Tuesday, June 25, 2013

Copper Mine NPV

Tintina Resources announced that its Preliminary Economic Assessment (capital budgeting analysis) of the company's Black Butte Copper Project in central Montana resulted in an IRR of 30.5 percent, an NPV of $218 million at a cost of capital of 8 percent, and a 3.6 year payback. The company announced a post-tax NPV of $110 million, but infortunately appears to have used the same 8 percent cost of capital. A pre-tax valuation should use a pre-tax interest rate, while a post-tax valuation should use a post-tax interest rate. 

Wednesday, June 19, 2013

A Bad Cost Of Capital

Yahoo's recent acquisition of Tumblr has been viewed by many as an acqui-hire of Tumblr's founder David Karp. However, for some analysts, the acquisition is a $1.1 billion mistake. And while we haven't done an analysis of the acquisition ourselves, we really hate it when others make glaring mistakes in their analysis. In the article, the author states:

"The WACC of 9.8% feels high. If we instead use the risk-free rate of 4.5%, then the U.S.-only RPM hurdle rate drops to $0.81, the international-included RPM hurdle rate drops to $0.41."

We have several really big problems with this statement. A WACC of 9.8 percent seems fairly reasonable for a blog hosting company that derives its revenue from advertising. We estimated GE's WACC at www.thatswacc.com and were given a WACC of 7.12 percent. Given that Tumblr is riskier than GE, we would argue that if anything, 9.8 percent could even be a little low. If that weren't bad enough, the author decides to use the risk-free rate in place of WACC, which is the same as saying that the acquisition of Tumblr is risk-free! Finally, the author uses a 4.5 percent risk-free rate. Given that the 30-year Treasury bond currently yields about 3.3 percent, we would love to get a 4.5 percent risk-free rate.

Tuesday, June 18, 2013

LIBOR Indictment

Tom Hayes, a former UBS and Citigroup trader, was indicted on eight counts of conspiracy to defraud by the U.K.'s Serious Fraud Office. Hayes was one of three people arrested in December 2012 for allegedly manipulating LIBOR. Hayes has also been indicted in the U.S. for LIBOR manipulation, although Britain's laws regarding double jeopardy will prevent his extradition to the U.S. if he is tried in the U.K. The investigation into LIBOR manipulation has indicated that at least 45 people were involved. More indictments are expected in the future.

Monday, June 17, 2013

Google Class C Stock

Google has settled a shareholder lawsuit which will allow the company to issue a new Class C share. Since its IPO, Google has had Class A shares, held primarily by public shareholders and have one vote per share, and Class B shares, held by founders Sergey Brin and Larry Page, with 10 votes per share. The new Class C shares will have no vote. The agreement requires Google to give Class C shareholders a stock or cash payment if the Class C share price differs more than one percent from the Class A share price. Co-founders Brin and Page will also be required to sell Class B shares if they sell any Class C shares. This ensures that the duo will not increase their control of Google any more than it already is.

Diversification In A Multi-Factor World

Our guest blogger this week is Dr. Richard Roll from UCLA. Dr. Roll has published more than 100 articles and is perhaps most famous for stating that CAPM would never be tested in his lifetime as CAPM holds theoretically but is almost impossible to test empirically. Originally an aeronautical engineer, Dr. Roll wrote the operating manual for NASA's Saturn V rocket. Here, he discusses how correlation does not affect diversification in a multi-factor world.

In a multi-factor world, diversification benefits do not generally depend on correlation. This is because correlation, say between two investment portfolios, is a very poor measure of whether the portfolios are explained by the same underlying factors. If the factor loading (betas) are disparate, two portfolios can be perfectly explained by the same factors, yet their simple correlation can be zero or even negative.

In general, the individual assets in two portfolios can be re-weighted to make portfolio betas congruent. This implies that true diversification benefits depend only on the idiosyncratic volatility that remains after re-weighting to align betas. Similarly, the risk reduction from adding an asset to an existing portfolio does not depend on the asset’s correlation with the portfolio, contrary to the prescription in many investment textbooks.

