• Was Facebook Forced To Go Public?

    The news has been filled lately with stories lamenting Facebook’s botched IPO.  Investors are unhappy and pointing fingers at CEO Mark Zuckerberg. 


    But an interesting article in Fortune magazine this week explains why Facebook didn’t have to issue shares and go public after all.  According to Lashinsky (30 Aug, 2012), Facebook executives claimed that they were “forced” to go public because they had too many shareholders.  (See Davidoff in the NY Times, 29 Nov 2011).


    But not so.  From the Fortune magazine article:


    Over and over, senior Facebook executives lamented that they were being "forced" to go public by arcane Securities and Exchange Commission rules triggered by a company's shareholder count. Because so many of Facebook's employees are shareholders, Facebook had to become a public company. And so the firm was dragged kicking and screaming into the world of Sarbanes-Oxley, Nasdaq bell-ringing and so on.


    Too bad that isn't true. There are two little problems with that narrative. First, the newly minted JOBS Act, which raised the shareholder cap—from 500 to 2,000—to make it easier for small, growing companies to avoid SEC regulation, grandfathered Facebook. More to the point, the law never said Facebook had to go public. The law said Facebook had to disclose its financial results with the SEC. Big difference. Cargill and other big companies without publicly traded equity file their results with the SEC but remain private.


  • Agency Conflict at AOL

    AOL has announced that it will return cash to shareholders.  This week, AOL said it will pay a one-time dividend of $5.15 per share for a total of $500 million.  Additionally, the company announced that it would repurchase $600 million of shares, up from the previously announced $550 million share repurchase. 


    According to this CNN Money report (Isadore, Aug 27, 2012):


    In April, AOL reached a deal to sell 800 patents to Microsoft for $1.06 billion. The company said at the time that it intended "to return a significant portion of the sale proceeds to shareholders."


    But even before reaching that deal, activist shareholder group Starboard Value LP, had been pushing for AOL to sell its patents and return cash to shareholders through a share repurchase and dividend.


    Why the pressure to return cash to shareholders? 


    According to the NY Times (Rusli, April 10, 2012), Starboard Value LP, one of the largest shareholders of AOL simply doesn’t trust company management to do the right thing with its free cash flow.  In a letter dated April 10, 2012, Starboard wrote this:


    Of additional concern is the potential future use of cash. Pro forma for the patent sale, we estimate that AOL will have approximately $1.43 billion of cash, or $15.35 per share. This represents more than half of the current market capitalization. AOL has a dismal track record of capital allocation, having spent $2.3 billion on acquisitions since 1999 and recording a goodwill impairment charge of approximately $1.4 billion during 2010 alone. Although management stated its intention to “return a significant portion of the proceeds to shareholders,” we do not understand why the Company would only return a “significant portion.” Why wouldn’t the Company simply return all of the proceeds? We remain concerned that shareholder capital will continue to be used for poorly conceived acquisitions and investments into money-losing initiatives like Patch and other Display properties.


    For discussion:


    ·        How does this interaction between AOL and Starboard demonstrate agency conflict? 


    ·        Advanced: For further reading, see Jensen, Michael C. 1986. Agency costs of free cash flow, corporate finace, and takeovers, American Economic Review, 76 (2) 323-329.  (available online at http://ssrn.com/abstract=99580)



  • Ethan Allen: Investing in Tough Times

    Over the next few months, we’ll watch Ethan Allen as a “mini-case.”  Each week, I’ll try to include one or two posts related to the firm as it relates to finance. 


    What does a high-end furniture manufacturer do during tough times?


    According to CEO of Ethan Allen, Farooq Kathwari, invest in new product lines.  In recent years, Ethan Allen has “refreshed or replaced” 60% of its product lines, according to the CNBC video above.  The company consolidated and restructured its manufacturing.  And yet, in spite of the added investment, Ethan Allen has managed to pay a dividend. 


    Now that the restructuring has taken place, the company’s next agenda item is to increase sales.  If a housing recovery does gain steam, then that would certainly help the bottom line.


    For discussion:


    ·       Which component of cash flow will show whether the company is successful in generating sales over the next couple of years?    


    ·       Though the accounting Statement of Cash Flows does not correspond perfectly to a finance definition of cash flows, the statement on p. 38 of the annual report found here gives some indication of the investment and cash flow activity of the firm.  What information can you glean from this statement?


    ·       Search for “restructuring” in the annual report.  What conclusions can you draw about the future cash flows of the firm?


  • Hurricane Risk Management

    (Photo: Hurricane Ike off the Lesser Antilles, source: NASA, available in the public domain.)



