a little more on MTLQQ–Motors Liquidation

The website is better

I happened to look at the MTLQQ website last Thursday.  It has been expanded considerably since my last visit, some months ago.  The site now has links to thousands of pages of bankruptcy-related documents.  And for nostalgia fans, you can also get past General Motors annual reports.

One section of the bankruptcy filing gives 852 pages of pending lawsuits.

Another lists MTLQQ’s properties, which include the Hyatt Hills golf complex in Clark, New Jersey.  HH has nine holes of regulation golf and a miniature golf layout.  It’s being carried at about $5 million.  How did that get in there?  Why only nine holes?

The most important section lists MTLQQ’s assets, as of the bankruptcy, at $2.1 billion and its liabilities at $27.4 billion–meaning a total company  deficit of $25.3 billion.

Monthly SEC filings

The newest are an 8-K and a copy of the monthly report for September to the bankruptcy court, filed on November 12th.

Excerpts:

MTLQQ had a $100 million loss for the three months ending September.  That’s not so surprising if you read the interview summary below.

Liabilities have expanded to about $35 billion.  The major creditors are unsecured bond holders ($27.3 billion), unions ($3.5 billion) and product liability claims ($1.5 billion).

A Financial Times interview with the CEO

The interview with Al Koch, a liquidation specialist whose firm was hired by the bankruptcy court, has a few salient points:

1.  he’s developing a ten-year plan to dissolve MTLQQ

2.  MTLQQ is still receiving about a thousand new claims a day, which is more than had been expected.  They fall into three main categories–vehicle liability, tax, and environment.

3.  Koch doesn’t expect to net anything from asset sales.  “It’s not so much about how much we’re going to get as about how much we’re going to pay,” since maintaining an idled car plant can cost $3 million a year.

Conclusion

Yes, MTLQQ does own 10% of the “new” GM plus warrants to buy another 15%.  But, even assuming the liabilities don’t expand from here, which they have already shown a tendency to do, the first $35 billion of that is owed to MTLQQ’s creditors.  In other words, for you to make any money from owning MTLQQ, you have to believe that when it eventually relists, the “new” GM will have a market cap as big as IBM or GE.  What are the chances of that?

You can also see my first post, dated September 9, 2009.

Hybrid bonds and contingent convertibles

Investment banking “practical jokes”

Every upcycle, clever investment bankers devise exotic securities that they sell to gullible portfolio managers, who come to regret their purchase decision almost immediately.  They continue to rue their bull-market impulsiveness for the many months it takes them to find (if they can) some even more gullible person to sell them to.

One of my favorite issues of this type was a wildly oversubscribed issue made by Hong Kong property company New World Development in 1993, at the height of an emerging markets mania.  It was a zero-coupon bond, convertible into shares of a China subsidiary of New World that did not yet exist, except as a name on a certificate of incorporation.

The hybrid bond

This time around, a leading candidate for purchase blunder of the cycle is the hybrid bond, a type of security issued notably by financial institutions.

What made these securities hybrid?  They had terms of 40-60 years, or sometimes were perpetual, that is, principal was never returned–just like stocks.  Also, the interest payment could be reduced or eliminated without causing a default.

What made them bonds?  A good question. That’s what they were called on the front page of the prospectuses.  This naming made them eligible to be purchased by bond fund managers.  The inducement to purchase was a relatively high yield.  The instruments ranked below all other bonds, just above equities, in the pecking order in case of bankruptcy.

If bonds were food, I think the Food and Drug Administration would have been alerted to hybrids, just like it was when Aunt Jemima was selling “blueberry waffles” that had no blueberries in them.  In fact, some tax authorities or industry regulators do classify the hybrids as equity. But a couple of years ago, this was regarded as another beauty of the hybrids, because having regulators count them as equity bolstered the issuers’ capital ratios.

Fast-forward to the present

Lloyds Banking Group  of the UK has a bunch of these hybrids on its balance sheet.  It wants to swap them for a new type of securities, which it is calling contingent convertible bonds.

The idea is that under normal circumstances the securities will be bonds, paying interest and having a bond’s liquidation preference over equity.  But if Lloyds gets into trouble (again), the securities would convert automatically into equity, losing their bankruptcy advantage and presumably their income payment as well.  The trigger for conversion would be Lloyds’ tier 1 capital ratio falling below 5%.

Yes, this is kind of like having medical insurance that terminates if you get sick.  No, it’s not a joke.  On second thought, though, this could be a little more investment banking humor. Sometimes, it’s hard to tell.

I can’t imagine contingent convertibles finding any takers in an original issue, other than at the tippy-top of the business cycle.  But Lloyds and the EU are playing hardball with the conversion offer.   Unswapped hybrids are set to cease making interest payments after the swap period ends.

