Yearly Archives: 2013

the Larry Summers market rally

September 16, 2013 By in Current Market Thoughts Tags: , , , , , 1 Comment

Summers withdraws

Yesterday evening, Lawrence Summers, President Obama’s choice to replace Ben Bernanke as Chairman of the Federal Reserve, announced he was withdrawing his name from consideration.

Global stocks and US bonds jumped on the news.  The dollar declined slightly, as well.

why the celebration?

The consensus view on Wall Street is that Mr. Summers would have begun to raise interest rates in the US much more aggressively than had been the Bernanke policy.  It isn’t clear that Mr. Summers’ view is wrong.  After all, the Fed is justifying its current super-accommodative stance by pointing to its mandate to fight unemployment , not the more typical central bank responsibilities to keep the economy on an even keel.

But Mr. Summers is also somewhat of a loose cannon.

For example, he was removed as president of Harvard after alienating the tenured faculty by his brusque management style.  He’s also suggested that the paucity of women scientists in the US may be due to genetic deficiencies in the female brain.  As well, in an article titles “How Harvard Lost Russia,” the Institutional Investor questions Mr. Summers’ defense of a protege, Andrei Schleifer, who was convicted of conspiracy to defraud the US for violating conflict of interest rules while working as a government adviser in Russia.

why the withdrawal?

Mr. Summers’ withdrawal comes after a series of prominent Senate Democrats publicly announced they would not vote in his favor.  The one who caught my eye is Elizabeth Warren of Massachusetts, who was a professor at Harvard while Summers was president.

who will the new nominee be?  

It’s hard to say.  The gracelessness with which Mr. Obama terminated Ben Bernanke a few months ago suggests there’s a big personal eqo issue involved.  Janet Yellen, the number two person at the Fed, and the “easy” choice, was never Mr. Obama’s favorite–maybe because she was an adviser to the Clintons.  I guess it’s possible that choosing Summers was less about him than about Ms. Yellen.

Since Mr. Summers’ abrasive personality and peculiar social views are as much a pert of his rejection as his economics, it could be that a new nominee will also hold Summers’ more aggressive interest rate views.

In any event, I think the present market advance is a one-day affair, that may well be reversed when a new Fed nominee more acceptable to the Senate surfaces.

 

 

Verizon Wireless: who’s getting the better of the deal, Verizon (VZ) or Vodafone (VOD)?

September 13, 2013 By in Current Market Thoughts, Stock ideas, Strategy, Technology, Wireless Tags: , , , , , , , , , Leave a comment

I think it’s VZ.  The company says that even at a cost of $130 billion the buy-in of VOD’s 45% minority interest will add 10% to VZ’s earnings.  But VZ is also adding a significant amount of risk in leveraging itself financially.

a simplified history

In 1982 the federal government forced the breakup of the monopoly telephone service provider, ATT.  It separated the parts into a national long-distance provider, which retained the ATT name, and a bunch of regional local service providers, nicknamed the “Baby Bells.”  Each Baby Bell contained its area’s nascent mobile services.

Soon enough, the Baby Bells began to merge with one another, ultimately forming into a Western US group (which subsequently acquired “new” ATT and took on the ATT name) and an Eastern group, which subsequently renamed itself Verizon.  Proto-VZ wanted to keep its mobile assets.  Proto-ATT didn’t.  To keep the mobile assets out of the clutches of prot0-VZ, Airtouch, the proto-ATT mobile operation, sold itself to VOD in 2000.

VOD promptly struck a deal with VZ in which it merged Airtouch with the VZ mobile operations to form Verizon Wireless.  VZ had operating control and a 55% interest.  VOD had veto power over some decisions and held the other 45% of Verizon Wireless.

Got all that?

culture clash

VOD is a British company.  It apparently believed in the old-style colonial European way of doing business, according to which a firm with global pretensions could get more bang for a buck (or quid, in this case) of capital by taking large minority interests in important foreign  firms.  Through superior intellect/management technique, or force of will, or sheer European-ness, it would dominate the board of directors.  It would thereby get the benefits of 100% ownership without the capital outlay.   The resulting network of companies would move in lockstep with its European leader, buying the capital equipment suggested (getting discounts for all) and perhaps paying management fees to the European company for its advice.

VZ, an American firm, would have thought that no one in his right mind would accept a minority stake.  If would have figured that VOD would soon see the light and be persuaded to sell.

