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Tag Archives: money
question from a reader: the merger of Alpha Natural Resources and Massey Energy
the question
24.149.88.16
Submitted on 2011/09/22 at 3:39 am
I listened to a debate recently on the merits of small commodity companies
acquiring larger ones. The company in question was Alpha Natural Resources purchasing much larger Massie Coal.
Can a smaller commodity company like ANR actually make the investment finacially feasible when they bought a company that was already foundering?
I enjoy your blog greatly!
my thoughts
At the outset, you should be clear that, although I’ve done extensive research in natural resources over the years, I don’t know much about the coal industry. So personally I don’t know enough to want to buy ANR stock. But I can see several issues a buyer might want to explore.
background
ANR, which has private equity roots, was formed in 2002 to buy assets from Pittston Coal and has since growth by acquisition. Its largest purchase to date is Massey Coal, a 2000 spinoff from Fluor. It bought Massey in June 2011 for about $1 billion in cash plus just over 100 million shares of ANR stock, worth $5 billion+ at that time.
By revenues, both are roughly equal in size. Mine output seems to be similar as well, with 5/6 thermal coal for power generation and 1/6 higher-value coking coal for blast furnace steel making.
Massey is the owner of the Upper Big Branch Mine in West Virgina, which experienced the worst domestic coal mining disaster of the past forty years on April 5, 2010. A methane gas explosion there killed 29 miners.
Since the Massey takeover, ANR shares have lost about 60% of their value. Part of this is due to general selloff of commodity stocks on worries about economic slowdown, part to former Massey shareholders cashing in their profits, part to ANR’s announcement in September that sales volumes will be lower than expected.
merger issues
My experience is that there are two types of risk in a merger like this:
–Are Massey’s safety problems confined to this one mine, or has that company been cutting corners to increase profits of other mines as well? Certainly, industry gossip may provide clues. But until ANR actually analyzes the Massey properties one by one in detail, it won’t know for sure. Aside from the human issue, the question is whether ANR will have to make substantial capital investment to get the Massey mines functioning properly. In other words, are the Massey properties actually less profitable than they appear to outsiders?
–Does ANR have the management depth to run an enterprise twice its former size. It may be able to rely on the former Massey management. But suppose they just refuse to do what ANR wants? Sounds silly, but culture clash is a significant risk. The risk going in is much higher when there’s evidence of badly-run operations.
In addition, is the ANR management composed of deeply knowledgeable and experienced coal miners? …or is it basically a financial company doing a “rollup,” that can make generic efficiency improvements but entrusts the actual operation of the business to others? I don’t know.
–One positive thing. The combination was done mostly for stock. So increased financial leverage isn’t a risk.
specific questions
A quick look at Value Line shows that ANR achieves only about half the operating margin of the VL coal industry. Why?
My guess is that coking coal may be as much as a third of ANR’s profits, although only about 1/6 of volumes shipped. At least some of that goes to China. If so, have recent profits been inflated by flooding and transport problems in Australia? How long will that advantage last?
more on “discounting”
discounting
“Discounting” is the jargon that Wall Street uses to describe the process of factoring changes in consensus beliefs about future happenings into today’s stock prices. I’ve outlined the basics of discounting in an earlier post.
fundamental vs. technical analysis
Fundamental analysis, the study of company-specific and economy-wide economic and financial information, and technical analysis, the study of charts, can be seen as two approaches to discounting. In the first case, researchers try to figure out what information is most important for making a security’s price go up or down, and then actively search for relevant data. In the second, investors study chart patterns as a way of figuring out what fundamental analysts are doing and then riding on their coattails.
the internet
The internet has changed the amount, quality and cost of information in dramatic fashion. For example:
–When I was building an international equity investing organization for a major financial institution in the early 1990s, it cost about $300,000 a year in today’s dollars to get access to all corporate SEC filings. The data came on microfiche and was available about six weeks after the documents were filed. Today, the information is free on the SEC’s Edgar website; documents are available the instant they’re filed (companies do this electronically).
–Thanks to regulation FD (Fair Disclosure), company presentations are routinely webcast and are available through the company website. Typically, they’re archived for at least a year. True, breakout sessions at conferences, small group meetings or one-on-ones aren’t, but these mostly serve to fill in the blanks for analysts not familiar with a firm. Companies may sound like they’re revealing new information, but they’re not.
–A Bloomberg terminal still costs $30,000-$50,000 a year, depending on its capabilities. But discount brokers offer most of what an individual investor needs to their customers on their websites for free.
discounting and Greece
Discounting isn’t a one-time event. It’s a process.