The offer situation isn’t as bad as it looks at first blush, however–it’s worse. Not taking it may be very difficult to do.  Depending on their current carrying value in portfolios, post-exchange, post-interest-elimination hybrids may have to be considered as further impaired and written down.   Also, it seems to me that any remaining hybrids have got to be much less liquid than they are now.  So they may be impossible to dispose of, thereby having to remain on the lists of holdings sent to clients for some time to come.

Moral to the story?

I’m not sure there is one.  If we consider hybrids and contingent converts as two parts to one story, the combo probably rockets to the top of my list of bull market follies.  My only other thought is that this is Liar’s Poker all over again.

An update from Nov. 22nd

Here’s the link.

How your broker gets paid (I)–the individual broker’s share

This isn’t really one question, but two:

1.  How is the individual you deal with compensated?, and

2.  How does the organization the person is a part of get profit from your business?

In this post, I’ll write about how the individual broker is paid.  In the following one, I’ll write about how the broker’s firm benefits from having you as a customer.

Ask your broker

The easiest way to find this information out is to ask the person you’ve selected to advise you.  After all, if you can’t talk openly with him/her about money, what will you be able to talk about?  And it would seem pretty foolish to purchase services of any type without knowing what the price for those services is going to be.  Despite this, it’s my impression that many customers are reluctant to ask.

I’m going to limit myself to writing about financial advisors who help you to develop a financial strategy (which may, or may not, have any investment merit) and to oversee its execution.  There are also advisors who specialize in the first task alone.  You go to them with your financial information, they develop a plan for a fee, but it’s up to you to execute the plan by investing the money yourself.  I’ve never met one, so I can’t comment.

The broker/financial advisor

two payment possibilities

A client typically can choose between two options in paying for investment advice:

1.  paying a commission on each transaction, or

2.  paying a continuing fee for all services.  The fee is usually a percentage of the assets the broker is supposed to be watching, typically between 1%-2%, although it’s sometimes higher.

Twenty-five years ago, the predominant choice was paying commissions.  As with everything else, there were ways to “game” the system.  The broker could recommend excessive trading, or “churn” the account.  He/she could also “forget” to tell the client about lower-commission ways to buy mutual funds (today’s computer systems won’t allow this sort of transaction to go through).  But it was probably the scandalous days of the late Eighties that persuaded the industry to emphasize the wrap fee business.  At that time, brokerage firms sold tones of gigantic-fee, no-value (something anyone who stopped to read the prospectuses–including clients–would have immediately found out) real estate and oil and gas tax shelters to their customers.  Not only did that destroy the brokers’ reputations, but subsequent lawsuits took back much of the money the brokers “earned.”

The percent-of-assets method is much more common today.  It, too, has its “gaming” potential.  In this case, though, it’s collecting the fee and providing little or no investment advice.  There has been mild regulatory questioning of why, for example, in an account that’s 100% in government bonds and where no trading occurs, the client is better off having his advisor deduct 2% of his assets from the account each year rather than pay a fee for each transaction.

gross fees vs. net

A broker working for a traditional brokerage house like Merrill Lynch or Smith Barney only receives a portion of the overall (gross) fees that his clients pay to the firm.  That percentage, called net fees, is typically 30%-50% of the gross, depending on the skill and client base of the broker in question.  The firm’s share goes to pay for office space, advertising (and maybe sales leads), administrative, regulatory and computer support, an investment research staff, plus a profit element.

At the other end of the spectrum, a financial planner or broker may elect to work independently or as part of a loose organization that provides trading and recordkeeping support.  The individual, however, provides his/her own office and administrative help.  In this case, the net commissions may be 80% or more of the gross.

Compensation your broker may not talk about

There are several other ways a broker benefits from clients’ business, namely:

“trailing” commissions, or 12b1 fees: The SEC allows mutual funds to pay a small portion of their assets, usually 25 or 30 basis points, for marketing.  The idea is that this gets more new money into the funds, thereby spreading administrative expenses over a larger asset base.  In practice, these fees are virtually always paid to the broker who sold the fund shares to a client, as an inducement/reward for the client continuing to hold the fund.  It’s not much of an inducement, though, since every fund group pays the same.  Still, it can mean $1000 a year or more for each client a financial advisor has.

“perks”: These would include an administrative assistant, a corner office–or even separate office space, a higher net commission percentage, access to analysts/portfolio managers that would normally denied to most brokers.

“educational” travel: Reward trips might be sponsored by the brokerage firm or by third-party asset managers.  Meetings are usually held at resort locations, with activities like golf available after formal sessions.  The sessions typically cover investment strategy, marketing techniques and the characteristics of the products the sponsoring organization offers.

broker hiring wars: This is a big one.  Brokerage house periodically try to rebuild/upgrade their sales forces by headhunting successful salesmen from their rivals.

