Rabobank’s latest fundraising: Europe trying to define bondholders’ responsibility in default

the problem

To an American, one of the striking aspects of the financial crisis has been the reluctance, both of politically powerful bondholders (many of them state-controlled entities) and of country governments, to accept any impairment in the value of the debt securities of ailing financial institutions.  The prevailing thinking seems to have been that, no matter how the debt documents read, there was an implicit social promise that the negative consequences of default should fall entirely on shareholders or government.

(In the US, in contrast, it’s very clear that bondholders, too, participate in the losses from a bankruptcy–though with the quirk that the treatment a class of bonds receives is more dependent on its size and the bargaining power of its representatives than the explicit promises in the bond indenture.)

contingent convertibles

The European way of doing things has proven to put excessive strain on public finances.  One of the possible solutions being discussed to this problem is issuance of contingent convertibles or “CoCo” bonds.  Cocos would spell out in the issuing documents specific circumstances of deteriorating issuer finances that would trigger conversion of part or all of the bond capital into equity.  Conversion would simultaneously reduce the amount of debt on the balance sheet and shore up shareholders’ capital.

The idea really hasn’t gotten off the ground so far.

contingent capital bonds

However, Rabobank of the Netherlands sold a contingent capital bond last weeks that pundits are hailing as an instances of a successful CoCo bond.  The issue, $2 billion at a yield of 8.375%, was more than 3x oversubscribed.  If Rabobank’s equity falls below 8% of total capital, the value of these bonds automatically shrinks–even to zero–until Rabobank’s equity ratio reaches the 8% level again.

Although I’ll admit the issues is interesting, I’m not sure it’s a harbinger of anything.  Why?

–Perhaps least important, this isn’t really a coco at all.  Rabobank is a cooperative society.  It was formed two centuries ago by a large number of agricultural banks, which hold its ownership interests.   So there’s no publicly traded stock for the bond to convert into.  The bond principal vaporizes instead.  I’m not sure there’s a big difference, though, between getting a share of stock in a dud bank or getting nothing, other than how fast you get to recognize your loss.

–Rabobank has a AAA credit rating (although S&P has put it on watch for downgrading) and is mostly a retail bank.  So it has a very different risk profile from the troubled big universal banks of the EU.

–According to the Financial Times, 70% of the issue was taken up by individual investors.  My guess is they don’t have much of a clue about what they’ve bought.  They see a high coupon from a conservatively managed bank–and little else.

the question of pecking order

This bond brings up another question.

Rabobank already has second contingent capital bond outstanding, this one about $1.7 billion and issued last year.  Its terms call for holders to lose 75% of their capital, and have the remainder returned to them, if Rabobank’s equity ratio falls below 7%. (By the way, Rabobank has just over $50 billion in equity, which makes up about 14% of capital).  Because the newly issued bond’s vaporization clause is triggered prior to the 2010 bond’s, it gives some protection to the latter.  That should mean an uptick in price for the 2010 issue.  The question I have is that this seems so arbitrary. Could investors in 2010 have known in advance that they would receive this extra protection?  Probably not.

On second thought, if they had an optimistic enough disposition a year ago, maybe they could.  Rabobank seems dedicated to continue to issue its coca bonds.  One would assume that the cooperative will try to make the vaporization line as high as possible.  This desire will likely be tempered by the thought that, since its retail customers may be large holders of the cocas, the line should be set at a level where there’s only the remotest possibility that the vaporization clause will be triggered.  Last year that number was 7%.  This year it’s 8%.  My guess is that as/when confidence continues to build in Europe, Rabobank will push the vaporization threshold higher.