    We moved to South Florida just months before Hurricane Andrew hit Miami.  Our friends at the beach evacuated and we were bracing for a direct hit to our new apartment in the Ft. Lauderdale area.  It missed us but devastated the community just a few miles south.


    This month marks the 20th anniversary of Hurricane Andrew.  Several years later, Hurricane Katrina hit Louisiana.  With damages of $108 million in 2005, Katrina is the costliest hurricane to hit the U.S. coast.  In 2008, more damage came from Hurricane Ike. 


    2008 was the year that the CME listed derivatives tied to hurricane activity.  According to a recent article in the CME magazine Open Markets (Nielsen, 28 Aug 2012):


    The product aims to meet the needs of both the derivative trading community and the insurance market while being easily understood by being simple to calculate and based on publicly verifiable data. In addition to insurers, other customers – such as energy companies, pension funds, state governments and utility companies –through use of the products are able to hedge their risk of hurricanes striking in the United States in five areas defined as the Gulf Coast, Florida, the Southern Atlantic Coast, the Northern Atlantic Coast and the Eastern U.S. CME expanded the instruments in 2009 with the introduction of binary options. Of the products available to hedge against hurricane-related risk, CME’s product is one of the few that trades on an exchange.


    (Read the full article here)


    Of course, some might feel like these contracts are nothing more than a roll of the dice.  But with hurricane activity on the rise, these contracts help those in the insurance market hedge their risks. 


    For discussion:


    ·        What other factors contribute to the high cost of hurricanes that hit the U.S.?


    ·        Go to the CME website (http://www.cmegroup.com/) and describe a futures contract on hurricane activity.  How would an insurance company use this contract to hedge its risk?



  • Finance and the Goal of the Firm

    In finance, we teach that the value of a firm is the sum of its past projects and its future projects.  When managers of a firm make decisions that maximize the value of the firm, they are effectively making decisions that lead to profitable projects, both today and in the future. 


    So it should make sense that business school would lead us to maximizing shareholder wealth as the goal of the firm.  Maximizing revenue is short-sighted.  Maximizing net income can lead to some bad long-term consequences.  Likewise minimizing costs can cause the firm to forego good projects.  But making decisions that cause the price of the company's stock to increase in the long-run should lead to projects that would benefit the owners or shareholders now and in the future.


    Let’s look at a typical firm: Ethan Allen, the manufacturer of quality home furnishings.  On their corporate website, they don't come right out and say that shareholder wealth is the goal, but rather talk about the quality of the products and the company's guiding principles.  


    From the corporate website, the company follows the following principle:


    Good governance is good for profitability – and good for our talented and committed team. As a group we embrace ten key Leadership Principles, which define our commitment to excellence. Living by these principles is paramount. They are the compass that guides us to achieve our full potential, both as individuals within the company and as a major player in the industry.


    (source: http://www.ethanallen.com/corporate/principles)


    For discussion:


    Watch the video from Ethan Allen below.  What does it tell you about the goal of this firm? Is the goal consistent with the traditional goal of shareholder wealth maximization?  If so, how?




  • One Step Forward for Apple, One Step Backward for Samsung

    Apple beat Samsung in court today.  A California judge ruled that Samsung had indeed infringed on software patents and awarded $1 billion to Apple. 


    According CNN Money, Samsung’s statement emailed to CNN after the verdict said, “This is not the final word in this case….It is unfortunate that patent law can be manipulated to give one company a monopoly over rectangles with rounded corners.”


    From the article:


    Samsung has to be sorely disappointed, but it has enough cash to handle the $1 billion ruling with relative ease: It earned $12 billion last year and has $14 billion in cash in the bank.


    If Samsung does choose to appeal, it's unclear what timeline that move will follow. The case involved 109 pages of instructions, a fact that made headlines, although in a surprise move, the jury came back with a verdict after only three days


    (Read the full article here)


    Investors in Apple’s stock were happy.  Apple shares (AAPL) traded to a high of $669 per share today and closed at $663.  However, this news leaves Samsung customers facing uncertainty about the future of their smartphones.  There may be changes coming soon as Samsung deals with the aftermath of the lawsuit.  In fact, there may be fall-out for other makers of android tablets and phones.  Now that Apple has won, they may pursue other lawsuits against such rivals as Google.






  • Social Security and the Time Value of Money

    Knowing a little something about the time value of money will help us make choices about our social security benefits.  Especially for us women.


    According to this Smartmoney article, a recent Wharton study suggests that financial advisers may be missing the mark when they advise women.  The time value of money matters, particularly because women tend to outlive men. 


