Monthly Archives: June 2016

thinking about Brexit

June 9, 2016 By in Brexit, EU financial crisis, Uncategorized Tags: , , Leave a comment

In two weeks, on the 23rd, the UK will vote on whether to remain in the EU or leave.  Polls show that the leave forces, which were once in the minority, have pulled to just about neck and neck with the remain camp.  One caveat:  I don’t know enough about the national mood in the UK to have a view about whether citizens are likely to reveal their true intentions to pollsters, which is always an issue with controversial topics.  My sense is the leave camp is populated with the same left-behind-by-globalization people as in the rest of the world, who dream that a return to a semi-mythical isolationist past will solve all their problems.

Britain has never been in favor of the ultimate “United States of Europe” destination for the EU project, which imagines an ever-closer union to mimic, and counter, the political/economic power of the US.  Because of this, some have argued (incorrectly, in my view) that a vote to leave will be a long-term political plus.

As investors, though, our task in understanding the implications of a possible Brexit is simpler:  what are the implications of Brexit for publicly traded firms doing business in the UK?

I see two, both negative:

–over the course of the past decades, many non-EU multinationals have decided to make the UK their base of EU operations.  The UK offers a large potential workforce, English as the national language and a legal system less strongly tilted to favor locals than is the case elsewhere in the union.  Also, of course, being inside the EU frontier, the UK is not subject to the tariff and red tape barriers that outsiders might face.

A “leave” vote on Brexit eliminates this last advantage.  At the very least, a period of uncertainty would follow until new trade, travel…agreements are negotiated.  These are unlikely to make the lot of the UK better–the question is how much worst things will be.  For companies without extensive manufacturing in the UK, the best solution may be not to wait but to decamp to, say, Ireland as fast as possible.

–the UK is by a mile the financial capital of the EU.  Same reasons as for multinationals in general.  In addition, the UK pursued a “regulation lite” policy to lure financial firms to its shores in the runup to the banking collapse of almost a decade ago.  (One result of that regrettable policy is that much of the highly unethical behavior of US and foreign banks that led to the financial meltdown, and which would have been against the law elsewhere, was technically ok in the UK.)  Post-Brexit, these firms would be on the outside looking in.  New EU banking policies would determine their fate.

 

My overall guess is that the UK leaving the EU would be bad economically for both sides–although the effect might well be lost in the general malaise (aging populations, generally weak government finances, hometown-favoring legal systems) that characterizes the EU today.  Subsequent action by EU policy makers to favor, or not, exports from the UK (which make up almost half of Britain’s total exports) will determine how badly UK-based multinationals will be hurt.  In the meantime, absent large falls in their stock prices (my guess is that 10% declines, a figure I plucked out of the air, will be the norm), I don’t imagine the firms in question will be drawing much favorable investor interest.

oil at $50 a barrel

June 8, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , , , , , Leave a comment

It has been a wild ride.

Crude began to run up in early 2007.  It went from $50 a barrel to a peak of around $150 in mid-2008.  Recession caused the price to plunge to $30 a barrel late that year.  From there it began a second, slower climb that saw it break back above $100 in early 2011. Crude meandered between $100 and $125 until mid-2014, when increasing shale oil production from the US caused supply to outstrip demand by about 1% – 2% a year.  That was enough to cause a second slide, again to $30, that appears to have ended this February.

Since then, the price has rebounded to $50 a barrel, where it sits now.

To recap:  $50, then $150, then $30, then $125, then $30, now $50.

Where to from here?

We know that supply remains relatively steady, with additions to output from the Middle East offsetting falls in US shale oil liftings caused by lower prices.  We also know that lower prices have stimulated consumption.

The past eight years have also shown us that crude can have exaggerated reactions to small shifts in supply and/or demand.  So, in one sense, no knows what the crude oil market will do next.

On the other hand, we can set some parameters.

–the first is psychological.  The oil price has fallen to $30 a barrel twice in the last eight years.  The first was in the depths of the worst recession since the Great Depression.  The second was during a period of general market craziness earlier this year (caused, I think, by algorithms run amok).  I think it’s a reasonable assumption that prices will have a difficult time getting that low again–and if they do that they won’t stay there for long.

–the second is physical, and is about shale oil.  Overall shale oil output in the US is now shrinking.  Firms still pumping out shale oil are of two types:  companies being forced by their banks to sell oil to repay loans; and companies whose costs are low enough that they’re making a reasonable profit at today’s prices.  Cash flow from the first group is by and large going to creditors, so this output will diminish as existing wells are tapped out.  That’s probably happening right now, since shale oil wells typically have very short lives. This means, I think, the question about when new supply comes to market–putting a cap on prices, and perhaps causing them to weaken–comes down to when healthy shale oil firms will uncap existing, non-producing wells, and/or begin to drill new ones in large enough amounts to reverse the current output shrinkage.

I’m guessing–and that’s all it is, a guess–the magic number is $60 a barrel.

My personal conclusion, therefore, is that the crude price may still have a gentle upward bias, but that most of the bounce up from $30 is behind us.

 

 

 

Dell’s buyout underpriced;T Rowe Price’s costly mistake

June 7, 2016 By in takeover rules, Uncategorized Tags: , , , , , 1 Comment

the Dell leveraged buyout

Three years ago, Michael Dell decided to take the company he founded private in a leveraged buyout.  Last week, the Delaware Chancery court ruled that the buyout price was woefully low.  It said that a fair offering to shareholders would have been $17.62 a share (how precise!), not the $13.75/share actually paid.

