Thursday, January 30, 2014

Bad News, Good News

Exxon Mobil and Royal Dutch Shell both announced earnings today. For Exxon Mobil, quarterly profits were down 16 percent and annual profits were down 27 percent. The company discussed projects that were expected to be online in the next two years, which it believes will increase earnings in future years. Royal Dutch Shell announced that its earnings were down 48 percent for the quarter and 23 percent for the year. Shell also announced that it would sell $15 billion in assets over the next two years. You would think that the news was equally bad for both companies, but perhaps Exxon's focus on new projects would benefit the company's stock. Instead, Exxon Mobil stock dropped 1.18 percent on the day, while Royal Dutch Shell stock increased 1.13 percent.

Wednesday, January 22, 2014

Capital Budgeting Projections

While all of the numbers in a capital budgeting analysis are projections, you would expect that the projections for the initial cost would be fairly accurate, but that is not always the case. For example, the Kashagan oil field in Kazahkstan is the world's largest oil discovery in 30 years. A group led by Exxon Mobil, Royal Dutch Shell, and Total have been involved in developing the project, at a budget of $10 billion. However, the cost of the project is now at least $50 billion. Similarly, Chevron started the Gorgon LNG plan in Australia with a budget of $20 billion. The cost of that project is now $54 billion. Remember, all cash flows for a project under consideration are projections. This is one reason scenario analysis is so important because it permits us to examine what can happen if we are wrong.

An IPO to Drink In

When a company files an IPO, the prospectus is designed to inform potential investors about the company. A Hong Kong nightclub named Magnum has filed an IPO to raise $16 million and we are sure there will be a loud price pop. The IPO is 3,000 times oversubscribed, meaning investors are willing to buy 3,000 more shares than are being offered. The prospectus is an interesting read, if for nothing other than the description of clubbing as "Clubbing is a popular night time activity which has evolved from the discotheques of the 1970s into a modern form of social gathering with lively music, elaborate lighting and a dance floor, supplemented by both alcoholic and non-alcoholic beverages." Of course, the prospectus goes on to describe the risks of the investments, including the fact that "There has been a trend of 'club-hopping' developing in Hong Kong in recent years which means customers have the tendency to visit multiple clubs in one night." Of course, don't forget the risk that revenue comes from sales “generally known as alcoholic beverages served by glass and prepared by bartenders mixing different alcohol and ingredients.” If you are so inclined, have a glance at the prospectus, but be warned: It is 378 pages long!

Tuesday, January 21, 2014

TVM Lies

While we greatly respect Warren Buffett as an investor, we are disappointed at his time value of money skills. Buffett's Berkshire Hathaway has agreed to insure a reported $1 billion prize given to anyone who correctly predicts a perfect bracket in this year's NCAA March Madness. If you win, you don't get the $1 billion now, but rather $25 million per year for 40 years. If you want a lump sum, you would receive $500 million today. We would expect that the Oracle of Omaha would know that advertising the total annuity payments as the value of the annuity winnings is misleading, even though state sponsored lotteries use the same deception. For the record, see if you don't agree that the choices offered you result in an interest rate of 3.93 percent. And while we wouldn't turn down the $500 million and encourage you to enter since the entry is free, the odds of winning are 1 in  9.2 quintillion.

GE's Profit Rises On Negative Taxes

GE had promised an increase in its profit margin and an increase in overall profits for 2013. The company did increase its profit margin, although it did not meet its target increase, but profits were aided by a tax gain of $1 billion. During the 4th quarter of 2013, GE Capital sold its Swiss operations, which generated the $1 billion tax credit. During 2013, GE Capital's tax rate was negative 14 percent. While we like the idea of negative taxes, the only way to achieve this dubious distinction is to lose money, which GE did on the sale of its Swiss operations.

Peugeot's SEO

French auto maker Peugeot announced a 3 billion euro ($4.1 billion) capital increase. Dongfeng, Peugot's Chinese partner, will put up 750 million euros, the French government will put up 750 million euros, and the company will have a rights issue for an additional 1.4 billion euros. Peugeot needs the additional equity to fund new models and expand into new markets. Because the new shares will be sold at a discount and dilute existing shares, you would expect a stock price reaction. Indeed, you are correct as Peugeot's stock price dropped 11 percent.

Wednesday, January 15, 2014

BP's Stock Buyback

BP has two recently announced stock buyback programs, one for $8 billion and one for the "bulk" of the $10 billion it received from an asset sale. During the 3rd quarter of 2013, BP bought back 14 million shares a week, stepping that up to 22 million shares a week in the fourth quarter. So far this year, BP has been buying back an average of 37 million shares per week. With about 3.14 billion shares outstanding, BP would buy back all of its outstanding stock in about 85 weeks, although we doubt the buyback will reach that level.

EPS And Currency Risk

A recent report using results from 78 companies that do business abroad and quantified currency losses showed that these companies lost a combined $4.18 billion during the third quarter of 2013. The currencies that most affected earnings were the Japanese yen, Australian dollar, euro, and Indian rupee. Although that sounds bad, the reported loss in earnings during the 3rd quarter of 2012 due to currency fluctuations was $22.73 billion. The average loss in EPS by companies reporting currency losses was $.03.

Sunday, January 12, 2014

Securitization Increasing

Securitization, the process of pooling different types of debt into bonds that have payments backed by the debt, is on the rise. Mortgage backed securities (MBS) and collateralized debt obligations (CDO) were blamed in part for the 2008 financial meltdown. In 2013, about $800 million of securitized debt was issued worldwide (excluding residential mortgages). Although a dramatic increase from the $200 million or so issued in 2009 and 2010, the total is far short of the more than $2.5 trillion issued in 2005 and 2006. Although regulators often argued about the evils of securitized debt, it also allows the market to pump lending into the system, which could help increase economic growth.

Friday, January 10, 2014

Fast News

We argued in the textbook that an efficient market reacts rapidly to new information. So how fast does the market react? Pretty quickly according to traders. Dow Jones & Co., publisher of The Wall Street Journal, announced a lawsuit against Ransquawk, a service that "scrapes" articles published online by Dow Jones and others and immediately squawks the news to its subscribers. According to Ransquawk, 8 of the largest 10 banks it the world use the service. Dow Jones argues that Ransquawk is misappropriating "hot news," an action that is not permitted under a 1918 Supreme Court ruling. Given that Ransquawk is a fee-based service, we must assume the banks using the service believe that the extra few seconds gained in hearing about the news is worth the price of the service.

Thursday, January 9, 2014

U.S. Oil And Natural Gas Capital Spending

The American Petroleum Institute recently released projected capital spending on oil and natural gas projects in the U.S. through 2020 and the numbers are staggering. During 2014, an estimated $87.4 billion will be spent in the U.S., with spending declining to $75.0 billion in 2020. During the next seven years, a projected $568.4 billion will be spent on U.S. oil and natural gas projects. With the dollar amount being invested, we hope a careful capital budgeting analysis is being performed on these projects.

Wednesday, January 8, 2014

IRS Changes Deduction/Capitalization

Starting January 1st, companies face new regulations about whether spending on fixed assets is an expense or capitalized, which means the spending is depreciated over time. As with any other regulation, there are loopholes. For example, companies with audited financial statements can deduct $5,000 per invoice. This means an audited company could order 10 new computers at $4,900 each on 10 separate invoices and deduct the expense immediately. If the company made the same purchase on one invoice, the $49,000 would be capitalized and depreciated. Remember, while depreciation itself is not a cash flow, it does create important tax shield cash flows that we must take into account in capital budgeting.