Maybe the Rabobank cocas will become a bellwether for retail investor sentiment in the EU.  But it seems to me their success will be very little indication of prospects for other banks’ issuing cocos–particularly to institutional investors.

is retail money coming back to the stock market? …yes and no

the news

There have been numerous reports in the financial press over the past month or so that, after two+ years on the sidelines, retail investors are beginning to return to the stock market.  The latest of these appeared in the Financial Times yesterday.  The FT article is a bit selective.  It points out that Charles Schwab added $26.2 billion in new assets in the December quarter, the largest amount in one quarter for the past two years.  It reports that competitor TD Ameritrade added $9.7 billion to its books for the period, but doesn’t mention that this is about average for the firm over the past year and that it added more than $10 billion to its books in the June 2010 quarter.

The latest ICI figures–the Investment Company Institute, the money management trade association, which seem to have been a lagging indicator, are finally starting to confirm the trend that newspapers have been reporting.  The weekly figures for January 12th show $3.78 billion flowing into domestic-oriented equity funds, continuing flows into international/global stock funds, and moderation in the (still positive) flow of money into taxable bond funds.

One significant point is beginning to emerge.  According to the FT, the money flows to the discount brokers are primarily day traders, not buy-and-hold investors.  This latter, much larger, group remains firmly in the highly defensive posture it adopted over two years ago.  The speculative orientation of the recent assets opening brokerage accounts is confirmed by TD Ameritrade’s comment that the use of margin loans by its clients is up 31% year over year.


The new inflow of retail money likely gives Wall Street a further gentle upward bias.

The fact that there is still considerable private investor money on the sidelines suggests there is more positive news to come on funds flow front.  In other words, the new money doesn’t appear to be a harbinger of the end of the bull market.

The day trader character of the new money suggests that short-term volatility in the market will increase.  To the extent that day traders concentrate on mid- and small-cap names, the volatility in this area should be most affected.  For a long-term investor, this is good news, since it means better buying and selling opportunities for anyone willing to exercise patience.

The use of margin suggests inevitable corrections in the market will be swifter and deeper than they would be otherwise, as high leverage works against traders.


AAPL’s December 2010 quarter (1Q11): the usual, but a lot more of it

the results

AAPL reported December quarter earnings (the first quarter of the company’s fiscal 2011) after the market in New York closed yesterday.  Revenues were up 70% year on year.  Earnings per share were $6.43 for the three months.  This compares with eps of $3.67 for the comparable period of fiscal 2010–a 75% year on year gain.  AAPL did get a small benefit from the retroactive reinstatement of the R&D tax credit in the US.  Pre-tax results were up 67%.Analysts weren’t anywhere close to the mark.  The consensus was $5.40, a buck a share–or about $900 million–below the actual results.  Wow!

the details


Desktops were flat at 1.2 million units.  Laptops were up 37% at 2.9 million.  The new MacBook Airs flew off the shelves.


Units were 16.2 million, up 86% year on year.  AAPL was supply constrained.


The company sold 7.3 million iPads in the quarter, 3.1 million more than in 4Q10.  For the three quarters the product has been in existence, AAPL has sold just under 15 million.  Supply has finally caught up with the level of demand.

Consulting firm IDC predicts the tablet market will be 4x the current size–that means around 80 million annual units–in two years.  AAPL sees no viable competition, so far.  In the company’s opinion, no one wants a Windows machine and the Androids available to date don’t have enough functionality.  New Android models shown at the Consumer Electronics Show in Las Vegas recently are just “vapor.”


Unit sales were down about 8% vs. 1Q10, following recent trends.  After all, something had to be less than perfect.  iPod Touches were up 27%, however and now comprise over 50% of unit volume.

Apple stores

Revenues for this distribution arm were $3.8 billion, up 95% year over year.  Stores in China, only four of them in total, had the highest traffic and highest revenues in AAPL’s retail network.

the Pacific

Revenues in greater China were $2.6 billion for the quarter.  That’s 4x what the company took in during 1Q10, and 2.5x+ its sales for the full fiscal 2009.

Mac sales were up 67% in the Pacific, 10x the pc market growth there.


