate Moss), but can pay off handsomely, both from an absolute return basis and from a diversification perspective.
Money ultimately goes to where it is treated best in the long-term, so if Cindy doesn’t fit your style, feel free to expand your portfolio into other asset classes (e.g., stocks, bonds, real estate, commodities, etc.). Just be wary of stuffing all your money under the mattress, earning virtually nothing on your money – certainly Cindy Crawford is a much more appealing option than that.
Wade W. Slome, CFA, CFP®
P.S. For all women followers of Investing Caffeine, I will do my best to even the score, by writing next about the Marcus Schenkenberg economy.
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including those with exposure to Brazil and other emerging markets), but at the time of publishing SCM had no direct position in any other security directly referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Securing Your Bacon and Oreo Future
Stuffing money under the mattress earning next to nothing (e.g., 1.3% on a on a 1-year CD or a whopping 1.59% on a 5-year Treasury Note) may feel secure and safe, but how protected is that mattress money, when you consider the inflation eating away at its purchasing power?
We’ve all been confronted by older friends and family members proudly claiming, “When I was your age, (“fill in XYZ product here”) cost me a nickel and today it costs $5,000!” Well guess what…you’re going to become that same curmudgeon, except 20 or 30 years from now, you’re going to replace the product that cost a “nickel” with a “$15 3-D movie,” “$200 pair of jeans” and “$15,000 family health plan.” Chances are these seemingly lofty priced products and services will look like screaming bargains in the years to come.
The inflation boogeyman has been relatively tame over the last three decades. Kudos goes to former Federal Reserve Chairman Paul Volcker, who tamed out-of-control double-digit inflation by increasing short-term interest rates to 20% and choking off the money supply. Despite, the Bernanke printing presses smoking from excess activity, money has been clogged up on the banks’ balance sheets. This phenomenon, coupled with the debt-induced excess capacity of our economy, has led to core inflation lingering around the low single-digit range. Some even believe we will follow in the foot-steps of Japanese deflation (see why we will not follow Japan’s Lost Decades).
The Essentials: Oreos and Bacon
Even if you believe movie, jeans, and healthcare won’t continue inflating at a rapid clip, I’m even more concerned about the critical essentials – for example, indispensable items like Oreos and bacon. Little did you probably know, but according to ProQuest’s Historic newspaper database, a package of Oreos has more than quadrupled in price over the last 30 years to over $4.00 per package – let’s just say I’m not looking forward to spending $16.00 a pop for these heavenly, synthetic, hockey-puck-like, creamy delights.
Beyond Oreos, another essential staple of my diet came under intense scrutiny during my analysis. I’ve perused many an uninspiring chart in my day, but I must admit I experienced a rush of adrenaline when I stumbled across a chart highlighting my favorite pork product. Unfortunately the chart delivered a disheartening message. For my fellow pork lovers, I was saddened to learn those greasy, charred slices of salty protein paradise (a.k.a. bacon strips), have about tripled in price over a similar timeframe as the Oreos. Let us pray we will not suffer the same outcome again.
Sliced Bacon Prices (per lb.) – Source (Bureau of Labor Statistics)
It’s Not Getting Any Easier
Volatility aside, investing has become more challenging than ever. However, efficiently investing your nest egg has never been more critical. Why has efficiently managing your investments become so vital? First off, let’s take a look at the entitlement picture. Not so rosy. I suppose there are some retirees that will skate by enjoying their fully allocated Social Security check and Medicare services, but for the rest of us chumps, those luxurious future entitlements are quickly turning to a mirage.
What the financial crisis, rating agency conflicts, Madoff scandal, Lehman Brothers bankruptcy, AIG collapse, Goldman Sachs hearings, FinReg legislation, etc. taught us is the structural financial system is flawed. The system favors institutions and penalizes the investor with fees, commissions, transactions costs, fine print, and layers of conflicts of interests. All is not lost however. For most investors, the money stuffed under the mattress earning nothing needs to be resourcefully put to work at higher returns in order to offset rising prices. Putting together a diversified, low-cost, tax-efficient portfolio with an investment management firm that invests on a fee-only basis (thereby limiting conflicts) will put you on a path of financial success to cover the imperative but escalating living expenses, including of course, Oreos and bacon.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in KFT, GS, Lehman Brothers, AIG (however own derivative tied to insurance subsidary), or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Buy-Out Firms Shooting Blanks
Photo source: Photobucket
During the golden age of the mega-buyouts in the mid-2000s, when banks were lending like drunken sailors, and private equity firms were taking the practically free funding to shoot at almost every company in sight, it’s no wonder managers of these funds were “high-fiving” each other. Unfortunately for the participants, the music ended in 2007, and the heavy debt-loaded guns that previously were killing large elephant deals got replaced with harmless toy guns shooting blanks at phantom transactions.
Peter Morris, a former Morgan Stanley (MS) banker and author of the scornful report, “Private Equity, Public Loss,” took a critical eye at the industry pointing to the reasons these high risk-taking private equity firms are underperforming the S&P 500 significantly. Bolstering his underperformance assertions, Morris points to 542 deals in the Yale endowment that underperformed by -40% once fees were subtracted. The Center for the Study of Financial Innovation, which is affiliated with Morris, cites a 2005 paper by Steven Kaplan (University of Chicago), and Antoinette Schoar (Massachusetts Institute of Technology). The paper shows the average buy-out fund underperformed the S&P 500 index from 1980 – 2001.
Another factor that Morris feels should not be ignored relates to risk. Morris feels the excessive risk profiles associated with these private equity funds have not been adequately considered by many unknowing investors and public taxpayers. Pensioners are vulnerable to these underperforming, risk-adjusted returns, while unassuming taxpayers could also be on the hook if risky private equity bets go bad. Under certain scenarios these potentially rocky private equity investments could bring a financial institution to its knees and force governments to use taxpayer bailout money. The Financial Times features a $6.5 billion investment made by Terra Firma, which was subsequently written down to zero, to make its point about the inherent risk private equity plays in the overall financial system.
Heads We Win, Tails You Lose
What makes the purported underperformance more scathing is the fact that these funds should bear higher returns to compensate investors for the additional liquidity risk and leverage that is undertaken. Like hedge funds, most private equity funds charge a 2% management fee, and a 20% performance fee for results achieved above a certain hurdle rate. The problem, that many outside observers highlight, is that the private equity firms have very little skin in the game, for example as little as 2%. With not a lot of their own dough in the game, the fund managers have a built in incentive to swing for the fences, because a profit windfall will filter to them should they hit it big. Morris characterizes this conflict of interest as “heads we win, tails you lose.” Another knock against investors revolves around return calculations. The opacity surrounding returns makes private equity less attractive, since valuations are only truly accurately reflected upon sale, which often takes many years.
Have all these shortcomings scared off investors? Apparently not. Just recently Blackstone Group (BX) raised a new $13.5 billion fund, the firm’s 6th fund, fresh off of its 5th fund that raised a total of $20 billion. The focus of the new fund will be on Asia and North America. In the short-run, Europe will occupy less of the fund’s attention until the region’s economy recovers.
To the extent more of these studies garner traction, I’m sure the private equity industry will react with a forceful response, especially with billions in potential fees at stake. One thing is for sure, investors have become more demanding and shrewd post the financial crisis, so if private equity managers want to earn the rich fees of yesteryear, they will need to do better than shoot blanks.
Read The Financial Times Buy-Out Study Article
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MS, BX, Terra Firma or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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