Lehman Brother's Crash

The collapse of the Lehman Brothers happened over seven years ago, I’m surprised this could happen to one of the world’s largest banks! I watched the ‘The Last Days of the Lehman Brothers’ documentary which definitely gave me more of an understanding in what actually happened. The Lehman Brothers was a huge bank, they had 25,000 employees.

The investment bank overstated the value of their assets, deliberately, such as the collateralised debt obligations (CBO’s). This, along with the issues of subprime mortgages in the US gave Lehman Brothers a $25 billion debt which they definitely did not see coming!

This is a huge amount of money to have not noticed. So when they finally noticed this sizeable gap, they had to write down their commercial real estate assets by $7 billion, from $40 billion to $33 billion. Bit of a difference. The bank’s rating was also downgraded, not a good time for Lehman Brothers. But did they learn from that? Not really. They actually just continued doing what they were already doing, without making any real changes, until it became a huge problem. (Even more huge than $25 billion of debt).

There were other companies that got themselves into difficulties, along with Lehman Brothers. AIG, the global insurance giant was one of these companies. They were trading in credit default swaps, but again mortgages became an issue. The mortgages that were tied to the credit default swaps began to regularly default. AIG began to run out of cash, they couldn’t cover their losses and had to resort to an emergency loan from the bank, believed to be around $40 billion (again, a small sum…). AIG were bailed out by the government, unlike Lehman Brothers, this was because they were perceived to be such a big company that this would have a major effect on consumers and other companies around the world.

The government had to stop bailing out companies. The US Treasury ended up refusing to give Barclays a guarantee on Lehman’s trading obligations, meaning that the deal would eventually fall through - the US Treasury said that they would be unwilling to use public funds to save banks who had caused this issue themselves (good on them?).

It’s a difficult decision, because the Government cannot always be the ones to bail out companies who are getting themselves into financial distress. Especially for Lehman Brothers, it would have been difficult to justify bailing them out due to them understanding the financial position and further worsening it.

Football Value - An Increasingly Expensive Market

The cost of transfers in football is continuously on the rise, to the point where players are being valued at £100 million, the current record being £86 million that Real Madrid paid for Gareth Bale from Tottenham Hotspur. In the British transfer market, prices are inflated for players who are experienced in the Premier League, they generally have a faster impact on a team than those who come from leagues abroad and will need time to adapt to the English playing style.

The revenues created from football come from many sources. Ticket sales make little impact on the money made by football clubs. Large proportions of their revenues come from corporate hospitality, sponsorships and TV deals. This summer, a new Premier League TV deal will kick in that is worth £5 billion. This money will be spread through the teams in the league, meaning that the cost of relegation this season will be even more costly than before!

In the EPL (English Premier League), the TV money is split between the teams depending on various factors. These include how many times the team had a televised match, and where they finish in the league. This is widely regarded as the fairest way to share out the TV money. In Spain, however, the TV companies work directly with the clubs in the league, meaning that giants such as Barcelona, Real Madrid and Athletico Madrid take in significantly higher TV revenues than the other clubs. This increased revenue then leads to them have higher transfer funds and being able to attract a higher calibre of player.

In England, there are several ‘top’ teams, including Arsenal, Manchester City, Chelsea, Liverpool, Manchester United and Tottenham Hotspur. These are the teams that we generally expect to fill the top positions in the league come the end of the season. However, financial fair play rules have now kicked in meaning that the likes of Manchester City cannot continue to spend huge amounts of money and allow the owners to be paying for all of this. Now there are restraints on the amount of money a club can spend to ensure that the rules are fairer and there is more chance for other clubs to make an impact in the league. This season, we have seen considerably smaller clubs, such as Leicester City be a great success and they are currently sitting top of the league after more than half of the season played, they have managed this without spending the huge amounts that some other clubs have. We have also seen one of the biggest spenders in the league sitting dangerously close to the relegation zone, yet they spend millions and millions each transfer window and so many of their players are taking in wages of over £100,000 a week.

