Thursday, October 25, 2018

Sears' Financial Distress Costs

We mentioned in the textbook that there are indirect financial distress costs, which, unfortunately, Sears is experiencing. Because of Sears' financial problems, suppliers are not willing to sell to Sears, or are tightening credit terms. Part of the reason is that suppliers continued to sell to Toys R Us, but then only received 20 cents on the dollar. A poll indicates that 66 percent of suppliers are demanding cash payment or payment on delivery and 26 percent were on regular terms, but not longer than 30 days. In fact, more than 200 suppliers have quit selling to Sears at all. This can create a "death spiral" as Sears cannot order goods to sell at a time when sales are already low, meaning fewer customers even go to Sears' stores. 

Tuesday, October 23, 2018

Netflix's Capital Structure

As we discussed in the text, the optimal capital structure for a company is the result of many interacting factors. And while we can observe capital structures in practice, it is less frequent for a company to state its target capital structure. Recently, Netflix announced that was issuing $2 billion in debt to help the company reach its optimal capital structure, which the company said should be 20 to 25 percent debt-to-market capitalization. At the current market value of equity, the company would need to issue between $22 and $30 billion of debt. What makes this debt issue really interesting is that though company is burning through cash, the announced purpose of the bond is to increase leverage.  

Market Quiz has a seven question quiz on current capital markets. There are some interesting questions, including the relative size of the venture capital market compared to IPOs, the issuance size of the preferred stock market (keep in mind that Apple's market capitalization is over $1 trillion), and the slope of the Treasury yield curve.

Thursday, October 11, 2018

Bond Ratings And Mergers

A recent article in Bloomberg highlights a potential threat to the bond market. Recent years have seen a number of high-priced acquisitions funded by debt. As a result, many of these companies have dramatically increased leverage as measured by Debt/EBITDA. This has caused a drop in credit ratings, with $2.47 trillion worth of debt now rated as BBB, more than three times the 2008 level of BBB debt. Even though many of the deals are funded through debt, a common assumption is that synergies and the improved cash flow would allow the company to quickly pay down debt. But a hiccup in the economy or synergies not materializing could limit debt pay down. In the last three recessions, from 7 to 15 percent of investment grades bonds were downgraded to junk status. Given the higher amount of debt with lower credit ratings, a recession in the next couple of years could push a massive amount of corporate debt into junk territory.

Sears Bankruptcy

It appears that Sears, once the world’s largest retailer, may file for bankruptcy as soon as this weekend. One alternative being explored is a Section 363, or stalking horse, filing. In a Section 363 filing, the company would sell some of its assets, but the sale would still have to be approved by the bankruptcy court. For example, CEO Eddie Lampert has already offered $480 million for the company’s Kenmore appliance and home improvement division. If successful, the company would exit the bankruptcy with fewer assets, but less debt as well.

Wednesday, October 10, 2018

Michael's Bond Losses

As Hurricane Michael hits the Gulf Coast, pension funds, endowments, and other large investors are getting nervous.  About $15.7 billion wort of CAT bonds are exposed to a Florida hurricane. Large investors have been drawn into CAT bonds because of higher potential returns and the diversification these bonds can provide. The total CAT bond market is currently at $30 billion. For a major catastrophe, an insurance company typically cover the first part of its loss, then relies on reinsurance or securities to help cover the rest. If the trigger is hit on a CAT bond, often the bond is cancelled, meaning the bondholder receives no further coupon payments and no par value upon redemption. 

Tuesday, October 9, 2018

Interest Rates And Bond Prices

As we noted in the textbook, an increase in interest rates will decrease the price of a bond. And recently, interest rates have been rising. U.S. high-grade debt is down 2.53 percent this year and the 10-year U.S. Treasury bond has lost 3.23 percent this year as well. To give you an idea of the magnitude of losses worldwide, the Barclays Multiverse Index, which includes investment grade and high yield bonds from around the globe, has lost about $916 billion in market value this year.

Inflation Expectations

One thing to keep in mind with present value calculations, if you calculate the present value using real cash flows and the real interest rate or nominal cash flows and the nominal interest rate, the present value will be unaffected. This is true for capital budgeting as well So where can you get expectations of future inflation? One place is the New York Federal Reserve, which publishes microeconomic data, including expectations of consumer inflation. We should warn you, these are expectations, and like any expectations, are not exact.

Wednesday, October 3, 2018

Comcast Bonds

In order to finance the $39 billion acquisition of Sky Plc, Comcast sold $27 billion worth of unsecured bonds. This is the second largest bond offering of the year and the fourth largest all-time. The company sold 12 different bonds, ranging from a 2-year maturity to a 40-year maturity in the offer. Investors jumped at the bonds, putting in orders for $88 billion, which allowed Comcast to issue the 40-year maturity at a yield spread of 1.75 percent above Treasuries. The bond issue will increase Comcast's leverage from 2.2 times EBITDA to 3.6 times EBITDA. The bonds are rated A with a negative outlook, which means there may be a downgrade in the future.