Third time is the charm?

So on this weeks blog I’m going to look at mergers and acquisitions and the current story that caught my attention this week is the LSE and Deutsche Börse deal. These talks aren’t even the first or second time but the third time these two companies have tried to merge together. Below are just three of the problems that LSE and Deutsche Börse will have to deal with in this merger.

This current deal will see the two largest European exchanges working on an all-share “merger of equals”. Is it even possible for mergers to be equal? At present Deutsche Börse is the bigger of the two companies and will end up with 54.4% of the merged company. It will be based in London but will have headquarters in London and Frankfurt.  It’s strange to me that businesses can think that a merger will be completely equal when previous examples have shown that it can’t work. Forbes states that these corporate marriages of equals ‘in which two firms of roughly similar size combine, with neither a buyer nor a target and typically no cash changing hands—account for a disproportionate share of disastrous failures’.  

One examples of the “merger of equals” failing are the union of Daimler and Chrysler. After two years of the merger Jürgen Schrempp managed to see off the former CEO of Chrysler and was the only person running the new company.  The former CEO of Chrysler later stated the term “merger of equals” was just used by Jürgen Schrempp to get Chrysler to merge with him. 9 years after the merge it fell through and the companies went their separate ways. Another failed "merger of equals" was Maurice Lévy with Omnicom. Thus with this is LSE and Deutsche Börse deal really a “merger of equals”?

With the current uncertainty of whether the UK will stay in the EU the present Deutsche Börse CEO has stated “a decision by the United Kingdom electorate to leave the European Union would put the project at risk”.  Both companies believe that whatever the results of the referendum the merger makes strategic sense and wouldn’t be a condition of the merger. However if the UK leave the EU it would have huge effects for the merger and it seems logical that most of the operations would move back to Frankfurt.

Their first failed attempt was back in 2000, where Deutsche Börse were in talks of a merger but the deal was gatecrashed by Sweden’s OM Exchange who tried to gain LSE through a hostile takeover. And this could be a huge worry for this current merger. The ICE and CME may both decide to acquire a key part in the European market; and so they could both place an offer for LSE. As much as these two competitive offers have been rumored, I feel if they decide to bid neither of these two companies will be successful. Merging with a company across the North Sea is a lot more feasible than across the Atlantic with one set back being time zone differences. But if nothing else this could be classed as a pac man defense and will drive up the price Deutsche Börse will pay.

With all of these factors and Jensen and Ruback’s research showing that on average the bidding company makes no gain with a merge is all of this hassle with LSE and Deutsche Börse merger worth it?

Thank you for reading it and I would love to hear your thoughts on the merger.

“Money is a she. She sleeps in the bed with you with one eye open. Next thing you know, she might be gone forever” - Gordon Gekko

So for this week’s blog I spent the evening watching Wall Street- Money never sleeps. Although I’ve never seen the first film, Gekko’s character to me is based on the crooks of the 80’s like Michael Milken who’s insider trading and rigged deals were the fashion back then. After Gekko was sent to prison most people probably  presumed there wouldn’t have been a sequel but 23 years later here we are.

The writer definitely decided to cash in on the 2008 financial crisis and essentially stole the whole movie script from real world events. The film tackles the issues of MBS, CDOs and distressed debt through two Wall Street firms Keller Zabel and Churchill Schwartz  (basically Lehman Brothers/ Bear Stearns and JP Morgan Chase/ Goldman Sachs).

Keller Zabel gets caught with far too much debt, is targeted by merciless short sellers, and runs out of cash within a week. Which leads to meetings at Federal bank, discussions on credit-default swap, collateralized debt obligations and whether the government should bail out banks. Does this all sound familiar? YES!! Because I talked about this exact thing in my blog a few weeks ago discussing the Lehman brothers case. I enjoyed this film when I first watched it in the cinema; that’s why I decided to watch it again for this blog. But this time all I could do was make these comparisons and wondered did the writers actually do any work!?

The comparisons don’t just stop there; Bretton James, the CEO of Churchill Schwartz who comes across as a mix between CEO of JPMorgan and CEO of Goldman Sachs. There is no bigger example of the similarity than the fact Goldman Sachs  betting against the housing market at the same time it was creating mortgage deals; which is similar to what Bretton James was doing in the film.

The area that struck me the most was Gekko’s quotes in the film; "You're all fucked, you’re the Ninja Generation.  No income.  No job.  No assets.” As I suppose I am part of this Ninja generation this worried me. Why are we the Ninja generation? Can I blame the likes of Wall Street? Why are people like Lloyd Blankfein getting away with betting against the housing market, and how can Gordon Gekko get sent to prison for insider trading yet as soon as he is released he starts trading on the London stock exchange (I know Gekko is fictional but  I bet it has happened). 

‘The mental stumbling block, for most Americans, is that financial crimes don't feel real; you don't see the culprits waving guns in liquor stores or dragging coeds into bushes. But these frauds are worse than common robberies. They're crimes of intellectual choice, made by people who are already rich and who have every conceivable social advantage, acting on a simple, cynical calculation: Let's steal whatever we can, then dare the victims to find the juice to reclaim their money through a captive bureaucracy.’

Whilst researching this area I found a great article in The Rolling Stones, which ends with the paragraph above. This article perfectly sums up my feelingsto how they have managed to get away with these financial crimes (article link: http://www.rollingstone.com/politics/news/why-isnt-wall-street-in-jail-20110216).

So after reading this article and watching the film the questions I’m left with this week include:

Are we being too soft with the stock market and financial crimes?

Who's responsible for our NINJA generation? And why are they never called to account?