AAPL expects revenue of $22 billion and eps of $4.90 for 2Q11.  An observant analyst pointed out that the guidance was for an 18% quarter on quarter drop in sales, which is more than the usual seasonal decline.  Management’s answer could have been that AAPL didn’t know what seasonality in iPad sales might be like–or that rumors of a new version of the iPad to be launched in April might deter would-be buyers.  Instead, the spokespeople kind of laughed at the analyst (whose spreadsheets are meticulous) and said the guidance was for 65% growth and that was enough.

my thoughts

The stock doesn’t look expensive.  APPL made $15.15 a share in earnings last fiscal year.  The analyst consensus prior to this call was $19.94 for fiscal 2011, with the highest estimate at $23.31 (these are all weird, overly precise numbers.  What’s wrong with these people?).  Given that AAPL will likely put up around $12 in eps for the first half, $23.31 looks easily doable.  Let’s say the company comes in with $24.

AAPL was trading at about $350 last Friday.  That would put the stock on 17.5x.  17.5 x $24 = $420.  Using no judgment, but just acting mechanically, if Apple earns $24 a share and if the stock can maintain a 17.5x multiple, it should be trading about 20% higher in the summer/fall than it is now.

Steve Jobs’ health

Of course, I’m kind of worried that the $24 number that I’ve just plucked out of the sky might be too high.  I’m more worried about the multiple, though.  That’s where Steve Jobs’ health problems come in.

A good growth stock, like AAPL has been, has an open-ended quality to it, in two senses.  What makes a growth stock is the possibility that earnings will be better than the market expects for longer than investors realize.  Theres always an “at least as good as…” and an “at least as long as…” aspect to it.  Once a company stops delivering positive surprises, or once the market begins to believe it can see the end of the road of super-good growth, investors begin to treat the stock differently.

Because the market believes in the central role of Mr. Jobs’ creativity in leading AAPL to the iPod and the iPhone, his medical leave raises the possibility that once the iPad has played out–even though that will likely take years–there’ll be nothing left in the company’s bag of tricks to be the next new hit product.

To some degree, this is already happening with AAPL.  Over the past year or more, Wall Street has been reacting to spectacular earnings growth in two ways:  stock price rise, and price-earnings multiple contraction.

As a result of this line of thought, I’m not sure whether AAPL is really cheap at today’s price.

I have a second issue, as well.

To step back and approach the question from another angle–AAPL as a struggling pc company when Steve Jobs came back to work for the company.  He launched the iPod that doubled the size of the firm and had a “halo effect” in reviving interest in Macs.  Then AAPL came out with the iPhone, which doubled the size of the company again.  And he’s now produced the iPad.  To do the same trick again–doubling the size of the company–the iPad has to be 2x the size of the iPhone.  Half the size of the iPhone?  –easy, I think.  the same size?  –doable.  Twice the size?  –no way.

That’s what I believe.  This implies the growth dynamic for AAPL is not as good today as it was a couple of years ago. If the iPad is going to be much bigger than the iPhone has been, then the stock is cheap, in my opinion, even without Steve Jobs.  But I can’t convince myself it is.

So I have little desire to buy–although I may well get a second-generation iPad when that comes out.  I don’t own the stock today, but my sense is it wouldn’t be my biggest position any more but I’d hang onto some.



renminbi as an international currency–more steps forward

About a month ago, I wrote a post summarizing the steps the Chinese government has already taken on its march to join the US dollar as a world reserve currency.  That is to say, Beijing wants the renminbi to be used not only as a reference currency in the worldwide trade in goods and services, but also to be held as a store of value in the coffers of the world’s private and government central banks.  Almost no one believes that’s Beijing’s final destination, however.  The ultimate goal, I think, is to supplant the dollar, rather than supplement it.

For a while now, China has been encouraging companies involved in international trade to construct and settle their transactions in renminbi instead of (mostly) dollars.  To this end, it has been allowing more of its currency to seep out of the mainland and be held legally in foreign banks, notably in Hong Kong.  In addition, it has been supplying currency to foreign central banks who want to provide renminbi to firms that make up their countries’ side of the deals.  One catch, though:  the money can get out of China very easily.  Getting it back in is another matter.