    From the article:


    Slightly more than half of women 65 and older rely on Social Security for three-quarters of their income, according to the Employee Benefits Research Institute. Choosing when to start taking benefits — a decision that can be affected by factors like health, savings and other sources of income — is complex even for pros. While seniors can start receiving checks as early as age 62, doing so means they’ll get less each month than they would if they waited until the maximum age of 70 to start taking distributions. Spouses that don’t work — usually women, in the baby boomer generation currently reaching retirement age — also receive benefits based on their partners’ earnings.


    But women’s longevity is not being taken into account in the calculus, the study found. “At age 62, there’s a lot you can do,” says co-author Andrew Biggs, a former Social Security Administration official. “You may have a big 401(k), you can go still go back to work. At 72, there are a lot fewer options.”


    (Read the full article here)


    For discussion:


    Why do you think financial advisers may fail to advise women properly?


    How would you advise the women in your family as they approach the age of retirement?


  • The Economics of Chess

    Lessons from Chess:


    1.    Learn to think like your opponent

    2.    Sometimes you face a force move: if you don’t take action, then checkmate.

    3.    Have a long-term vision.


    These are some of the principles taught by Dr. Ken Rogoff, Professor of Economics at Harvard University and chess grandmaster. 


    Maybe those navigating us through financial storms can use a lesson.


    For discussion:


    How does Professor Rogoff relate these lessons to the financial crisis?


  • The Winners and Losers of Investor Sentiment

    According to a recent Gallup poll, 73% of Americans polled view the computer industry positively while only 22% view the oil and gas industry positively.  In fact, the five worst industries are oil and gas, the federal government, banking, real estate, and airlines.


    From the Gallup report (August 16, 2012):


    The cause of the oil and gas industry's bad image is most likely the frequent and sometimes inexplicably large spikes in the price of gas. At the time of this survey, in fact, the price of gas was on the rise. Plus, the oil and gas industry may get dinged by some Americans for its perceived poor environmental record.


    On the other hand, America has remained the world's dominant player in many aspects of the computer industry, with companies like Apple, Google, and Facebook standing as examples of entrepreneurial efforts that arose in short periods of time to offer products and services used the world over. It appears that Americans appreciate these success stories and hold these industry sectors in high esteem.


    Read the full report here


    What does this mean to financial markets?


    According to the Efficient Market Hypothesis (EMH), stocks should trade at their “fair” price—not too high, not too low.  However, one school of thought suggests investor sentiment influences stock returns. 


    According to the American Association of Individual Investors (AAIA):


    Although investors would like to imagine that their decisions are rational, most have bought at near-highs due to fear of losing out on gains and sold at near-lows due to fear of further losses. This herd behavior is called market sentiment; when market sentiment is low, the majority believes the market will fall, while high market sentiment means that the majority feels the market will rise in value. However, more often than not, the market will move against the sentiment of the majority. Therefore, many professional money managers use market sentiment as a contrarian indicator, buying when sentiment is pessimistic and selling when sentiment is optimistic.


    Read the AAIA report here


    For discussion:

    ·       What does the EMH say about making investment decisions based on investor sentiment?




    ·       According to the AAIA report, what are some indicators of investor sentiment?

  • When Financial Stability Hurts: The Case of the Canadian Dollar

    Strength in the Canadian dollar (CAD) is causing pain for Canadian manufacturers.  That’s because as the price of the CAD rises, manufacturers like the big three auto companies find it more expensive to produce up north. 

    The Globe and Mail (Toronto, 19 Aug 2012) reports:

    When the CAW negotiated its last contracts with the Detroit Three, one Canadian dollar bought only about 80 U.S. cents – which research by the Organization for Economic Co-operation and Development and others suggests is the fair value of Canada’s currency.

    A gap that big in the exchange rate makes Canada an attractive option for an American company, as it can shave its labour bill simply by locating production north of the border. But now, the loonie is trading at par with the greenback. Canada suddenly looks less attractive, especially when skilled labour in states such as Indiana is willing to work for less.

    For discussion:

    How is monetary policy impacting the cost for auto manufacturers? 

    According to this ABC News video below, how is Canadian monetary policy influencing other industries?

    Click Here to watch the video

  • Junk Bonds Attract Investors

    Where can you earn investment returns? 


    Not in your bank account or money market funds.  Not in investment-grade bonds.  And who knows whether you can in the stock market.  But according to this report from the NY Times, investors are making money in junk bonds.


    From the article:


    The market for junk bonds, risky corporate debt that pays high interest rates, is red hot. Such debt, also known as high-yield bonds, has returned 10.2 percent year-to-date, according to a JPMorgan high-yield index. Junk bond funds are on a pace to take in a record amount of money this year. Companies with less than stellar credit are issuing hundreds of billions of dollars of bonds.


