Wednesday, October 25, 2017

Chipotle's Vanishing Options

In 2015, Chipotle stock hit its peak price of about $758 per share, and executives owned stock options worth millions. Since then, the stock has plunged more 60 percent and executives have lost millions. For example, CEO Steve Ells lost $37.5 million worth of stock options, CFO Jack Hartung lost $34.8 million, and CMO Mark Crumpacker lost $10.7 million. In total, the four top executives at Chipotle, including former co-CEO Montgomery Moran, lost $225 million during the stock price plunge. These options were all granted before 2014 as Chipotle stopped issuing stock appreciation rights after shareholders criticized them as being too large and not linked to performance.

Wednesday, October 18, 2017

The Stock Market Is A Home Run



Many people are familiar with the Super Bowl indicator: If an old AFL team wins the Super Bowl, the stock market will be down for the year and if an old NFL team wins the Super Bowl, the stock market will increase during the year. A new sports-related stock market indicator is the home run/strikeout total for Major League Baseball. As total home runs and strikeouts increase, the stock market increases and as the total home run runs and strikeouts decrease, the stock market decreases. Unfortunately, the researcher who discovered this relationship argues the connection is reversed, so the change in the stock market predicts the home run/strikeout total. Guess we won’t be able to use this as a predictor of stock returns.

Debt and Taxes

A proposal to reduce the U.S. corporate tax rate from 35 percent to 20 percent also includes a provision to limit the tax deductibility of interest expense. Corporations have responded in a dramatic fashion to this proposal by repurchasing $178.5 billion worth of bonds through early October of this year. In contrast, companies repurchased only $87.3 billion of bonds for the same period last year. Of course the potential increase in interest rates could also be driving debt repurchases as companies look to lock in low coupon rates. For example, Wal-Mart issued $6 billion in new bonds to help finance an $8.5 billion repurchase. Both causes have driven debt repurchases to astounding levels.

Tuesday, October 10, 2017

P&G Shareholders Reject Peltz

Activist investor Nelson Peltz has apparently lost his bid for a seat on the Proctor & Gamble board. Peltz had sought to gain one seat on the 11 person board. At a market cap of $232 billion, the proxy fight was the largest in history, with the sides spending more than $100 million on mailings, phone calls, and advertisements. Peltz is expected to contend the results as the final outcome was within one percent. A major explanation for the win by P&G is believed to be the large number of individual stockholders in P&G stock.

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.

Tuesday, July 18, 2017

A Boardless Company

It seems that Hampton Creek, know for its eggless mayonnaise, is boardless as well. A recent report indicates that five board members have recently resigned, leaving co-founder and CEO Josh Tetrick as the only remaining board member. The company has had a string of setbacks, including allegations of food safety after it bought back products from supermarkets. The company issued a statement indicating that the lack of a board gave more power to the staff, it appears that the direction of the company is now entirely in the hands of Tetrick.

Monday, July 17, 2017

Cash Flow Rises

According to a recent study, free cash flow for 20 industries increased to 4.97 percent last year, meaning that for every dollar of sales, companies generated 4.97 cents in cash flow. An increase in operating efficiency generated .89 percent, a decrease in working capital contributed .69 percent, and lower capex contributed .17 percent. The lower capex spending may be worrisome as it is an indication of lower investment in fixed assets.

From 1.68 million to 1

In June, Greek shipping company DryShips executed a 1-for-5 reverse stock split. While this itself is not unusual, it was the 7th reverse stock split by the company in the last 13 months! In fact, if you had owned 1.68 million shares of the company stock on March 12, 2016, you would currently own only one share. And the company stock has dropped over 99.9 percent. The stock would have to increase by 17.79 billion percent to reach its all-time high. One investor, who had invested $220,000, the bulk of his nest egg, currently has less than $1 invested in the company. Hopefully, this will drive home the importance of diversification. The story of DryShips is long and may involve "pseudo-underwriting", and one investor, Kalani Securities, Ltd., appears to have made millions on the stock.

Wednesday, July 12, 2017

CEO Pay

High CEO pay is often in the news, with many pundits arguing that CEOs are paid too much. However, if a good CEO can increase the value of the company by an amount greater than the pay, then the CEO is a positive NPV investment. A recent study finds that companies with a CEO-worker pay ratio in the 85th percentile had an ROA 13 percent greater than the industry median and a Tobin's q that was 2.1 percent greater than the median. In other words, firm's with a high CEO-worker pay ratio tend to outperform other companies when evaluated with these metrics.