Thank you for reading please feel free to leave any comments.

The confusing world of dividends

‘The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together’. This a great quote by Fischer Black represents my feelings towards dividends, a company that pays the most dividends is the best on to invest in right? There are so many theories on the correct way for businesses to give dividends it’s hard to see the wood from the trees.

I’m only going to briefly discuss a couple of these theories otherwise I’d probably be able to write a book with them all. The first theory I’ll mention is my two least favorite people I talked about last week Modigliani & Miller and their theory of dividend irrelevance. It completely fathoms me that their theories are still talked about because each one I have come across so far can’t be related into the real world (again this theory doesn’t count tax!!!!) so in reality is completely and utterly useless. Their idea with this theory is that dividends is a residual payment after NPV projects are financed, basically to assume each year a businesses opportunities completely change to the previous year and will fluctuate for good to bad. Thus with this policy shareholders don’t know the level of dividends (if any) they will receive each year.

Now after I’ve just insulted Modigliani & Miller, I’ll just mention the thing I like about this theory. I like that it takes into consideration the fact that paying dividends is wasting money that could be used within the company for R&D. For example Google don’t pay any dividends to their investors and share prices still continuously rise. However people know that when they invest into Google they won’t receive dividends; with M&M’s approach it changes every year and for a shareholder the unknown of what’s coming next sits uncomfortably with most.

The other theory I’ll talk about in this blog post is signaling; this is where investors see dividends as giving information on company’s performance/prospects. Following this theory high dividends= good news and low dividends= bad news.

An example of this theory work is with Barclay’s earlier this week they announced a cut in dividends to put the money towards restructuring and capital resilience. A chief analyst at Cenkos even say’s the cuts are justified for the success of the company in the restructuring. However investors have seen this slash as a negative and thus led to share prices falling by 8%. This situation is proving that signaling is used in the market and even with analyst saying that this cut is helping build the future of Barclay’s, investors have automatically taken the slash as there must be bad news coming soon.

However an example of this working against the investor is last summer BHP Billiton announced their worst profits in a decade but still increased their dividends by 2%. This lead to the share price rising 5.5% this looked like BHP Billiton was sending the signal of ‘don’t worry we will turn things around’. In reality they were up shits creek without a paddle and have now scrapped dividends. BHP Billiton’s example shows how signaling can be manipulated to give a certain impression of the company.

So back to the question that Fischer Black’s quote left me with, I don’t necessarily think that the bigger the dividends the more successful the company is. I believe that a lot of shareholders have an extremely short-term view when it comes to investment and businesses try to appease this. Taking the dividends might seem great at the time but surely receiving a smaller dividends, letting the company spend some of that money within the business and in the long term having a greater return on the share price is better. Companies that pay’s higher than average dividends leaves me with a question of why aren’t they investing that money?

It’s a hard area making sure the company has the correct dividends policy, the main thing to remember with these theories is non of them are mutually exclusive and so a business can use a mix to find the best policy for themselves.

Thank you for reading my ramblings please feel free to leave any comments.

Are Modigliani and Millar right?

In 1958 Modigliani and Millar came up with this great proposition that the market value of a company is independent from its capital structure. And thus capital structure has no impact on WACC.

Modigliani and Millar are clearly very clever guys so why in 1958 did they leave taxation out of their work? They clearly knew that all countries change some type of corporation tax. Not only did they presume there is no taxation amongst other things they also said there are perfect capital markets. These things clearly didn’t help prove if their theory would work in the real world.

Unsurprisingly they revisited their findings and changed it in 1963, but yet the only change they made was add taxation. However by only this small difference by adding tax led to Modigliani and Millar theory changing dramatically! Because debt is a tax-deductible expense, which can be offset against profits; thus increasing debt decreases WACC but increases shareholder wealth. Furthermore in the 1963 theory it then goes on to state that to deal with an increasing WACC a company should become highly geared.

This is where my levelheaded mind kicks in as increasing and increasing a company’s debt doesn’t sit well with me. Surely there becomes a point if a company is doing this where they can’t pay the debt installments and don’t have any more assets to put against a loan. Higher levels of debt to equity increase the likely hood of bankruptcy!! Which surely would lower the value of the business? If I were a shareholder in that company I would be running for the hills or they would have to prove to me it is worth staying with a greater rate of return.

The examples are endless of businesses following M&M’s theory of increasing their debt didn’t work out well for them.

Firstly Samson missed its debt payment last August, which lead to the company declaring themselves bankrupt after racking up $3.25 billion in debt. Understandably being in the oil business Samson would have a certain level of debt with the oil industry having extremely high costs. But acquiring the amount of debt they had meant when the oil and gas prices dropped, profit reduced and they couldn’t pay their debt payments. They then had to put forth a plan that would hand equity in the restricted company to junior leaders who in return would forgive the $1 billion in debt they hold.

Another company from last year is American Apparel a successful company but again ran up debts and it went wrong to the point where their shares crashed and they have had to file bankruptcy. The company has had to agree to sell off $200million to their creditors in a debt to equity swap.

Other examples include AIG debt leading to the getting bailed out, Afren who defaulted on payments and the documentary RBS: Inside the Bank that ran out of money says it all again. A business has to have a rainy day fund; you need cash in the bank!!

I understand that debt is a good way to finance a business and having a reasonable amount of debt that a business can keep on top of is good. For the life of me I just don’t see why a business would want to pile the debt on themselves to follow M&M’s theory which has too many assumptions.

After writing this article though I am left with one question what is a reasonable amount of debt for a business?

Thank you for reading; please feel free to write any comments