    Fueling this frenzy are investors of all stripes — including individuals, mutual funds and state pensions — who are desperate for returns in their bond portfolios and willing to take more risk to get them. Demand is insatiable, even as analysts warn that the market has become overheated and is ripe for a fall.


    “In a yield-starved world, high-yield bonds are right now the only game in town,” said Les Levi, a managing director at the investment bank North Sea Partners. “The market is giddy.”


    Unfortunately, as the article goes on to say, high yield bonds are not providing returns that are all that high.  Record low interest rates mean that investors are only earning about 6.6% on average.  That’s not much reward for the level of risk. 


    For discussion:


    How does the current junk bond market compare with the infamous junk bond days of the 1980s? 


  • The Business of Prisons

    There’s something unsettling about the industry: for-profit prisons performing a role traditionally filled by the government. 


    Controversial but profitable, companies like Corrections Corporation of America (ticker: CXW) have been running prisons for years.  Operating at a lower cost per inmate, they seem to be a solution to the financial burden on states and municipalities.   And competition is a good thing, so why not competition among corrections providers?


    But the unintended consequences of this growing industry may be huge.  After all, how would a for-profit prison benefit?  The answer is by getting bigger and accepting more inmates.  So rather than society benefiting from fewer criminals, this is an industry that profits from more criminals. 


    What about the cost to taxpayers?  Just because the state isn’t operating the prison doesn’t mean the cost disappears.  The cost is simply shifted as the state pays firms like CCA for their services. 


    The whole thing smacks of some futuristic movie where a corporation runs the country.  Don’t get me wrong; I’m a fan of free enterprise.  But this enterprise is just a little unsettling.


    For discussion


    Read the CNBC articles below about for-profit prisons and discuss the arguments for and against the growth of this industry. 


    ·        Prisons for Profit: Don't Hope for a Breakout



    ·        Billions behind Bars: Inside America’s Prison Industry



  • A Recession-Proof Business Model

    …buy me some peanuts and Cracker Jack …


    What other business can generate $700 million in revenues from low-priced items like $1 hotdogs and sodas.  With $80 million in revenues from ticket sales, $70 million from concessions, and $50 million from merchandise, minor league baseball is a business model that hits it out of the park.


    An evening at the ball park is fun—and cheaper than the movies.  Kids and grown-ups can be treated to a slice of America at a relatively low cost, making the business of Minor League ball recession-proof.  Family friendly entertainment at an affordable price. 


    In this BusinessNewsDaily article, Minor League Baseball owner Peter Kirk describes how he grew his business. 

    Based on this article, what are some of the cash flows you need to estimate if you were going to buy a minor league team?  How would you go about estimating them?  What sensitivity and scenario analyses would you undertake before you make your decision?

  • The NPV of an Olympic Gold Medal


    (Photo courtesy of London 2012)



    Every investment has a net present value or NPV.  This is the difference between the cost of the investment and its value.  In finance, the value or “market value” of the investment is the present value of all future cash flows. 


    Let’s consider the NPV of a gold medal.  First, the cost.  The cost isn’t incurred as a lump sum, as with some investments, but rather the investment is over a long period of time—years.  This article by Bloomberg describes the costs incurred by an Olympic swimmer.  Some of these costs include:


    1.      Swimming lessons beginning in childhood

    2.      Membership in a swim club where swimmers can train with a coach

    3.      Food, a significant amount of food.

    4.      Equipment

    5.      Travel


    Not to mention the opportunity cost that a swimmer incurs: hours of training means hours not spent at a job. 


    Now for the benefits.  The cash inflows that an Olympic athlete can earn include sponsorships and the medals themselves. 


    Is it worth it?  For the gold medal winners like Michael Phelps, yes. 


    Try using the values listed in the linked Bloomberg article to determine the NPV of being an Olympic swimmer and decide for yourself. 



  • The Manchester United IPO

    The famous football (soccer) club from the UK is now a publicly traded stock, and traders are excited.  According to this CNBC report, these shares offer investors a chance to own an “iconic brand” and one of the biggest sports franchises in the world.  On the downside, the company is using its newfound money to pay down debt, and this is not popular among investors. 


    High frequency traders don’t care.  They see an opportunity to buy and sell and make pennies with each transaction.  So they’re off and running and trading volume has reached 20 million shares already.


    For discussion:

    In your opinion, is Manchester United a good investment?


  • The Shape of the Yield Curve Matters

    According to Mohamed El-Erian, the CEOof the Pacific Investment Management Company (PIMCO), investors should beware of a steepening yield curve in the U.S. Treasury market. 

