Tuesday, December 18, 2018

The Benefits Of Diversification

We have discussed how diversification works and shown examples, but what about how it works in your portfolio? A recent article in Money discusses how much you should have invested in stocks depending on your age. And while we don't want to take a position in this, we would like to point out the "Finding the Right Mix" figure shown in the article. As you can see, in general, the range of possible returns declines as you increase the percentage of bonds in a portfolio. This is the decline in volatility that is also exhibited in the lower standard deviation from adding bonds to a stock portfolio. 

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.