Or maybe that’s just how the two parties rationalized the unhappy partnership that they entered into.

what each party gets from the deal

Verizon

–when the deal closes early next year, VZ will have access to the cash flow from Verizon Wireless for the first time.  US tax law   requires that a parent have an 80% interest in a subsidiary before cash can flow tax-free from it to the parent

–VOD will no longer have an operational say in Verizon Wireless

–the very mature fixed-line telephone business will be a significantly smaller proportion of the whole

–the deal is accretive to earnings by 10%

Vodafone

–VOD extracts itself from its awkward minority position

–ir gets a big payday, even after distributing the bulk of the proceeds to shareholders, which it will presumably use for EU acquisitions

–VOD believes it can use a provision in UK tax law regarding transactions between conglomerates to pay only about $8 billion it taxes on this deal

Tobin’s q and LinkedIn (LNKD)

September 12, 2013 By in Stock ideas, Tobin's q Tags: , , , , , , , , , Leave a comment

James Tobin was a Nobel Prize-winning economics professor at Yale.  One of the things he’s famous for is his formulation of the “q” ratio, which is:   total market value of a publicly traded company’s outstanding stock ÷ the replacement value of the company’s net assets.

Sometimes q is taken to mean:  per share stock price ÷ book value per share.  But that’s not right.  A company may have a brand name or powerful distribution network that don’t show up in book value (Warren Buffett’s key investment insight).  Or it may have potentially lucrative mineral leases that appear on the books only as raw land, because they haven’t been fully explored.  Or, in today’s world, a firm may have created big software research/development assets whose only effect on accounting values comes from the subtraction of associated salaries from earnings.

Tobin understood that sometimes a company has assets that are hidden from public view.  As a result, a company’s true q is likely best known–or solely known–to its top management.

Tobin’s advice to managers is this:  if your company q > 1, meaning the stock is worth more than the value of the company’s assets, sell stock.  If your q < 1, buy stock back in.  Never do the reverse.

There’s a certain paradox to q.  If, out of the blue, a company launches a stock offering whose proceeds will find no obvious near-term use, then top management, which knows the firm the best, must think the present q is a lot bigger than 1.  If so, no rational person should want to buy the shares being offered.

…which brings us to LNKD, which has recently announced a $1 billion stock offering.  Year-to-date, the stock is up 123% vs, an 18% gain for the S&P.  The trailing PE, which is probably not relevant, is 730x.

My guess is that the offering will be heavily oversubscribed, despite the implicit warning that the offering itself entails.

It will be interesting to see how LNKD shares fare over the coming months.

housecleaning at the Dow Industrials

September 11, 2013 By in Dow vs. S&P, index funds, Keeping Score, Portfolio management Tags: , , , , , , Leave a comment

Standard and Poors, the part of the McGraw Hill empire that controls the Dow Jones averages, announced today that the Dow Industrials would be bouncing out three of its thirty components, effective September 20th.

The companies to be shown the door are :  Alcoa (AA), Bank of America (BAC) and Hewlett-Packard (HPQ).  Their offense?   …stock prices that are too low, and not enough diversification appeal.

They’re being replaced by:  Goldman Sachs (GS), Visa (V) and Nike (NKE), all of which have higher stock prices and supposedly give the Dow more diversification.

We all know the Dow is a weird index.  That’s because it’s calculated using each stock’s per share price (not the total value of the company’s equity) as the weighting factor.  So a stock that sells for $50 a share has twice the potential impact on the index of a stock that sells for $25–even though the latter may be a much bigger company, with a much larger total market value.

No wonder Alcoa, an $8 stock, and Bank of America ($14.60) are gone.  They’re insignificant!

No surprise, either that Apple ($494) and Google ($888) aren’t in.     …too large.

Why calculate an index this way?  The only answer I can come up with is that in the (computer- and calculator-less) late nineteenth century, when the Dow was invented, the math was simple enough for reporters to get done quickly at the end of the day.

Why does it still exist?   …and why do individual investors still pay attention?  At first blush, the answer is that the Dow is almost all the news media talk about.  But the media would ditch it in a second if the Dow weren’t a surprisingly good mimic of the more sensibly constructed S&P 500, which is what investment professionals use as their benchmark.

Think about it for a minute (something I haven’t done until recently).  What are the chances that a small, wacky index can track the S&P 500 so closely?