Monday, July 10, 2017

Toyota's Manufacturing Option

Toyota recently spent $1.3 billion to overhaul its plant in Georgetown, Kentucky. The plant was originally designed to build the Camry and Avalon, which are both assembled on the same platform. However, a shift in consumer purchasing patterns has increased the sales of SUVs. The Georgetown plant could not manufacture these more profitable vehicles, an opportunity cost to the company. The plant remodel means that Toyota can produce 11 different models at the plant, allowing the company to switch production more quickly and cheaply in the future to meet consumer demand more efficiently. Toyota also plans to mix and match more components between its models, another increase in manufacturing optionality.

Sunday, May 14, 2017

Spotify Direct To Market?

Spotify was one of the most eagerly awaited IPOs of this year, but it appears that the company may bypass the IPO market entirely. Recently, sources said that Spotify would be the first major company to carry out a direct listing on the NYSE. In a traditional IPO, the company sells stock to investors through investment banks. The company receives the funds raised, less the underwriter's commission. In a direct listing, the exchange lists the stock, allowing employees to buy and sell shares on the market. No new shares are created and no funds are raised by the company.

Wednesday, May 3, 2017

Long-Term Treasuries

In 1977, 30-year Treasury bonds first started being regularly issued. The issuance of these bonds was discontinued in 2001, then reintroduced in 2006. Although longer maturity Treasury bonds have been issued, for example, the 50-year bonds used to finance the Panama Canal, for about 40 years, 30-year bonds have been the longest term bonds issued by the U.S. government. With historically low interest rates, several countries have chosen to go the really long-term route. For example, Ireland, Belgium and Mexico have issued 100-year bonds, and Austria has issued 70-year debt. Recently, Steve Mnuchin, the United States Secretary of the Treasury, indicated that the Treasury was considering the issuance of 50-year Treasury bonds to lock in long-term interest rates. Opponents argue that the liquidity in the 50-year maturity market is not sufficient to support regular auctions for these bonds. Finding the necessary demand needed because of low liquidity could prove costly. Only time will tell if the U.S. Treasury decides to issue 50-year maturity bonds.

Wednesday, April 26, 2017

Currency Losses Decline

In a recent survey of 296 North American and European multinational companies for the fourth quarter of 2016, they lost a combined $10.47 billion due to currency swings, down considerably from $36.85 billion a year earlier. The average effect of these swings on EPS was $.04. The currencies that were mentioned the most as causing losses were the British pound, the euro, The Japanese yen, the Brazilian real and Canadian dollar.

Thursday, April 20, 2017

International Risk

Political risk exists in varying degrees, but the most severe is appropriation of a company's assets. GM became the latest company to have its assets appropriated in Venezuela as the government of that country took control of GM's remaining plant. The plant had stopped producing cars in 2015, manufacturing only spare parts since. GM joins a list of companies, including more than 60 oil companies, meat processing plants, rice farms, and the Manpa toilet paper plant, that have had assets seized by the Venezuelan government. In March, ExxonMobil had parts of a $1.4 billion award related to seizure of its assets by the Venezuelan overturned.

Tuesday, April 18, 2017

2016 Executive Compensation

Equilar, an employee compensation company, released the Equilar 100, CEO compensation at the largest 100 companies by revenue. Leading the list for 2016 was Thomas Rutledge, CEO of Charter Communications, who made about $98 million. In a distant second place was Mark Parker, CEO of Nike, who took home about $47.6 million. Warren Buffett, CEO of Berkshire Hathaway, brought home only $487,881 during 2016, the only CEO on the list to make less than $3 million. Of course you needn't worry for him, Warren is still worth about $73 billion.

Monday, April 10, 2017

The Cost Of Ethics

Back in October, we discussed how the unethical behavior at Wells Fargo cost the company business with California and Illinois. What we haven't discussed about the incident is the personal cost to former CEO John Stumpf and former community banking head Carrie Tolsedt. When Stumpf resigned, he gave up $41 million in pay. Evidently, the company's Board of Directors felt this wasn't enough as they announced that Stumpf would be forced to give back an additional $28 million in pay. For Carrie Tolstedt, she forfeited $19 million in pay when she resigned. The Board announced today that it was retroactively terminating her for cause and seeking to claw back an additional $47.3 million in pay.

Saturday, April 8, 2017

Finance And Sustainability

Although many think that sustainability and finance don't mix, sustainability is a major component of any corporation. For example, the availability and cost of a major component used in a project can dramatically affect the length and costs of that project. Pressed by investors, CFOs are now starting to discuss sustainability openly. One of the difficulties of such discussions is that a primary role for the CFO is to quantify the financial aspects of sustainability. For example, what are the costs of a natural resource used in production in 10 years? Such inputs are an obvious target for scenario and sensitivity analysis. 