1. For one thing, what’s painfully obvious to a seasoned observer or an industry specialist may only dawn on the average investor a considerable time later.
2. Also, bad news that relates to a specific event is typically not fully discounted until the event occurs–no matter how far in the future that may be. The financial crisis in Greece is a good example.
A year ago, a new administration in Athens revealed that the country had been falsifying its national accounts for many years. Greece had taken in less in taxes and also spent a lot more than it had ever revealed. How so? Its membership in the EU had allowed it to borrow much more than it could ever repay.
For at least six months, it has been clear that either the rest of the EU will be forced to pick up the tab and let Greece remain in the EU, or that Greece will default and lose its EU membership. In default, holders of Greek sovereign debt would lose most of their money. But, since that’s mostly big EU banks which might need government bailouts as a result, the effect is basically the same. EU taxpayers ultimately foot the bill.
Over recent months, however, EU stock markets–and the financials, in particular–have been subject to periodic waves of selling, driving prices ever lower, as investors express their fears about Greece. …despite the fact that in general terms everyone has already read the closing chapter of the story.
This pattern of discounting the same news over and over again is typical. It begins in denial (inadequate discounting) and may end in despair (overdiscounting), the same emotional pattern that shapes a bear market. While bear markets end in a whimper sometimes, however, discounting that anticipates a discrete event usually involves a final selling bout as the event actually occurs.
Over the weekend, the G-20 seems to have given the EU an ultimatum to resolve the Greek crisis quickly. We’ll see tomorrow how the markets react.
the current selloff
concrete signs of slowdown are emerging
A few days ago, Rio Tinto, the giant Melbourne/London mining conglomerate, said some Western customers (European?) are asking the company to delay shipment of contracted amounts of industrial metals (how this works financially is an interesting, semi-complex topic, but irrelevant here) . FedEx announced this week that orders for airfreight shipment to the US, the EU and Japan are losing momentum as customers opt for slower and cheaper ways of getting their products into retail outlets.
In other words, for the first time in two years +, some firms are beginning to worry about having too much inventory and to work it down. In one sense, this isn’t good. But it had to happen eventually. And the equity markets have been discounting this development since July. After all, FDX has lost a third of its value in the past three months; RIO has been clipped by 37% over the same span.
So this is not really news. And as FDX said, customers’ hair isn’t on fire. They’re just being a little cautious.
the real problem is in the EU
There, a modern version of the Iliad, sans Helen, seems to be playing out, with France and Germany taking the role of Troy and, well …Greece in the role of Greece.
In a nutshell: the EU let Greece in about a decade ago, even though it didn’t really qualify, giving it unrestricted access to EU credit. Greece promptly borrowed (and spent) a gazillion times what it could ever repay, funded ultimately by the ever hapless financial institutions of Germany and France. Greece says it’s sorry and will change its ways–but is actually doing very little. It seems instead to be milking the situation for the best possible terms for default, or perhaps just for more time at the EU credit trough–which, I guess, is what almost anyone would do in their situation.
On the other hand, German politicians are on the horns of a dilemma. They either fund a Greek bailout, in which case they’re tossed out of office, or they let Greece default and destroy their banks. And they’ll be thrown out of office again. So they don’t want to act, either. Arguably, this is also their best strategy (short of actually doing their jobs and fixing things).
Having endured this stalemate for about a year, the nerve of European investors seems to me to have finally cracked. They’re selling anything not nailed down in a classic panic. The rest of the world is being dragged along for the ride.
If there’s silver lining to this, financial market panic may provide the political cover the EU needs to stop procrastinating and begin to act.
three stock market scenarios
I’ve sketched this out in a little more detail in Current Market Tactics this month and last.
I have three targets for the S&P over the coming year, depending on economic circumstances:
nothing wrong (hah!) 1350
muddling through 1170
recession ahead 1000.
I still think that muddling through is by far the most likely outcome. If so, 1170 would be the central tendency around which Wall Street will revolve. Panic aside, if an investor thought he would need a 7% return in order to be induced to take the risk of owning stocks, then he should be a buyer at an index level of 1090. That’s about 3.5% below yesterday’s close. Below that any selling, which I already regard as overdone, would enter into another, higher, level of craziness.
The main item on our wish list should be market stabilization.
what to do
My thoughts haven’t changed very much.
When we get to the other side of the current storm, I think the winners will be firms with Asian exposure, participants in technology-based change and companies that serve the affluent. At some point it will be right to trade your TIF in for WMT (I own the first but not the second), but not anytime soon.