Last week, though, according to the Financial Times, Beijing took another step.  It is now encouraging Chinese companies that are setting up businesses or making acquisitions abroad to do their business in renminbi, as well.   Such deals have to be approved by Beijing, just as any foreign currency purchase would be.  Same catch, though:  easy to get the money out, but once the cash leaves the mainland, there’s no guarantee it can get back in.

Of course, interest rates are low, so the opportunity cost of holding renminbi in short-term deposits isn’t high.  And if you think the Chinese currency is undervalued, you may be willing to bet on having it appreciate.  So you might say it’s kind of like gold, only without the physical storage difficulties.

There are two conclusions that I think we can draw from this development:

–the targets are unlikely to be publicly traded companies in the US or Europe.  I can’t imagine pension funds or index funds voting in favor of deals that would land them with hundreds of millions of dollars worth of renminbi that they would have to dispose of.  I don’t this is that big a change in strategy, since Washington and the EU have made it pretty clear they’ll throw up all sorts of (mostly bogus) political obstacles to almost any deal where the buyer is Chinese.

–If this initiative is successful, China is going to be piling up lots more dollars.  China was involved in a tenth of the global merger and acquisition activity last year.  The Economist predicts, I think, that this is just the tip of the iceberg.  My take on this thrust, plus the foreign aid to Latin America and Africa, and the offers to buy the government bonds of ailing European countries like Greece, is that a good part of China’s motivation has been to try to divest itself of as much of its gigantic hoard of US Treasury bonds before the profligate ways of Washington cause them to lose value.  In fact, the cover of the Economist issue (November 13, 2010) that I linked to above has the Chinese buyer offering a wad of American cash.

Suddenly, however, the emphasis has changed from shrinking the central bank’s pile of greenbacks to draining the domestic economy in China of part of its supply of “redbacks,” as some have begun to call the renminbi.

Why?  My guess is that Beijing has worked out that it can’t reduce the risk of holding tons of dollars by just spending them as fast as it can. More just keeps on coming in.  And it may well lose as much on bad acquisitions as it would on depreciation of the dollar.  The only real solution to its currency risk is to push harder to get more renminbi circulating outside the mainland and see what happens.

Step one will be to see if there are any sellers willing to take Chinese currency.

Investment implications?  This is more something to keep an eye on than to worry actively about.  An increased willingness of China to hold onto dollars would arguably be good for the US currency, at least for a while, and would imply that interest rates might stay a bit lower than they would otherwise.  But let’s see how big the offshore renminbi market gets before doing anything else.

walking around Las Vegas last week

I was in Las Vegas with my family last week for the first time in about a year.

The naked girders of a planned addition to LVS’s Palazzo are still rusting away as they were a year ago.  And the metal bones of a couple of other casino projects decorate lots across the street from the WYNN resort.

The Trump hotel has opened, with the C-A-S-I-N-O letters removed from the sign on the front that marks the (long) drive from the Strip to the hotel door.  The absence of lights in the rooms after dark indicate that either everyone is wearing night-vision goggles or there aren’t many tenants.

I went into the Cosmopolitan, which is very trendy and has a strange, narrow rectangular casino floor.  And I saw the CityCenter for the first time–hotels, condos, casino and mall.  Very impressive, pretty empty–and an odd-looking casino here, too.

For a while, it looked as if snow would prevent us from flying back to the east coast.  A quick check of travel websites showed plenty of $50 and under rooms around, including at the Mirage.

A number of retail stores have gone out of business but the survivors aren’t sporting the profusion of SALE! banners they were in early 2010. Lots more people in restaurants.  A bunch of new restaurants, as well.

my thoughts

There were many more people around the Strip and in the casinos than I saw a year ago, even though the time we were there was a non-convention week, just after the CES.

