breakup at Wynn Resorts (WYNN): what happened last Saturday

a little history

Steve Wynn is an iconic figure in the casino gaming industry.  Among other feats, he almost single-handedly re-glamorized the Las Vegas Strip while he was CEO of Mirage Resorts.  During the economic downturn of 2000, however, the board of that company accepted a takeover bid from MGM and showed Mr. Wynn the door.

Mr. Wynn then joined forces with Kazuo Okada, owner of a Japanese slot machine company, to develop a new upscale resort on nearby land.  Mr. Okada invested $380 million to obtain a 50% share of the venture.  Needing more money to advance his plans, Wynn Resorts went public in 2002.  So doing reduced Wynn’s and Okada’s ownership shares to 20% each.  Mr. Okada became the largest shareholder in WYNN when Mr. Wynn’s ex-wife received half of his stock in a divorce settlement.

the past year or so

The Compliance Committee of the WYNN board is led by board member Robert Miller, a former district attorney who served as governor of Nevada for ten years.  In February 2011, its investigation into the feasibility of opening a casino in the Philippines uncovered questions about possible violations of the Foreign Corrupt Practices Act (FCPA) by Mr. Okada in the Philippines while obtaining a casino license for himself there.

The board’s concern:  having a major shareholder and board member who could be deemed “unsuitable” to hold a casino license would put existing licenses in jeopardy.  As well, it would likely rule WYNN out as a candidate for new licenses (think:  Singapore, or permission to build a new casino in Macau).

In February 2011 the Compliance Committee opened an investigation of Mr. Okada.  Board worries were apparently heightened by Mr. Okada’s comments at board meetings, his unwillingness to participate in board FCPA training and his refusal to sign the company’s code of conduct.

(Reading between the lines, it also sounds like Mr. Okada continued to pressure the board to participate in his Philippine casino venture–something the board had ruled out–and had been intimating in the Philippines and elsewhere that he was secretly carrying out the board’s wishes.)

In September 2011, WYNN concluded there was a threat to WYNN’s business if Mr. Okada remained a board member/shareholder of WYNN and pursued his Philippine project.  The WYNN general counsel and compliance officer outlined the company position to Mr. Okada’s lawyers.  Mr. Okada said he didn’t see any conflict and declined to take any action.

WYNN then hired an outside law firm, run by a former head of the FBI, to conduct a detailed investigation.  According to Governor Miller, the inquiry turned up a pattern of violations of the FCPA by Mr. Okada and his companies.  Mr. Okada also told the investigators during a lengthy interview that he strongly believes he can continue to give valuable “gifts” to foreign officials, despite the fact this violates US anti-bribery laws.

last weekend

Last Saturday, after consulting with two sets of outside legal experts on gaming law, the WYNN board met.  It removed Mr. Okada as a director.  And it used the power given to it in the corporate charter to cancel Mr. Okada’s shares in WYNN.  It issued him a 10-year promissory note for $1.9 billion, bearing interest at 2% (payable in arrears), in compensation.

my thoughts

…just when you thought you’d seen everything!!

1.  I’m an investor, not a lawyer.  So I have to remind myself that I don’t have the specialized knowledge and training that may be needed to evaluate this situation correctly.

Still, given the array of prominent experts WYNN has assembled, I’d be shocked if the Nevada regulators don’t declare Mr. Okada to be “unsuitable” to hold a casino license in that state once it conducts its own investigation.  If so, I’d guess that undercuts possible legal action by Mr. Okada.

2.  WYNN’s charter apparently gives it the right to immediately revoke the shares of any owner the company finds to be “unsuitable,” which is a determination the board made about Mr. Okada on Saturday.

There’s no question of asking Mr. Okada to sell his holding; as of Saturday those shares no longer exist.

3.  The company charter apparently specifies the manner of compensation for cancelled shares.  Payment is supposed to be based on fair value and can be through a promissary note of at most ten-year maturity, paying an annual coupon of 2%.

Mr. Okada’s shares are “certificated,” meaning there’s either an electronic notation or a stamped notice, if they’re physical shares, saying that the stock has restrictions on sale.  WYNN didn’t say what the restrictions are, but they probably give WYNN the right to vet any potential buyer.  The certification would presumably bind any buyer, not just Mr. Okada.  It stands to reason that restricted shares aren’t as valuable as unrestricted ones.  …but by how much?

WYNN hired yet another expert firm, to determine “fair value” for the Okada holding.  Its conclusion:  fair value is a 30% discount to last Friday’s closing price.

4.  WYNN’s market capitalization was $14 billion last Friday.  So the market value of the Okada holding, were the shares unrestricted, would have been $2.8 billion.  In a sense, remaining shareholders make a gain of $900 million ($2.8 billion minus the $1.9 billion note), or about 8%, on their holdings through the share cancellation.

My guess is that the benefit to remaining shareholders is greater than that, if for no other reason than that the increasingly public tussle between Mr. Okada and the rest of the WYNN board was depressing the share price.  Because this situation is so unusual, however, I doubt Wall Street will assign even 8% extra to WYNN shares.

