Tag Archives: finance

the Tesla (TSLA)/SolarCity (SCTY) merger

August 2, 2016 By in mergers and acquisitions, Uncategorized Tags: , , , , 1 Comment

Yesterday, TSLA and SCTY announced the two firms had reached agreement for TSLA to acquire SCTY in an all stock deal.  TSLA will exchange .11 shares of its stock for each share of SCTY, with closing sometime before yearend.  SCTY has 45 days to shop for a better offer.

Most commentaries I’ve read seem to miss two things:

–the original TSLA proposal said it anticipated an exchange ratio of between .122 and .131 to one, subject to closer examination of SCTY’s books.  The purpose of the range, as I see it, was to put a ceiling on what TSLA would pay for SCTY, no matter what good things it found on closer inspection.

Well, the opposite has happened.  The actual offer falls 10% below the lower bound, suggesting that SCTY looks considerably less great on the inside than its public financials would suggest.

–the combined entity, despite anticipated administrative/marketing savings of $150 million a year, assumes it will need to make an equity financing next year.

 

Overall, however, I think this is a good deal for SCTY.  Although I have traded the stock from time to time, the one thing that has always bothered me about SCTY is its stepchild status in the Elon Musk empire.  I say stepchild because TSLA, not SCTY, owns the Gigafactory, which will supply state-of-the-art batteries to SCTY.  To me, this signaled that TSLA was in the heart of the Elon Musk empire and that SCTY was on the periphery.  The merger changes that.

three ways to account for associated companies

July 27, 2016 By in Accounting, Nintendo, Uncategorized Tags: , , , , , , , 1 Comment

This post is to lay the groundwork for understanding what Nintendo actually said about Pokemon Go last Friday.

There are three basic ways to account for companies that a firm owns an interest of less than 100% in another firm.

–the cost method.  This is used when the firm whose financial reports we’re talking about has neither influence nor control over the operations of the enterprise held.  A good rule of thumb is that this means a holding of less than 20% of the outstanding shares.

In this situation, the holding is listed on the balance sheet as a long-term investment at acquisition cost.

Under normal circumstances, the income statement contains no accounting of the holding’s financial results.

Two exceptions:  dividends paid are recorded as income; if the asset is impaired, the loss is shown on the income statement.

On the other hand, if the value of the holding increases, there’s no reflection of this in the owner’s financials.  Yes, accounting theory says the holding value should be adjusted periodically for changes in the investment’s fortunes, but as a practical matter this is rarely done.

—equity interests.  This is where the holding firm is judged to have influence but not control over the entity held.  Typically, this applies to holdings that fall between 20% and 50% ownership of the investment.

If so, the owner records his share of the financial results of the holding on a single line toward the bottom of the income statement.  This line is called “Equity Interests” or something like that and is an after-tax aggregate of all such equity interests.

The holder also adjusts the balance sheet value for profits (up), losses (down) and dividends received (down).

—consolidation.  This is the case where the holding firm exercises influence and control.  The rule of thumb here is that ownership of 50% or higher implies having both.

If the ownership is less than 100%, the consolidating company still reports results–revenues, costs etc.–from operations as if it owned 100%.  But it add correcting, after-tax entries, both in the income statement and on the balance sheet, typically labelled “Minority interests” that subtract out the portion of earnings and assets held by others.  Again, these are aggregate figures and not broken out holding-by-holding.  Minority interests are usually recorded toward the bottom of the income statement, somewhere near the consolidated net income line.

Tomorrow, how this applies to the Nintendo announcement

 

mutual fund and ETF fund flows

July 21, 2016 By in ETFs Vs. Mutual Funds, mutual fund holders and financial advisors, Portfolio management, Uncategorized Tags: , , , , , , 2 Comments

away from active management…

There’s a long-term movement by investors of all stripes away from actively managed mutual funds into index funds and ETFs.  As Morningstar has recently reported, such switching has reached 2008-era levels in recent months.  Surges like this have been the norm during periods of uncertainty.

The mantra of index proponents has long been that investors can’t control performance, but they can control costs.  Therefore, all other things being more or less equal, investors should look for, and buy, the lowest-cost alternative in each category they’re interested in.  That’s virtually always an index fund or an ETF.

Active managers haven’t helped themselves by generally underperforming index products before their (higher) fees.

…but net stock inflows

What I find interesting and encouraging is that stock products overall are receiving net inflows–meaning that the inflows to passive products are higher than the outflows from active ones.

why today is different

Having been an active manager and having generally outperformed, neither of these negative factors for active managers bothered me particularly during my investing career.  One thing has changed in the current environment, though, to the detriment of all active management.

It’s something no one is talking about that I’m aware of.  But it’s a crucial part of the argument in favor of passive investing, in my opinion.

what is an acceptable net return?

It’s the change in investor expectations about what constitutes an acceptable net return.

If we go back to early 2000, the 10-year Treasury bond yield was about 6.5%, and a one-year CD yielded 5.5%.  US stocks had just concluded a second decade of double-digit average annual returns.  So whether your annual net return from bonds was 5.5% or 5.0%, or whether your net return from stocks was 12% or 11%, may not have made that much difference to you.  So you wouldn’t look at costs so critically.