The employment offers typically consist of three elements:

–a contract binding the broker to the new firm, usually for three or four years,

–a signing bonus, and

–an increased net commission percentage for the length of the contract.

The signing bonus is usually some multiple of the prior year’s compensation, verified by a W-2 form.  Over the years, signing bonuses I’ve been aware of have ranged from 50% of prior year’s pay to the 260% reported earlier this year by the Financial Times. This makes job-hopping the equivalent of the professional athlete’s free agency–the biggest payday of the broker’s career…until the next job hop.

(An aside:  years ago, brokerage houses encouraged their salesmen to concentrate on selling in-house funds.

Two reasons:

–they were more profitable for the brokerage and,

–more importantly, they tied the client to the firm.  Rivals’ computer systems weren’t set up to accept the in-house funds or to provide any strategy/holdings/performance information about them.  So clients literally couldn’t transfer their accounts if their broker left for another firm.  That amounted to having to leave a lot of existing clients behind, thereby making leaving hugely more difficult.

The broker response?–sell only third-party funds, which all firms’ systems could handle.)


LVS Macau update–Wynn Resorts, too

Sands China

On Monday Bloomberg reported the unofficial details of the upcoming IPO in Hong Kong of  Sands China, LVS’s Macau subsidiary.  According to the news organization, LVS hopes to sell 1.87 billion shares, or 23.4% of Sands China, at between HK$10.38 and HK$13.88.  At the high end of the range, this would mean US$3.4 billion in proceeds for LVS.

Remember, too, that LVS has already raised $600 million through a September offering of bonds convertible into Sands China stock at a discount to the IPO price.  These shares represent about another 4.5% of Sands China.

IPO headwinds?

This will be an interesting IPO to watch, particularly its pricing.  LVS’s strategy, which appears to me to have been the soundest alternative, was to follow quickly on the heels of the IPO of the Macau subsidiary of the better-known Wynn Resorts.  The hope would have been that Wynn Macau would have had a spectacularly successful launch, setting a very high valuation standard and whetting investors’ appetite for another new casino stock.

Since its debut, however, Wynn Macau has struggled to remain above the IPO price of HK$10.08 and has (briefly) traded below HK$8.70.  This is doubtless in part due to the flood of IPOs now engulfing the Hong Kong market.  But Wynn Macau’s price action also contrasts sharply with that of Sinopharm, launched at about the same time, which is now 65% above its IPO price.

Also, according to Bloomberg, the high end of the range for Sands China would price the business at 16.5x next year’s operating earnings.  This would be about a 15% premium to the valuation Wynn Macau is being awarded in the market.

In addition, the Sands IPO will presumably launch at about the same time as Minsheng Banking.  Minsheng, a mainland Chinese bank, is planning the largest Hong Kong IPO in two years, aimed at taking in about 3x what Sands China hopes to raise.

Certainly the IPO will get done.  Will Sands China be able to convince investors that it deserves the highest rating of all the casino stocks in Hong Kong?  It will be a very strong endorsement for LVS if it can.

Wynn Resorts’ $4 special dividend

For its part, WYNN announced yesterday its intention to pay a special dividend to stockholders of $4 a share, the third such payout in its short history.  WYNN will also initiate a regular dividend of $.20/share in the first quarter of 2010.

It’s worth noting that WYNN, which felt compelled to raise new equity twice during the financial crisis to bolster its financial position (the company parted ways with its CFO after the second one), now is comfortable enough to return $500 million to shareholders.  More important, the company’s lenders feel comfortable enough to permit this to happen.

Finally, the Chinese authorities, who sparked the current banner period for Macau casino operators by relaxing visa requirements for visitors from southern China, have just tightened them a bit again.

11/23/09   An update on Sands China:  here’s the link.

Book Value (II)–where it doesn’t work so well

As I mentioned in my prior post on book value, using it as a valuation tool works best when the company in question has plain-vanilla assets, and where assembling capital to be able to purchase productive assets–whose worth is accurately shown on the balance sheet–is a key part of its ability to compete.

It stands to reason, then, that problems will arise when this condition isn’t met.

Examples:

Companies with powerful brand names or distribution networks. This was Warren Buffett’s essential insight a half-century ago.  If  for twenty years a company spends 3% of sales each year on advertising a given product, it will in all likelihood have established customer awareness of its brand.  The brand may not be Tide or Cheerios or Lexus (although it may be), still the brand probably has a considerable value.  But not only doesn’t that expense not show up anywhere on the balance sheet, it has reduced profits, and therefore the shareholders’ equity account, for all that time.  Takeover bids for companies with brand names almost always come at a sizable premium to book for this reason.

One of the great retailing stories of the last fifty years has been the demise of the department store, department by department, by specialty retailers, who distributed in highly focused, single-purpose stores in suburban locations.  Toys R US, Limited and Bed, Bath & Beyond are only a few examples.