Of course, it’s dangerous to generalize from just walking around.  I remember once, when Caesar’s was a public company, going to Atlantic City and seeing the Caesar’s there packed to the gills.  I called the company the following day and commented that they must be happy with the business they were doing.  They weren’t!  A main door was broken in the shut position, so gamblers who had lost all the money they intended to couldn’t get out–and were blocking the way to the slot machines.

Having said that, I’m willing to believe that Las Vegas is on the mend.

My walk brought home, however, just how extensive the hotel overcapacity in Las Vegas is.  Occupancies and room rates will remain low for a long time, I think.  That’s important, since the casinos themselves only account for about half a company’s profits in the good times.  The rest is the hotel.

I also suspect that the two new casinos at Cosmopolitan and CityCenter will end up being more or less overflow capacity that will be filled only when others are packed.  If so, the casino overcapacity isn’t so bad.  The real issue for this part of the business is whether American entrepreneurs (the prime casino patrons) will feel like gambling again.  My impression is that they already are.

The upcoming round of quarterly earnings reports for Las Vegas companies will be interesting.  My guess is that the second-line hotel casinos will suffer the most.  WYNN (I own it) is, I think, the only front-line firm with the financial wherewithal to keep refurbishing its rooms to keep its hotels in tip-top shape.  I wonder if that will make any difference.

Intel’s 4Q10: stellar numbers, but no respect from Wall Street

the results

Thursday January 13th, INTC reported its 4Q10 results.  The firm earned $3.4 billion (a company record), or $.59 per diluted share, on revenue of $11.5 billion (another record).  This compares with the Wall Street consensus of $.50.

For the full year 2010, INTC posted eps of $2.05 on revenue of $43.6 billion (more records).  The figures compare favorably with the brokerage house median estimate in late 2009 of about $1.25.

Management also said the first quarter won’t show its normal seasonal revenue decline, but will be about the same as 4Q10.  Despite  all the good news, and a prospective dividend yield of 3.45% (higher than the 10-year Treasury), the stock traded down in an up market on Friday–a day in which the IT sector as a whole was up almost a percent.

the details

unusual items

Earnings for 4Q10 were $3.4 billion vs. $2.3 billion in the comparable period of the prior year.  4Q09 results were depressed by a $1.3 billion (before a $438 million tax benefit) settlement with AMD; 4Q10 expenses were about $200 million higher than forecast, due to a new cross-licensing agreement that settles litigation with Nvidia.

The tax rate for 4Q10 was 24% vs. guidance of 31%, due to retroactive reinstatement of the US tax credit for R&D.  The tax rate for 4Q09 was 12%, or half the rate of 4Q10, as INTC made year-end adjustments for having a larger than expected percentage of earnings in low tax rate areas.

Operating income, ex the AMD settlement, for 4Q10 was up 16% vs. 4Q09.  This figure gives a better indication of the true growth in INTC’s profits.

the business

Revenues were up 3% quarter on quarter in a period when sales are normally up 8%.

Why?  The server business–both conventional servers and cloud computing–was strong, at + 15%.  But the consumer business–a much larger segment for INTC–was flat, both at the high end and for Atom as well.  The US and Japan showed typical seasonal strength, while Asia was weaker than usual.

INTC’s analysis of the poor consumer outcome is that computer makers reduced inventory of older INTC chips while they waited for the introduction of the company’s new Sandy Bridge line of processors.  A rebound in the consumer business as more Sandy Bridge chips become available is part of the reason for INTC’s confidence in the strength of 1Q11.  Wall Street, for good or ill, seems to be reading the consumer shortfall as a loss of business to tablets.  We’ll see.


Cross currents galore.

INTC seems to think revenues will rise by at least 10% in 2011–the chairman said 20% in his remarks but was promptly told by the CFO that the official guidance was 10%.

Gross margins will likely decline by about one percentage point, as startup costs for new 22 nanometer capacity, a key to INTC’s future, more than offset the positive effects on margins of higher unit volume and revenues.  In addition, the company plans to boost R&D spending by about $1 billion more than usual.  It will also lay out $9 billion on new capital equipment in 2011 vs. $5.2 billion in 2010–implying depreciation will also rise by about $1 billion this year.