Today, however, the epic decline in interest rates/inflation that fueled a good portion of that strong investment performance is over.  The 10-year Treasury now yields 1.6%.  Expectations for annual stock market returns probably exceed 5%, but are certainly below 10%.  The actual returns on stocks over the past two years have totalled around 12%, or 6% each year.

rising focus on cost control

In the current environment, cost control is a much bigger deal.  If I could have gotten a net return of 6% on an S&P 500 ETF in 2014 and 2015, for example, but have a 4% net from an actively managed mutual fund (half the shortfall due to fees, half to underperformance) that’s a third of my potential return gone.

It seems to me that so long as inflation remains contained–and I can see no reason to think otherwise–we’ll be in the current situation.  Unless/until active managers reduce fees substantially, switching to passive products will likely continue unabated.  And in an environment of falling fees and shrinking assets under management making needed improvements in investment performance will be that much more difficult.

 

takeovers and market price indications: Softbank/Arm Holdings

July 20, 2016 By in mergers and acquisitions, Risk Arbitrage, Uncategorized Tags: , , , , , , 1 Comment

Softbank is bidding £17 per share for ARM, an offer that management of the chip design company has quickly accepted.  ARM closed in London at £16.61 yesterday, after trading as high as £17.52 in the initial moments of Monday trading–the first time the London market was open after the bid announcement.

What is the price of ARM telling us?

Let’s make the (reasonable, in my opinion) assumption that the price of ARM is now being determined by the activity of merger and acquisition specialists, many of whom work in companies mainly, or wholly, devoted to this sort of analysis.

These specialists will consider three factors in figuring out what they’re willing to pay for ARM:

–the time they think it will take until the takeover is completed (let’s say, three months),

–the cost of borrowing money to buy ARM shares (2% per year?) and

–the return they expect to make from holding the shares and delivering them to Softbank.

They’ll buy if the return is high enough.  They’ll stay on the sidelines otherwise.

Suppose they think that without any doubt the Softbank bid for ARM is going to succeed–that no other bidder is going to emerge and that the takeover is going to encounter no regulatory problems (either delays or outright vetoing the combination).  In this case, the calculation is straightforward.  The only real question is the return the arbitrageur is willing to accept.

I haven’t been closely involved in this business for years.  Although I know the chain of reasoning that goes into determining a potential buy point, I no longer know the minimum an arbitrageur considers an acceptable.  If it were me, 10% would be the least I’d accept if I thought there were any risk;  5% might be my lower limit even if I saw clear sailing ahead.  If nothing else, I’m tying up borrowing power that I might be able to use more profitably elsewhere.

Let’s now look at the ARM price.

At £16.61, ARM is trading at a 2.3% discount to the offer price.  An arbitrageur who can borrow at 0.5% for three months stands to make a 1.8% return by buying ARM now.  Ugh!  The only way to make an acceptable return, if the assumptions I’ve outlined above are correct, is to leverage yourself to the sky.

 

From this analysis, I conclude two things:

–the market is not worrying about any regulatory impediments to the speedy conclusion of the union.  Quite the opposite.  Otherwise, someone would be shorting ARM.

–buyers seem to me to be speculating in a very mild way that a higher bid will emerge.  If they had strong confidence in another suitor coming forward, the stock would be trading above £17.  If they were 100% convinced that there would be no new offer, I think the stock would be trading closer to £16.25, a point which would represent an annualized 20% return to a purchaser using borrowed money.

 

 

 

the business of money management vs. the craft of portfolio management

June 21, 2016 By in Constructing a Portfolio, Portfolio management, Uncategorized Tags: , , , , Leave a comment

Charles Ellis once famously wrote that the average portfolio manager is just that–average.  This is an observation that, however true, still grates with me.  But it really doesn’t explain what is commonly believed that it does, namely, why average performance by experienced professional investors virtually always falls short of benchmark target.

I think there’s another explanation for the latter.

It’s that money management firms assume clients prefer a warm and fuzzy working relationship with a financial adviser over strong investment performance.

In a sense it’s only natural that firms should think that way.  Most are run by the head marketer, with the head investor having the CIO (Chief Investment Officer) title and has little to do with strategy (this is the same jocks vs. nerds issue that has the traders controlling Wall Street firms, not the analysts). And the conclusion was probably also correct until about a decade ago.

In practical terms, the thinking went like this:

–why hire an extra analyst, even if that would mean a higher probability of matching our index vs. falling, say, 50 basis points below it?  Better to hire an extra marketer who can bring in more assets.  After all, we earn our fees based on a percentage of assets under management, not on outperforming, and our clients don’t care anyway.

–similarly, why cap the assets our star managers manage at a level where they’re more certain of outperforming?  If they manage 2x or 3x as much, they may be forced into buying larger-cap stocks than they’re comfortable with, and the chances of their beating their benchmark may be lessened by their lack of maneuverability.  The answer: clients won’t notice that, either.

However, clients have noticed    …and are leaving active managers in droves.

More tomorrow.