Almost no one has heard of Child World or Lionel’s Kiddie City. That’s because they lost the race to establish the first national toy store chain to Toys R Us.  But even as TOY crossed the finish line first, dooming the others, their books values weren’t that dissimilar.

In today’s world, one might argue that the difference between Barnes and Noble and Borders is the former’s superior internet distribution.  Amazon beats them both for the same reason. Yet this difference is more one of management decision than balance sheet construction.  At .6x book value, it’s not clear to me that BGP is cheap.

2.  natural resources companies. This is really a specialist topic that I’ll eventually write more about.  This is the version done with crayons.

In the simplest terms, resource reserves are defined as what can be produced at a profit using today’s extraction technology.  As prices go up and as technology gets better the amount of economically recoverable oil, gas, gold, copper…a company has rises. But the company’s balance sheet list them only at the (depreciated) cost of finding the deposits.  That may have been fifty or even a hundred years ago.

As a result, the balance sheet metrics that apply to non-mining companies may have little relevance.  ExxonMobil, for example, carries its oil and gas reserves on its balance sheet at $67.6 billion but lists the present value of it reserves, calculated using the SEC method, at $86.0 billion.  In my estimation, this is an extremely conservative number.

Other mining companies typically only “prove up,” i.e., formally document and establish, reserves they may need to collateralize bank borrowing.  They may only be a small section of a huge orebody, but if the entire extent hasn’t been drilled to establish the mineral composition, the undrilled portion is technically not “reserves”– and therefore reported only as unexplored acreage.

3.  service companies. That is, companies that don’t manufacture goods, but provide services instead.  Software companies like Microsoft are a good example.  MSFT, which now trades at about $28 a share–in its heyday, it was as high as $60–has a book value of about $4 a share.  The price is 7x book.

But there’s nothing on its balance sheet for its brand name, or its domination of personal computer productivity software and operating systems.  It’s research and development expenditures are by and large expensed rather than put on the balance sheet.  So, like the case of advertising expense above, they reduce rather than add to book value.  Price/cash flow is probably a better measure here.

4.  companies that issue new stock. This could be to fund internal capital expansion or the purchase of a rival.  The stock issuance can change book value significantly.

Assume a company has 100 shares outstanding, book value of $10 a share and is trading at $20 a share.  If it issues 100 shares of new stock at $20 (yes, an issue this large is unlikely, but it illustrates the point), then it has book value of $1000 from the initial shares and book of $2000 from the new shares.  In other words, it’s new book value is $15.

5.  auditors’ practices in writing assets up or down. Most auditors, in my experience, are loathe to insist on writedown of impaired assets beyond the extent that company managements are content with.  Auditor practices vary, I think, as do management tolerances for writedowns.  As a result, so too do writedowns.  This is something to at least consider when doing company to company comparisons.

In addition, some countries–not the US–suggest/require that companies write their  assets up to fair market value periodically.  This sometimes makes book value comparison of companies domiciled in different countries, but with similar assets, problematic.

More trading down

Catalina Marketing analyses consumer buying behavior using the more than 250 million transactions holders of supermarket and pharmacy loyalty card holders that CM records each week.

The company’s studies of how consumer purchasing habits have changed since the financial crisis make interesting, if grim, reading.  Last June, for example, the Financial Times reported that the average national brand had lost a third of its previously most dependable customers to cheaper store-brand goods during 2008.

The FT has just reported the results of another CM study, this one about changes in the kinds of things Americans are buying in the supermarkets rather just changes in the suppliers chosen.  The findings:

1. impulse purchases are way down.  Sunglasses buys have been cut almost in half and sales of tights are off by nearly a third.

2.  men have left the salons and returned to supermarkets and drug stores for hair-care products

3.  dogs and cats are being reduced to eating dry food instead of the canned “wet” meals they enjoyed in better times

4.  families are apparently spending more time at home, if rising sales popcorn and a 70% year on year jump in purchases of ice cream and cake (comfort food?) are any indication.

The fact of trading down shouldn’t be particularly surprising, since it occurs in every recession.  Even the rapidity of the change in consumer behavior this time around and the large number of areas where trading down has occured may have lost their ability to shock, since we have been reading about–and experiencing them–for some time.

Two observations, though.  I wonder how far can we extrapolate changes in the way consumers are treating everyday purchases now to the way they will treat more expensive, less frequently purchased items when they need/want to buy them.  In other words, how confidently can we bank on an explosion of pent up demand when the unemployment rate begins to fall?

More important, why have big losers from trading down, the packaged goods manufacturers, begun to outperform in the stock market?  Investors aren’t buying utilities or telecom, so I don’t think this is simply a general counter-trend rally.  Can the trading down phenomenon already be fully discounted?  One option this might suggest for an active manager is to underweight other defensives–telecom and utilities–and overweight staples.  Let’s see if this movement has any legs first, though.