These implications evince the fundamental importance of measuring the underlying factors and estimating factor sensitivities for every asset. Several methods for measuring factors have been investigated in previous literature, but an easy-to-implement general method is simply to specify a group of heterogeneous indexes or traded portfolios. Exchange Traded Funds (ETFs) could be well-suited for this purpose.

FX Losses

A recent survey indicates that 25 percent of large multinationals were negatively impacted by currency fluctuations in the first quarter of 2013. The total losses for these 213 companies totaled $3.67 billion. The currency that caused the most losses was the yen, which has fallen 30 percent against the U.S. dollar since December 2012.

Monday, June 10, 2013

Sustainable Capital Budgeting

Sierra Nevada, maker of the famed Pale Ale, has utilized sustainable practices since the company's inception, largely as a measure to reduce costs. As the company has grown, it has retained the practice but has taken a more stringent examination of new projects. But, Bill Bales, the company's CFO, has noted that vendors often present unrealistic results. With energy-savings projects, vendors typically use future energy costs that are out of line with today's relatively low costs. Additionally, vendors account for tax credits that are unavailable to the company. Perhaps most egregiously, vendors will alter the capitalization rate (WACC) to make a project's NPV positive. As Bales notes, "What was wrong with the capitalization rate to begin with?"

Rupee Falls To Record Low

The Indian rupee fell to a record low of 57.77 against the U.S. dollar. The Indian rupee has been hurt by the strengthening U.S. economy, which is expected to reduce investments in emerging markets such as India. Notice, Deutsche Bank's stated that he expects the rupee to regain strength later in the year due to decreased inflation in India, which is using relative purchasing power parity to partially explain the change in exchange rates.

U.S. Credit Rating Rises

In August 2012, S&P cut the rating on U.S. Treasury debt from the coveted AAA rating to AA+ with a negative outlook. Ratings agencies typically release a credit outlook, which is the direction the rating agency expects the credit rating to move next. Today, S&P revised the outlook on U.S. Treasury debt to positive, which indicates the agency believes the probability of a credit downgrade is less than one in three.

Friday, June 7, 2013


Revenues from GE's Ecomagination program have grown from $5 billion per year to $27 billion per year in just five years. GE CEO Jeff Immelt announced that the program has has been so successful that the company would double the investment in the company's China division.

Wednesday, June 5, 2013

2013 Working Capital Survey

CFO just published the 2013 working capital survey by REL Consulting. The 1,000 large U.S. companies included in the survey had more than $1.1 trillion in excess working capital. Given the recent attention to large cash balances, this is not surprising. But, what may be more surprising is that 43 percent of the excess working capital is tied up in inventory. Net working capital increased 6 percent over the past year, and has increased 25 percent over the past three years. Only 16 companies in the 1,000 were able to avoid a 5 percent decrease in efficiency over the past three years in at least one of the important metrics: day's sales outstanding, day's inventory outstanding, or day's payable outstanding. Some of the better performers in day's working capital outstanding include Linn Energy (negative 63 days), Noble Energy (negative 54 days), Dell (negative 22 days), and Apple (negative 22 days).

Jefferson County Bankruptcy

Jefferson County, Alabama, has reached an agreement in its bankruptcy to refinance much of its debt. The county's bankruptcy filing, with debt of $4.2 billion, makes it the largest municipal bankruptcy in U.S. history. JPMorgan is giving up about $842 million, or about 70 percent of the face value of the debt it held of the county's bonds. JPMorgan has been been under fire because of the way the company had refinanced the county's debt in 2002 and 2003. After the refinancing, several elected officials were sentenced to prison. The terms of the settlement also included the resolution of a lawsuit filed by the county against JPMorgan.

Saturday, June 1, 2013

Junk Bond Issuance Rises

Junk bond issuance has reached $254 billion world-wide this year, up 53 percent from last year. However, there may be signs that investors' appetite for junk bonds is waning. The two leading exchange traded funds for junk bonds had $660 million in outflows last week and junk bond mutual funds had an outflow of $581 million over the same time.