As I recall, it wasn’t always this way.  Back in the day, investors tracked the Dow vs. the S&P.  If the Dow was doing better, it meant the ghost of Christmas past was in the room.  If the S&P was outperforming, then smaller stocks in less mature industries were on the relative rise.

Not so much anymore.

It seems to me a tremendous amount of brainpower and computer time has recently gone into–and continues to go into–tuning the Dow Industrials so that they’ll keep on tracking the S&P pretty faithfully.  That’s the really interesting thing about the Dow, to my mind.  And it’s the reason AA, BAC and HPQ had to go–not for diversification, but because they weren’t helping the Dow track the S&P.

Verizon (VZ), Vodafone (VOD) and flowback

September 10, 2013 By in flowback, hedge funds, index funds, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , , , , , Leave a comment

VZ is buying the 45% of Verizon Wireless that VOD owns.

VZ, which owns 55$ of Verizon Wireless, recently agreed  to buy the other 45% from VOD for around $130 billion.

From what I can tell so far, the deal will be good for VZ.  And, at the very least, VOD gets a boatload of cash and stock.  In hindsight, VZ would have been a lot better off striking the same deal in March, before the Fed began hinting that it was thinking of ending the current post-recession period of extra-super-accommodative money policy in the US.  The interest rate VZ would have paid on newly issued bonds would have been lower.

More on this topic in future posts.

There may not be a great need to load up on VZ ( which I own) immediately, however–even if you think the deal is a spectacular coup for VZ (too enthusiastic for me).  The reason is flowback.

what flowback is

VZ is going to issue over a billion shares of new stock to VOD as part of the purchase price.  VOD has already announced it will distribute to its shareholders all of the VZ stock it receives.  That’s something like one VZ share for every 40 VOD shares held (the exact ratio isn’t important).

What is important is that VOD is a UK corporation whose stock is traded in London.  The bulk of its shares are held either by UK or Continental European institutions.  US institutions hold only about 15%.

Put another way, early next year almost everyone who owns VOD will receive shares in a foreign stock, VZ.

What will they do with it?

For index funds, the answer is clear.  If it’s not in the index, it has to be sold.

For institutional managers in the EU, the answer depends, in the first instance, on what their contracts with customers say.  They’ve presumably been hired for their expertise in EU equities.  Management agreements probably stipulate that they’re not allowed to hold non-European securities.

Even if they are permitted to hold VZ, why do it?  Why take the risk of holding a stock that’s outside your area of competence–and which will require considerable research effort to get a firm grasp on.  Selling is a much safer option.

For individuals, if form runs true, the first they’ll hear of the deal will be when their broker calls to tell them that shares of VZ have plopped into their accounts–and to urge them to get rid of this weird thing.

That’s flowback.

It happens in all cross-border deals that involve stock.  When shares of the issuing company leave the home country, some portion will be sold immediately by investors who are unable or unwilling to hold what is for them a foreign stock.

Where do these sales take place?   …ultimately in the home market of the issuer.

the VZ case

For VZ, average daily trading volume is around 10 million – 12 million shares.   Occasionally, volume can get as high as 30 million- 40 million shares without moving the stock too much.

Let’s make up a number and say that flowback will be 300 million shares.  That’s easily an entire month’s trading volume.  So this could be a serious issue for VZ’s price.

mitigating factors

There are three that I see:

–Verizon Wireless is the largest and most important asset for both VZ and for VOD.  Non-index investors in the EU must have wanted exposure to Verizon Wireless to be holding VOD shares.  Arguably, they will want to continue to have that exposure and will therefore be less inclined than normal to want to sell.  So maybe some will be able to wangle exceptions from their clients.

–trading volume in VZ over the past seven trading days (not including today) has averaged about 25 million, or–let’s say–12 million shares above normal.  If this is all merger-related short-selling, which it probably is, then this trading has already created demand for 80+ million shares of VZ when the shorts are covered.

–the stock has a current dividend yield of 4.6%.  At some point, this and other VZ fundamentals should provide price support.

my take

Worries about flowback are one reason large cross-world acquisitions involving stock aren’t that common.  This one was clearly too big for VZ to do any other way.

My guess is that anticipatory selling in advance of the acquisition will make it hard for VZ to go up for a while.  I also think, however, that downward pressure from potential flowback will abate long before the deal actually occurs.

At some point, an excellent buying opportunity for VZ will emerge from acquisition-related stock activity.  The trick is deciding exactly when.  The most prudent strategy, I think, is to establish a small position and await further developments.