5.  Can Mr. Okada say he’s been harmed by the WYNN action?  Over the past decade, he’s received almost twice the value of his initial investment in dividends.  He’s now getting a note for 5x that amount.  My layman’s hunch is that his would be a hard case to make in court.

We’re in a wait-and-see situation now, in my opinion.  WYNN has asked the Wynn Macau board to remove Mr. Okada as a director, which I presume it will do.  It would be very interesting if the Macau authorities were to okay 1128’s pending new casino application once Mr. Okada is gone.  Another potential positive would be a speedy determination by Nevada regulators that Mr. Okada is indeed an “unsuitable” individual.

a second Greek bailout payment agreed: implications

an agreement

Greece and the IMF/EU have finally agreed on conditions for the latest tranche of bailout money, €170 billion, to be paid to the troubled Mediterranean country.  Greece will now have the funds to redeem €130 billion of its bonds that mature in the next few weeks.

little stock market reaction

Stock market reaction in Europe has been muted–a 2% gain yesterday, a give-back of about half that amount today as I’m writing this.

what went on in the talks?

I find it hard to interpret with any confidence what has been going on in negotiations between Greece and the EU/IMF.  It’s possible that the brinksmanship displayed in the talks on the question of whether Greece would remain in the Eurozone was all a show, performed for home country voters by politicians eager to minimize the negative consequences of any accord for their future electability.  But that’s not what I think.  My take is that Greece–which hadn’t come close to fulfilling the conditions of its initial bailout payment–figured until recently that the EU was negotiating from a position of extreme weakness.  Until the EU made it clear it was willing to let Greece leave the Eurozone, Greece felt it could extract almost any concession, provided it didn’t do so all at once but rather moved the bar a little bit at a time.  Once the EU began to plan for a Greek exit, Athens was forced to become serious about striking a deal.

implications

It seems to me that at the very least both sides have bought themselves some time.  I’d expect that the core EZ countries will continue to strengthen the capital structure of their domestic banks.  It’s understandable that potential buyers of the public assets Greece supposedly has on sale would be reluctant to bid until they were sure that they weren’t purchasing just before a significant currency devaluation.  So we’ll now have a chance to see how serious Greece is about these divestitures–and how desirable they actually are.

We’ll also have a chance to see whether the EU will retain its hard line that starving yourself through austerity is the best prescription for a return to robust health, or whether the ECB monetary policy will be a bit looser than it has let on to date. My guess is that it will.

Implications for stock market investors?  I think they’re less about a change in strategy than about confidence that the strategy is correct.  I view the EU as a low-growth area for an extended period of time.  And, although fears of a “Lehman moment” are off the table (not that markets ever really factored this possibility into stock prices), Europe will be subject to periodic worries about weaker EZ countries like Greece.

So the appropriate stance remains, I think, to be underweight the area and to concentrate on companies which are listed in the EU but which have the bulk of their operations located in the Americas or in the Pacific.

what’s that about Japan?

Actually, a much newer and more interesting macroeconomic development has been going on half a world away.  It’s quantitative easing in Japan.  More on this tomorrow.

 

layoffs on Wall Street: where do people go?

The weekend Financial Times has an interesting article about the decline in financial markets employment during the Great Recession.  It says that the industry lost over 200,000 workers, of whom more than 40,000 were relatively highly paid professionals.  The article relates a number of stories of transition to other kinds of work.

That’s basically what happens in investment-related businesses during downturns–people find other, unrelated industries to work in.

Looking at the situation a little more systematically,

finance has two main branches–three if you count the often bizarre area of financial “theory” that prospective finance teachers must master.

–commercial finance, commercial banking and corporate finance.  It deals with areas like lending, capital structure, budgeting, financial management controls, investing/raising cash for corporations, communicating with investors and regulators.  It’s generally insulated from the violent ups and downs of securities markets.

–investments, which deals with the structure and practices of securities markets.  People who focus on this branch of finance are generally much higher paid and much more highly specialized.

While it’s common for a commercial finance professional to move among different areas during a career, however, there’s virtually no carryover in skills, other than at the most basic level, from the investment specialty to the broader world of commercial finance.  In fact, other than early in one’s career, there’s very little movement possible among various areas–like stocks, bonds, trading, investment banking–within investments.  Career paths are that highly specialized.

This is a recipe for big career trouble for investment people if your sub-specialty suddenly has too many workers.

buy side vs sell side; professional investors vs. investment professionals

The industry commonly splits jobs into buy-side (investment management) and sell side (investment banking and brokerage).  There’s also typically very little movement between these two.  You can also distinguish between professional investors (the people who actually make investment decisions) and investment professionals (trading, sales/marketing and recordkeeping functions that provide services to portfolio managers).

professional investor issues.  The main industry problem over the past several years has been the decline in the value of assets under management.  This is the key problem for profits, since professional investors typically charge a percentage of assets under management as a fee.  Investment firms are also highly operationally leveraged–meaning they have roughly the same costs, no matter what the level of assets is–so the loss of assets under management results in a disproportionately large fall in operating income before compensation of portfolio managers.