Mix that all together and a 15% revenue increase would translate into an 11% rise in pretax income.  Assuming, as INTC does, a constant tax rate at 29%, that would imply around $2.30 in eps. My impression is that INTC is hoping for at least that. This compares with a Wall Street consensus before company guidance in the 4Q earnings report of a bit less than $2 and a post-results consensus of $2.11, which is the figure you’d get by assuming sales go up by 10%.

INTC is planning for significant growth in demand…

…as evidenced by the large increase in R&D and the aggressive capital expansion.  Reasons?

–emerging markets, where most of the world’s population is and where PCs are only now becoming affordable to the average person

–the enterprise server business is booming, and cloud computing–a big new user of servers–is in its infancy

–the “Internet of Things,” which will require huge numbers of embedded processors

–INTC design wins in tablets and smartphones, which will soften the blow of any switching (lots of speculation but I don’t think any has yet been seen) by consumers to these devices and away from laptops and netbooks.

…Wall Street is dubious

Based on brokerage house analysts’ estimates for 2011, INTC’s stock is trading on a price earnings ratio of about 10x–which is 75% of the market multiple and about half that of the median tech stock.  The last time INTC traded this cheaply was about fifteen years ago. The analyst’s estimates I’ve seen show no earnings growth to speak of in any of the next three years.

my thoughts

I own a modest amount of the stock, which tells you what conclusion I’ve come to.

INTC is an interesting case, though.

On the one hand, imagine what would happen if a private equity firm gained control of INTC (not that this could happen) and began to run the company for cash.  It would quietly cut R&D and capital spending, with the intent of generating eps of maybe $3 a share for three or four years.  It would likely also do something like what MSFT did a few years ago, bring in a cost-cutter from a mature cyclical industry, to reduce overall spending.  Say these efforts generate $14 a share in total.  INTC, as it stands now, has about $4 a share in liquid assets on the balance sheet, after repayment of debt.  Private equity would remove that.  Plant and equipment is on the books at about $3 a share.  Say the firm does a series of sales and leasebacks that raise operating costs but put another $3 in cash in its hands.  What would be left?    A business–maybe just the server business–capable of generating $1 a share in cash for a number of years.  Let’s say that could be sold for $6 a share.  $14 + $4 + $3 + $6 = $27.

$27 might not be the right number.  It might be $24–or it might be $30.  But I think a reasonable case can be made that INTC dead or broken up is worth much more than $21.  Ordinarily, we’re regard that as downside protection.

But that’s not the INTC management’s strategy.  Instead, the company is upping R&D and capex this year by a total of about $5 billion vs. 2010 levels.  And it’s spending a lot of the idle cash parked on its balance sheet on McAfee and a division from Infineon.  It’s doing so to exploit the growth opportunities, enumerated above, that it sees.  the company also clearly thinks it can be a viable competitor to ARM in smartphones and tablets–although I don’t yet see evidence in favor of the opinion.

That’s the bet.

Wall Street–and the stock price–are implicitly saying that the INTC management is going to destroy shareholder value in its attempt to become a growth company again.  Of course, no analyst is going to put this idea down in writing–fearing being cut off from access to management and having his firm left out of any investment banking deals that might come along.

I’m taking the other side.  Why?  …I think:

–expectations are low;

–the stock looks cheap to me;

–I regard INTC’s management is much more competent than Wall Street is giving it credit for–although whether it can make ARM-competitive products is open to question; and

–the worries that we have entered a post-PC world that doesn’t include INTC have been around for a long while and, I think, are mostly factored into today’s price.

–I think the negative judgment about INTC has been made before conclusive evidence is in.

The stock clearly needs to be monitored closely for evidence that the bear story has more merit than I think.  But for me the combination of what I see as large potential upside and limited downside make it worth holding.