Players have huge costs attached to them, we particularly see this in strikers. How can it be calculated that a player is worth £30 million? Take Andy Carroll for example, he was playing at Newcastle United and had recently come into the first team and was getting goals, he was becoming a regular starter. By no means was he a highly-experienced player. However, on the last day of the January transfer window, Liverpool came in with a bid of £35 million for him. This deal could not realistically be rejected. Here, we are talking about a player, who is, yes, very good, but by no means irreplaceable, especially with funds of £35 million. With that money, a club could invest in 7 young players who are predicted to make good future players. That could change an entire team. But what made Liverpool decide that Carroll was worth £35 million?!

When a player is signed on a large transfer fee, a club is going to want to secure their services for many years. This means that they can somewhat regard the fee as spread across, say 5 years. However, if a player is getting older, they will want to ensure that they can potentially get some money back from this deal so they may sell them on for a reduced fee before their contract is up.

The money involved in football has increased massively. Going back only as far as the 1980s, we saw football players being signed for £1 million, which was massive amounts of money. Now we see Lionel Messi being valued at over £120 million, with wages of over £250,000 per week. This is a drastic change from when even superstar players had full time jobs and football was their hobby on the side.

With the new TV deal being brought into the Premier League though, when will the obscene transfer fees stop increasing? Will we see a £1 billion player?

Debt or Equity?

There are various types of capital that a company can raise, I was interested to read that debt is actually a cheaper form than equity!

Initially, I was under the impression that selling shares is a great form of capital as you’re getting investment into the company, whilst giving out a potentially tiny portion of ownership and not even a guarantee of a dividend payout! Companies don’t need to give out dividends consistently every year (as discussed in my dividends blog a few weeks back), sometimes it can be a better option to reinvest these funds into new projects with a positive NPV and create more shareholder value. Well, it actually turns out that this isn’t the best method of raising funds within a company.

Getting debt on the other hand, affects balance sheets more significantly I’d say. It also means that there are regular mandatory payouts to the lender, including interest charges. To me, I think I’d rather have investors! But the actual story is, companies prefer debt over equity as it is cheaper..

Although I said it could be a tiny proportion of ownership that is being given out to these new investors, it is still ownership, and with that comes rights. These owners then begin to have a say in the running of the company, to a certain extent, depending on the size of their ownership. When a company has to pay back a loan or other borrowings, it is a certain amount. With equity, the payouts are continuous during the length of the ownership. This could result in a lot higher payback than a debt version.

So, the positives of equity outweigh the positives of debt. Realistically, this becomes a cheaper option of finance for a company looking to increase capital.

Mergers and Acquisitions

Merger and acquisitions deals are a lot more common than we think. The purpose of these deals is to generate shareholder value above that of the two companies added together when they were apart. There is $4.304 trillion investment into M&A deals in this 2015, according to International Business Times (I’ve included a link below of a pretty interesting article).

A merger is best defined as when two companies come together and form a new company, whereas an acquisition is when one company takes over another. I find these deals pretty interesting, especially when I found out that so many fail. It makes me wonder why so many companies go into these deals when they can be so risky.

Obviously there are a lot of reasons a company would initially go into an M&A deal, including reducing competition; generating shareholder wealth; securing supply; entering new markets; gaining intellectual property; taking advantage of a company being underpriced and many more. Generally, there will be more than one of these as reason for a business to complete an M&A deal. M&A deals are often referred to using the equation ‘1 + 1 = 3’ which highlights the intent to generate more value together than the two companies had separately.

When I looked into this topic a bit more, I realised how big the chance of failure is! There is so much room for error and the deal has to be executed impeccably for the deal to succeed. Some of these deals, however, are not down to managerial issues and are purely deals that were doomed to fail from the onset. Managerial motive can have a big impact on whether an M&A deal happens, a success in a deal like this can make a CEO’s career!