The moves to index products and from equity to fixed income, both of which generate lower fees, haven’t helped, either.

What do investment management firms do?  They prune the least profitable products, eliminate staff and lower the level of compensation for almost everyone who survives.  There isn’t much else they can do.  Laid-off money managers either go into business for themselves (massive layoffs of value-oriented PMs in the late 1990s formed the basis for much of today’s hedge fund industry) or find smaller, often regional or local, firms to work at.

investment professional issues.  On the buy side, firms trim their trading and marketing staffs and lower compensation for those who remain.  The investment industry is mature, however, meaning there are few new customers.  So firms gain business mostly by taking it away from other firms.  So marketing is a vital function–more important than the investment management itself.

On the sell side, it’s important to distinguish between high-value employees, who are masters of their trading or investment banking trades, and low-value workers, whose main function is to act in a sense as “overflow” capacity.  That is, they answer the phone and process orders, or visit clients and make presentations, during cyclical peaks in business.  They may not add much value, but the firm avoids losing potential profits by being unable to respond, even badly, customers’ requests.

Such second-tier workers are paid a lot, both in absolute terms and relative to the value they add.  But when business slows down, they’re the first to be laid off.

First-tier investment professionals typically earn (much) less in lean times.  They also risk being laid off, as well.  Like their portfolio manager counterparts, they may end up at regional or local firms.  Boom times give second-tier workers an inflated sense of their own abilities.  Typically, though, they’re unable to remain employed in the investment industry during downturns and eventually end up working in other professions.

where are we now?

My sense is that the investment industry is at a cyclical bottom for employment.  But the industry still has enormous idle capacity available with the staff it now has.  We won’t see the boom times of 2004-2007 again soon.

higher taxes on dividends? –implications for stock markets

the Obama proposal

President Obama has recently proposed that the current tax preference for corporate dividends paid to individuals be eliminated.  Instead of being taxed at most 15% of the amount received, dividends would be considered ordinary income and taxed by Washington at as high a rate as around 40%.

Personally, I’d prefer an overhaul–and simplification–of the current tax code instead of tweaks around the edges.  Rather than putting a foot into the  the quagmire of possible political motivations, however, let’s just take a look at what I think are likely results for US capital markets if it’s implemented.

what doesn’t change

1.  Tax-exempt and tax-deferred accounts would be unaffected.  For pension plans, 401ks and IRAs, and for non-profits, it will continue to make no difference whether they make money in the form of interest or dividend income, or of short-term or long-term capital gains.

2.  Aging Baby Boomers are developing an increasing preference for steady income over capital gains, which are sometimes there, sometimes not.  That won’t change either.

what does

3.  I think the biggest effect will be on company decisions to start making dividend payments or to increase a payout they already have.

It seems to me that most publicly traded corporations recognize the Baby Boom-induced change in investor preferences now happening in the US.  Understanding that a substantial, and rising, dividend is a positive for their stock, companies have been happy to return profits to shareholders this way.  They do this despite realizing that if you combine federal and state/local income levies, up to 25% of the payout will go to the taxman.

If dividends lose their tax preference, the percentage taken by the taxes will approach 50%.  That means a big drop in what the shareholder will retain, both numerically (a third) and psychologically.  For most companies, I suspect, it will tip the balance in favor of devoting free cash flow to share buybacks rather than dividend increases.

For my money, that takes a lot of the shine away from what I consider to be the most attractive part of the dividend-stock universe–companies with above-average dividends today and for which you can reasonably project a quickly rising free cash flow over the next few years.

4.  If the government continues to  keep interest rates at emergency lows and, by accident or design, it also removes much of the incentive for individuals to buy dividend-paying stocks, how do investors adjust?  Maybe there’s a boost in demand for junk bonds, although income-oriented investors have been buying riskier forms of fixed income for a long time.

I think biggest effect would be for investors to broaden their horizons further.  The 7%-8% yields on EU telecom stocks will suddenly look more attractive, despite currency risks.  So, too, emerging market securities, both bonds and dividend-paying stocks.

5.  Looking at #3 another way,  provided they’re large enough to lower the share count, stock buybacks raise earnings per share.  All other things being equal, that should mean a higher per share stock price.  If so, the higher share price would likely offset some or all of the negative effect of dividends increasing at a slower rate.  In other words, the mix of returns (price appreciation + dividend income) changes, and in a way that increases risk.  But the crucial investment question is whether the total return from both sources will be higher or lower than before.

No one knows the answer.  But if the total return is lower–that is, if the effect of higher taxes on dividends is to decrease the long-term value of US equities–then one would expect US investors of all stripes to look increasingly to stock markets outside the US.  In addition, on the margin, US companies might also begin to look to foreign venues to raise new capital, if they could achieve higher prices for their stock by doing so.

My bottom line:  this proposal is one to watch closely.  Like a snowball that starts rolling down a hill, its consequences could be far greater than just to raise taxes on older, upper middle class city dwellers.