If you can force yourself to get out from under your desk and witness the carnage, look for ways to upgrade your portfolio. When selling starts, it may be rational at first and the weakest stocks get sold off first. But then the selling often takes on a life of its own. When panic sets in and the bad-stock ammunition runs out, good stocks get thrown out the window at crazy prices as well. Why? That’s all that’s left to sell. No other reason.
My stocks got really whacked on Thursday, so I guess I’ve got to think that we’ve entered the latter phase.
Under the desk (or the bed) is sooo much more comfortable at a time like this, but my experience is that you’ve got to force yourself to at least analyze what’s going on.
If you can’t do this, or if you know you’d just do things you’d regret later–and you know your psychological makeup better than I do–find a good book.
By the way, in my view the current selling has nothing to do with year-end mutual fund housecleaning.
discounting
I want to add something about the discounting mechanism, but I’ll save that for Sunday.
Netflix and the art of raising prices
NFLIX, from afar
I don’t know NFLX well, other than as a user of its products. I’m still annoyed at myself for not having bought it two years ago. But I haven’t been motivated to do the work I’d need to own it, so I mostly just watch the price as a barometer of the market’s feelings about growthy, techy consumer stocks.
Clearly, the recent plunge from the $300+ high to the current $130 runs sharply counter to the experience of most consumer-oriented secular growth names (more about this tomorrow).
the recent price increase…I know that the company has other issues. I have no opinion, positive or negative, about the stock. I just want to make a comment about the mess that the company made about the price increases it recently announced. My take is that the move is actually a good thing. The way NFLX went about it, however, shows a stunning lack of basic management skill.
…is a good thing…
Why good? Yes, there are some cases where consumers actually want to pay more for an item–like buying an $8,000 Hermès handbag– to display their wealth or sophistication. This isn’t one of them. So for NFLX raising prices inevitably means losing customers. There’s no way around that.
If the early returns are reliable, however, upping prices by 15% has lost the company 4% of its subscribers. Revenues are still at least 10% higher than they would otherwise have been. And NFLX can presumably build from there. Also, customer defections, relative to the company’s expectations, have been concentrated in users of DVDs only, the segment that NFLX wants to de-emphasize.
…done in awful fashion
Top management of most consumer companies spend a great deal of time thinking about prices.
They know that there are tipping points where regular customers of the products/services may dramatically slow down usage if the price exceeds a certain level. They also know that these points are virtually impossible to predict in advance. In the casual restaurant business, for example, a venue with a $17 per person average check may have diners lining up all around the block. An $18 per person check-less than a 6% difference, on the other hand, may translate into lots of empty tables.
They also know that any really visible price rise–one that forces the consumer to think about how much he’s actually paying in total–is particularly perilous. As NFLX has found out the hard way, $8-$10 a month isn’t that significant for its customers. An extra $2, or the choice of remaining at the old price for a lower level of service, is. It focuses attention on the fact that NFLX can cost $150 or more a year. And, of course, there are probably a certain number of people who don’t use the service but have forgotten to remove the fee from the recurring payments on their credit cards.
As well, higher prices not only can spur customers to look for substitutes; they can provide a pricing umbrella under which rivals can prosper.
Also, techy things typically don’t go up in price. They either stay the same for a new model that’s a lot better, or they go down. As a result, for NFLX any price rise comes as a shock.
NFLX appears to have been completely clueless.
what could NFLX have done instead?
Remember, I haven’t studied NFLX closely, but there are a at least a couple of tried-and-true marketing tactics that companies use to raise prices. For example:
—new and improved. Companies often offer additional features–better content, preferred access, faster access, a wider selection, other stuff you may not need/want–as at least a psychological justification for customers paying more.
—a program of small but steady price rises. To eliminate sticker shock.
—a public relations campaign in advance, interviews in the media, or communication with customers, to explain the economic necessity for raising prices.
–more conservative guidance. This may simply have transferred the negative Wall Street reaction to the earlier point in time when NFLX gave guidance, rather than when the company lowered it. But it would have suggested that NFLX has a better feel for its customer reaction to higher pricing.
where to from here?
The Wall Street analysts’ earnings consensus for NFLX for 2011 is about $4.50 a share, meaning that the stock is trading at slightly under 30x current profits. While the stock doesn’t appear cheap to me, the company does appear to be growing at a pace much faster than 30%, even after its current stumble.
I think a buyer has to believe two things:
–that NFLX will continue to grow profits at 30%+ for as far as the eye can see, and
–either that management has made an isolated mistake, or that having sharp people at the top isn’t crucial to the company’s success.
The company is presenting at a conference today. We may get more input from that.