Tuesday, April 30, 2013

You Want Cash Now?

You have probably seen the advertisements for the lump sum settlement companies that pay you a lump sum today in exchange for your annuity payments. Suppose you just won the lottery and will get $50,000 per year for the next five years. You would prefer a lump sum today. We promise the rate you should get for selling your annuity is 8 percent. However, if you sign today, we will give you a 10 percent rate. Will you sign today so you can lock in the 10 percent interest rate? Hopefully you should know that increasing the interest rate decreases the present value. Unfortunately, it seems that many people don't understand this concept. A recent article highlights several examples of individuals who sold their pension checks for a lump sum payment with interest rates ranging from 27 percent to 106 percent. The companies involved in this practice avoid usury laws by arguing that the lump sum is not a loan but rather an advance.

Wednesday, April 24, 2013

AA-pple Bonds and Dividends

Apple announced that it was raising its quarterly dividend by 15 percent to $3.05 per share and that it would increase its share buyback program by $50 billion to a total of $60 billion. To fund these cash flows to shareholders, Apple plans to issue debt in the near future. Given that Apple has about $145 billion in cash on its balance sheet and generated $48 billion in free cash flow last year, you might expect a top bond rating for the yet to be issued ibonds, but S&P and Moody's announced bond ratings of AA+ and Aa1, respectively. It is believed that Apple is funding the buyback with bonds since the tax deductibility of the coupon payments will result in cheaper capital than if the company paid taxes on the repatriation of cash from its overseas subsidiaries.

Monday, April 22, 2013

2012 CEO Pay

Larry Ellison, CEO of Oracle, heads the 2012 list of top-paid CEOs. During the year, Mr. Ellison received a salary of $5.5 million and made $90.7 million in stock and options. Next on the list was Richard Bracken, CEO of HCA, with cash compensation of $26.7 million and $11.8 million in stock and options. Mark Parker, CEO of Nike, experienced the biggest jump in compensation. His 2012 compensation package was $35.2 million, a 219 percent increase over his 2011 compensation.

Tech VC Firms Shrinking

At the end of the tech boom in 2000 there were about 441 technology venture capital (VC) firms actively investing in new companies. A recent estimate puts the current number of active technology VC firms at about 86. To arrive at this number, Mark Suster, manager of venture capital fund-of-funds Flag Capital, eliminated all technology VC firms that have not invested in at least four new investments with at least $4 million invested in the past year. Even though there were only 86 active VC firms in 2012, it is actually an improvement from the 75 active firms in 2011.

Cheap Debt, Increased Leverage

In 2012, 369 companies increased their net debt/EBITDA ratio. As a result, the median net debt/EBITDA ratio has increased to 2.43. As the article notes, bank loan covenants typically require this ratio to remain below 5.  Companies with a particularly high ratio include Hologic (6) and Molson Coors Brewing (5.4). Although some companies saw an increase in this ratio due to increasing debt on the balance sheet, a troublesome reason for the increase in the net debt/EBITDA ratio at several companies is a decrease in EBITDA. For example, Kraft Foods saw its revenue drop by 1.7 percent and Micron Technology saw a decrease in EBITDA of 41 percent.

Wednesday, April 10, 2013

Predictions About The Future

A famous quote attributed to Mark Twain, Niels Bohr, Albert Einstein, and others, states "Prediction is very difficult, especially about the future." And for stock market returns, it appears that prediction is impossible. On today's Yahoo! Finance front page, two links appeared. The first, quoting Chris Martenson, predicted that the S&P 500 May Fall More Than 40% By Fall. The second headline, only four links below, stated "Watch: Jeremy Siegel Sees Dow at 18,000," a 20 percent increase. Dr. Siegel explained that he could see the Dow at 16,000 by the end of the year, a 7 percent increase, and a further increase to 18,000 in 2014.

Tuesday, April 9, 2013

JC Penney Bonds: 30 Percent Off

Retailer JC Penney has had a troubled year, with sales down 25 percent and the recent resignation of CEO Ron Johnson after only a year and a half on the job. A telling number for the company is that its bonds are trading at about 70 percent of par value, an indication bond investors feel the company may be headed toward bankruptcy. Another possible reason for the bond discount is the liquidity crunch the company may be facing this year. JC Penney is expected spend about $1 billion this year, about the same amount the company has on its balance sheet in cash and short-term investments.

Tuesday, April 2, 2013

Stockton's Bankruptcy

A judge is allowing the Chapter 9 bankruptcy filing by Stockton, Ca., to proceed. Stockton is the largest U.S. city to ever file for bankruptcy protection. Capital market creditors, who opposed Stockton's bankruptcy, disagree with Stockton's plan to fully fund the city's pension plan. The bankruptcy is being closely followed by municipal bond market participants and other municipalities as it appears Stockton will break with the long standing tradition of fully repaying principal to creditors in a municipal bankruptcy.

Monday, April 1, 2013

Rental Property Investment

We know several people who have rental property as part of their investment portfolio and at least as many who would like to own rental property. An article in the New York Times outlines some of the potential risks in rental property investing that many people overlook. For example, vacancy or natural disasters are possibilities. There are other potential risks such as a fire at the property and maintenance risks like pipes bursting or a leaking roof. By now, you should be well versed in risk and realize that these are idiosyncratic, or firm-specific, risks. Another potential risk with rental property that is often overlooked is that typically a large investment is required, which can result in the rental property being a large portion of a portfolio. This means you are left with a portfolio that is not diversified. While we are not saying that rental property cannot be a good investment, hopefully you have enough knowledge to consider how the risk of such an investment fits in your overall portfolio.

The DuPont Identity And Equity Multiplier

As you know, the DuPont Identity decomposes ROE into the profit margin, total asset turnover, and equity multiplier. To see how these factors can impact ROE, consider Goldman Sachs. Although the main topic of this article is pay on Wall Street and in professional baseball, partway through, it discusses the equity multiplier (called the leverage ratio in the article) for Goldman Sachs. During the credit bubble period, probably 2005 to 2008, Goldman's equity multiplier exceeded 25 and the company's ROE was above 30 percent. Now, Goldman's equity multiplier has dropped to about 12 and the ROE has dropped to the low teens.