Dell does not have to compensate many former shareholders, however.

What’s this all about?

Delaware rules

Most US companies are incorporated in Delaware, where the rules are well-tested and generally favorable toward business.  In Delaware, if holders of 90% of the outstanding shares of a takeover target accept the acquirer’s offer, the remaining 10% can be forced to do so, too.  Other US states and other countries may have different thresholds, but they also typically have similar rules to eliminate potentially bothersome small minority holdings.

Minorities aren’t completely without rights in Delaware, however.  They are allowed to refuse the offer and appeal the valuation in court.  This is a long and expensive procedure–three years in the Dell case.  At the end of the day minorities are not allowed to keep their shares.  The issue is solely about the price they get for selling them.  (Shareholders who are in the 10% because they don’t vote, or who don’t participate in the lawsuit, just get a check in the mail for the original takeout price.)

This is what happened with Dell.  It’s also the reason that Dell only has to compensate those who sued.  The vast majority of former Dell shareholders freely accepted a takeover offer that we now know was way too low.

T Rowe Price 

The money management firm’s internal analysis was that the Dell offer was inadequate.  It also appears to have taken part in the suit.  But the firm somehow made an administrative error in 2013 and voted to accept the Dell offer, not to protest the valuation.  The court ruled that T Rowe Price is stuck with that decision, even if it intended to do the opposite.  So it won’t benefit from last week’s ruling.  In fact, it is going to have to figure out how to pay people who owned funds containing Dell shares the $194 million they would have had, were it not for the voting mistake.  This will likely be a real pain in the neck, since it involves clients from three years ago, who may not sill be holding the funds affected.

 

the weak May Employment Situation report

June 6, 2016 By in employment, Employment Situation report, Uncategorized Tags: , , , , Leave a comment

the Employment Situation

Last Friday morning the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report for May.

The numbers were weak.

–According to the ES, the economy gained a net +38,000 new jobs last month.  This compares with economists’ estimates of over 100,000.

–Revisions to the prior two months’ data were both negative, together totaling -59,000 positions.  So government estimates of the number of people at work in the country actually fell for the first time in a long while.

mitigating factors

specific

About 35,000 Verizon workers were on strike during the month, a walkout that has since been settled.  That number was a subtraction from the May total.

The winter was unusually mild in populated areas of the country.  This suggests that some seasonal workers normally hired in the spring went to work earlier in the year.  One economist I saw estimates that factor might have shifted +60,000 job gains away from May. This isn’t a huge comfort, however, since, if we believe this, it implies that the favorable employment figures from earlier in the year are a little suspect as well.

general

Each month well over 3 million Americans get new jobs and an almost equal number leave their employment. The monthly job gains/losses are the difference between these two large figures.  Because of this, Labor Department statisticians say the figures are only accurate +/- 100,000 jobs.  Of course, no one brings this up when the figures are unusually good.

implications

The S&P 500 fell about three-quarters of a percent on the news, before rallying to close down by 0.29%–meaning Wall Street (correctly, in my view) isn’t concerned.

The Fed?  I don’t think the ES will make any difference, although the coming rise in the Fed Funds interest rate may be postponed until next month.

 

 

 

 

Apple (AAPL) and Time Warner (TWX)

June 3, 2016 By in mergers and acquisitions, Uncategorized Tags: , , , , , , Leave a comment

I read in the Financial Times recently that late last year AAPL approached TWX with the idea of buying it.  This follows on the heels of an announcement that AAPL has invested $1 billion in a local rival to Uber in China.

What ties the two moves together is that both are substantial deviations from the production of tech hardware, which is AAPL’s professed core business.  The Didi Chuxing move is a drop in the bucket, however.  The price tag for TWX would amount to perhaps 20% of AAPL’s market cap of $527 billion.  That would be a transformative acquisition.

What does this activity mean?

APPL generated about $40 billion in cash flow during the first six months of fiscal 2016 (its fiscal year ends in September).  All but $5 billion of that amount went, as usual, into the company’s holdings of cash and marketable securities, which now tops $230 billion. That’s almost a quarter of a trillion dollars, and represents almost half of AAPL’s market capitalization.

Sales of the iPhone are beginning to slow.  The worldwide market for smartphones is saturated, for all but the cheapest models.  So all vendors, including AAPL, are increasingly reliant on replacement demand.  This means smartphones, by far the largest part of AAPL’s business, won’t in the future show anything like the spectacular growth of the past.

This is not exactly news.  AAPL shares are down by 25% over the past year, while the S&P 500 is roughly unchanged.

To remain a growth stock, AAPL has to reinvent itself.  It has already done this twice, with the iPod and the iPhone.  This time, however, management appears to be conceding that there’s no obvious, internally developed way for it to move forward. A related issue: as currently configured, AAPL has no way to reinvest the enormous amount of cash on its balance sheet.

AAPL has apparently concluded that it needs to buy something, or somethings, that will significantly change its character.  The TWX news signals it is prepared to act (who leaked the story, about a half year after the approach?  Why now?).

The possibility of one or more large acquisitions adds a risk element not previously present with AAPL.  On the other hand, the idea that, ex acquisitions, the company will slowly begin to resemble a certificate of deposit isn’t exactly appealing, either to outside investors or to employees holding stock options.  And the sharp drop in the shares over the past 12 months must already discount something, as does a PE of around 10.

What to do?

As for me, I don’t own AAPL shares now and haven’t owned them for a long time.  If I did, I’d probably be intensifying my search for new names, with the intention of using my holding as a source of funds.