Cryptocurrencies Are Securities

One problem with cryptocurrency has been that the lack of regulation has led to several incidents of fraud. Recently, a Federal judge ruled that cryptocurrencies are securities and thus fall under the regulation of the SEC. Whether an asset is a security falls under the "Howey Test," that is whether it is an investment in a common enterprise and profits are earned from others' efforts. The SEC has announced that bitcoin and ether are exempt from regulation. A common argument from cryptocurrency founders is that the offer a promise to a network, platform, or service instead of profits.

Volkswagen's Option To Abandon

Volkswagen recently announced that it would discontinue production of the iconic Beetle, which was first manufactured in the 1930s. The Beetle was produced until 1978, when Volkswagen first dropped the car from production in Germany. The car was reintroduced in 1997. With sales of only 60,000 cars per year, evidently the NPV of continuing to produce Beetles was negative. Remember, the option to abandon exists with any project, although as the previous reintroduction of the Beetle shows, the abandonment need not always be permanent.

Internal Controls And Acuisitions

It is widely known that a large percentage of acquisitions fail to deliver pre-aqcuisition promises, but new research indicates that there may be an indication of trouble ahead. When a company acquires another company, it can exclude the acquired company from Section 404 of Sarbanes-Oxley. Section 404 requires external auditors to assess the the internal controls are adequate. Although inadequate controls result from a myriad of reasons, they are noted in 30 percent of cases where fraud is ultimately determined. One explanation of an acquiring company not being willing to comply with Section 404 is that new, unfavorable information, was found after the acquisition. 

Activist Bondholders

Because bondholders have a fixed claim on assets and no vote in company operations, they tend to be passive investors in companies. However, a new type of investor, the net-short bondholder, has become more prevalent. A net-short bondholder will buy a bond and at the same time take a larger short position in the same company's bonds. A short position benefits when the asset value decreases. Thus, the investor will lose in the long position but gain a larger amount in the short position. The investor will then implement a claim if the company violates any covenant. For example, Aurelius Capital Management took a net-short position in Windstream's corporate debt and then claimed a violation of a covenant two years prior. Windstream had even undertaken actions to satisfy bondholders that held the bonds when the violation occurred. In short, companies now must be even more careful when writing covenants for bonds. 

Merger Math

Several big merger or acquisition announcements have been in the news recently. And, although we argue that the analysis of a potential merger is an NPV analysis with consideration for synergies, many mergers and the payment are done by the "seat of your pants" method. For example, when Elon Musk announced he was considering taking Telsa private at $420 per share, his bid was based on a 20 percent premium to the current stick price, rounded up to $420 dollars per share. A cash flow analysis of Tesla was not necessary since it has no operating cash flows. And when Disney announced it was increasing its bid for 21st Century Fox by $19 billion, it was because the intrinsic value of these assets has increased, notably due to tax reform and operational improvements." While mergers tend to be a tricky analysis, we have severe doubts about any merger done by the seat of your pants method.

Moody's Fined

Moody's Investors Services, the well-known bond rating agency, was fined $16.5 million for failing to ensure the accuracy of its statistical models. The SEC accused the company of failures on more than 650 mortgage backed securities. Moody's assigned ratings on several bonds that were inconsistent with ratings for similar bonds and did not establish a rigorous control process for bond data entry, resulting in incorrect data entry. This resulted in bonds being given incorrect ratings.

Lower Taxes, NPV, and Company Value

A major benefit of the Tax Cuts and Jobs Act of 2017 is that it reduces taxes paid, which increases operating cash flow. Increased cash flow can increase the NPV of a project, even turning a negative NPV to a positive NPV, and increase the overall value of a company. Since the value of a project or the value of a company are both based on the present value of future cash flows, this result is fairly obvious. As a recent article points out, what is less obvious is that the reduced tax rate will also increase the required return on a project or a company. Since the cost of debt that is important for either valuation is the aftertax cost of debt, a reduced tax rate actually makes the cost of capital higher, all else the same. So, in discounting higher future cash flows with a higher cost of capital, the present value will not increase as much as you might think at first glance.