Commercial Paper Issuance Falls

In March 2016, an average of 95 AA-rated companies issued commercial paper per day. On March 29, 2017, only six such companies issued commercial paper. The reason behind the dramatic decline in commercial paper issuance is regulations enacted by the SEC to reduce risk in money market mutual funds. Historically, all money market funds had a net asset value (NAV) per share of $1. If the NAV dropped below $1, it was known as "breaking the buck" and had only occurred a limited number of times. In 2008, the Reserve Primary Fund became the largest money market fund to break the buck. In an attempt to reduce risk, the SEC changed the rules for institutional money market funds that means the NAV of these funds will not be pegged at $1. The result was a flight from institutional money market funds, reducing the availability of these funds as customers of commercial paper. This has made it more difficult for companies to raise short-term debt.

Friday, April 7, 2017

Loonie Taking Flight?

Since 2012, when the Canadian loonie reached parity with the U.S. dollar, the currency has taken a nose dive, dropping to a low of C$1.46 in early 2016. One benefit for Canada is that the cheap loonie created a trade advantage, helping that country's exports and benefiting the economy. With a better economy, whether the loonie will once again take flight is an important consideration for U.S. companies doing business in Canada. Strengthening of the loonie will increase the cost of goods imported to the U.S. from Canada, thereby reducing profits. These companies can lock in costs with forward contracts for commodities, or by hedging currency risk with futures, options, or swaps.

IPO Market Up

During the first quarter of 2017, 25 companies went public, raising $9.9 billion, the highest amount raised in the quarter over the past three years. Snap was the largest IPO in the quarter, raising $3.4 billion. There are currently 62 companies in the pipeline. These companies are expecting to raise $17 billion, a relatively thin pipeline.

Wednesday, January 18, 2017

Snapchat's Disappearing Votes

When Alphabet (parent company of Facebook) Google and Facebook went public, the founders of each, Sergey Brin and Larry Page and Mark Zuckerberg, wanted to maintain control of their respective companies. To accomplish, they created Class A shares, which have one vote and were sold to the public, and Class B shares, which have 10 votes per share. This effectively allowed the founders to control all decisions made by the company. One drawback is that as the companies grew and needed to issue more shares for employee stock options and acquisitions, the number of A shares grew, diluting control of the companies. Now, Snap, the parent of disappearing message app Snapchat, is planning an IPO and it appears that the company is going even further: It has been reported that the IPO will offer shares with no voting rights. All voting shares will be retained by the co-founders Evan Speigel and Bobby Murphy, who will retain 70 percent of the votes in the company.

The (Partial) Effects Of Tax Reform

With the U.S. corporate tax rate being among the highest among developed economies, there is discussion of corporate tax reform that would reduce the corporate tax rate from 35 percent to 20 percent, as well as the possibility of eliminating the deduction of interest expense entirely. So how would this affect corporate finance? A cut in the corporate tax rate on interest would reduce the attractiveness of debt as a form of financing, thereby reducing the amount of debt in the optimal corporate capital structure. One estimate is that the U.S. average debt-to-EBITDA ratio would drop from 4.1 to about 3 times, which would also affect the other financial leverage ratios. And the non-deductibility of interest expense would affect the calculation of the weighted average cost of capital. And, finally, at least for now, the decline in corporate debt will likely increase the credit rating for the remaining debt, driving the yield down on debt that does remain. All in all, major changes to U.S. based corporations.

Tuesday, January 17, 2017

Bond Issuance Booming

With the Federal Reserve recently increasing interest rates, you would expect that the amount of corporate bonds issuance would slow. However, at least in the first week of January, this was not the with the largest volume of bonds issued in history. Although the recent interest rate increases would seem to be a negative, it is believed that the Fed will further increase interest rates in 2017, making future bond issues even more expensive. And, while the average yield to maturity may have increased, the current 3.7 percent is still below the average over the past 10 years. Additionally, with the expected number of mergers and acquisitions expected for 2017, companies may be stockpiling cash in advance of these announcements.

Sears' Financial Distress Costs

When a company is in financial distress and bankruptcy is possible, it may be forced into actions that it would not like to undertake. For example, Sears, which has been has been faced with declining sales and mounting losses, recently announced that it was selling its iconic Craftsman tool brand. The sale of Craftsman to Stanley Black & Decker is for $900 million. Under the terms of the agreement, Sears will be able to sell Craftsman tools for 15 years royalty free. Sears also announced that it will close an additional 150 stores.