    Bloomberg (Detrixhe and Keene, Aug 9, 2012) reports:

    The difference in yields between two- and 10-year Treasuries widened to 1.44 percentage points, or 144 basis points, the most since May. Investors often demand a bigger yield premium on longer-maturity debt to guard against the risk that inflation will erode the value of fixed payments from the securities over time.

    The yield curve is a graph that shows the interest rates that are associated with different maturities.  Normally, short term rates are lower than long-term rates, but not always.  When short-term rates are lower than long-term rates, we see an upward sloping yield curve.  From time to time, long term rates are lower than short-term rates.  What that happens, the yield curve is said to be inverted. 

    Currently, short-term rates are near zero because of the Fed’s monetary policy.  Long term rates, on the other hand, have been rising .  El-Erian says to investors: beware.. 

    For discussion:

    ·        What is the current term structure of interest rates for U.S. Treasury rates?

    ·        What does the shape of the yield curve tell investors?

    ·        Advanced: What theories explain the shape of the yield curve?



  • Social Impact Bonds (New York Style)

    Bonds: contracts between a borrower (bond issuer) and a lender (bond investor) where the borrower agrees to repay the principal (face value) and interest (coupon) by the maturity date.  Municipalities such as cities and states are frequent bond issuers.  When municipal bonds are backed by the taxing authority of the city or state, the bonds are called general obligation bonds or GO bonds.  When the bonds will be repaid by the revenues associated with a project such as a toll road, the bonds are called revenue bonds.


    New York is among the states experimenting with a new type of bond—a social impact bond.  For these, bond payments are tied to some type of social benefit program.  In New York’s case, the borrowed money will be used to finance a prison program and the outcome—that is, the payment of principal and interest to the investor—will be based on recidivism.

    According to the NY Times (Chen, 2 Aug 2012):

    In New York City, Mayor Michael R. Bloomberg plans to announce on Thursday that Goldman Sachs will provide a $9.6 million loan to pay for a new four-year program intended to reduce the rate at which adolescent men incarcerated at Rikers Island reoffend after their release.


    …If the program reduces recidivism by 10 percent, Goldman would be repaid the full $9.6 million; if recidivism drops more, Goldman could make as much as $2.1 million in profit; if recidivism does not drop by at least 10 percent, Goldman would lose as much as $2.4 million.


    Social impact bonds are not new.  Read more about them here.


    For discussion:


    ·        How are social impact bonds similar to traditional bonds?  How are they different?


    ·        What are the benefits and risks to investors in these types of bonds?


    ·        In your opinion, why is Goldman Sachs considering such an investment?     




  • Corporate Opportunity to Borrow Cheap Money

    According to Bloomberg (Aug 2, 2012), “Companies are borrowing the most in the loan market since 2008 to finance acquisitions worldwide, betting that they can quickly replace the debt with permanent financing as yields on corporate bonds fall to records.”


    With interest rates are record lows and opportunities to get their hands on cheap money, companies are taking advantage of their access to money and using the money to pay for acquisitions.  Examples include:


    ·      InBev as it plans to buy 50 percent of Grupo Modelo

    ·      Nestle as it plans to buy Pfizer’s baby-food unit

    ·      Cnooc Ltd (the Chinese oil and gas explorer) as it seeks to buy Nexen Inc.


    For discussion:


    ·        Go to www.bondsonline.com > Investor tools > Corporate bond spreads.  What interest rate would a BB-company pay if it wanted to issue bonds with a 10-year maturity?  (note: the spreads are listed in “basis points” which are 0.01 percent.)


    ·        According to the Bloomberg article above, what are the risks if companies begin to borrow too much money to finance mergers and acquisitions?



  • Man versus Machine

    Due to a glitch in its computer system, trading firm Knight Capital lost millions and cost anxiety to many market participants.  Though not as bad as the flash crash of May 2010, this event reminded regulators that the battle between man and algorithm is not yet won. 


    Algorithmic trading, or high-frequency trading, is the use of sophisticated computer programs to try to beat the markets. 


    According to the NY Times (2 August 2012):


    …It was the latest black eye for the financial markets. The runaway trading suggests that regulators have not been able to keep up with electronic programs that increasingly dominate the supercharged market and have helped undermine investor confidence in stocks.


    Traders on Wednesday said that a rogue algorithm repeatedly bought and sold millions of shares of companies like RadioShack, Best Buy, Bank of America and American Airlines, sending trading volume surging. While the trading firm involved blamed a “technology issue,” the company and regulators were still trying to understand what went wrong.


    For discussion:

    What are the arguments for and against the use of algorithmic trading?