There is also the chance to do the reverse of this and break up companies, generally referred to as spin-offs. We also see that a lot of companies with several brands, divest some brands in order to streamline their brand portfolio. An example of this is when Procter and Gamble sold Iams to Spectrum, P&G as a business were not highly involved in the pet industry, so it was best to sell off this section of the company and focus on improving their other brands. This can be seen as the opposite of M&A deals.

There have been various examples of massive companies deciding to merge and it going disastrously and leading to a decrease in shareholder wealth, which is the opposite of what a company is out to achieve! An example of a massive merger was when US company Kraft bought UK company Cadbury, chocolate in America is a very different recipe to chocolate in the UK. Consumers did not take it well when it was announced that the traditional Cadbury chocolate recipe would be changed. I can’t say I took it well either - particularly the change in Creme Eggs! It remains to be seen what happens with this merger deal, I’ll keep you updated..

Have a read of this article if you’re interested! http://www.ibtimes.com/merger-acquisition-activity-hits-record-high-2015-report-2213166

Social Media Brand Value

Social networking is a huge market. There are millions upon millions of people who use social media daily. We have various types available to us, with some of the most well known being Facebook, Twitter, Instagram, Snapchat, Whatsapp and the more professional LinkedIn. Some of these platforms use advertising to make money, others have premium membership fees but others such as Snapchat don’t make money in these ways. Yet they all still have massive values, so how is it possible to value a brand which does not have a regular source of income such as sales.

These social media platforms are difficult to value as they don’t particularly have tangible assets, this makes it difficult to estimate a true value. A valuation can be useful to attract investors. On November 5, 2015, Facebook had valuations of $306 billion, according to CNBC, which is an incredible amount for a website with a low asset portfolio. There are a total of 1,440,000,000 active monthly users of Facebook which is a 12% increase from 2014.

There are various ways in which to value a company, with one of the most basic being Stock Market Valuation where the value is simply calculated as the share price x the number of shares. A social networking site, at present, is a good industry to invest in as it generates great returns. But looking to the future, can the social media platforms continue to generate such large amounts of profit without generally charging membership fees. I believe that if membership fees were introduced to the likes of Facebook, Twitter and Snapchat that the usage would decrease greatly, I know I would not pay for them! I can appreciate this is a stingey way to look at this as it would maybe cost up to £5 per month, but after being used to these sites being free, I know I would not be impressed if I was then asked to pay to use the site.

If people will be unwilling to pay for their memberships on these sites, the companies still need to ensure that they are generating revenues to survive and grow. Probably the best way to do this is through advertising, Facebook have now introduced advertising on the side of their news feed which is linked to what you search. I, for one, do not see a major problem in this, I am expecting to use Facebook for free so I understand that they need to make money somehow since that money is not coming from me! I have also seen how good advertising can be for companies on Facebook as they will reach a larger group of people so it seems to me a win-win situation.

It remains to be seen whether other social media platforms add in advertising, it would probably be more difficult for the likes of Snapchat to add advertising given the context of the site. So in order to gain value, they need to continue to add new features and update their app accordingly which will also ensure that they keep a high brand value!

Volkswagen - No PR is Bad PR?

So we’ve been hearing about Volkswagen’s emissions scandal for a good few weeks now, but in case you’ve been hiding under a rock since 18th September, Volkswagen have been found to have rigged their emissions testing of their cars by implementing a ‘defeat device’ which alters the car’s performance when it is being tested. Let’s just say this has not gone down well with the Americans, our friends across the pond are big on their environmental impact (which can only be a good thing!), so this news will have impacted VW’s reputation pretty badly. The tests found that the actual emissions from these vehicles are 40 times higher than US regulations. Not exactly ideal when you consider that there are potentially 11 million of the German cars affected. Could be a hefty cost associated to that? Yep. Apparently, Volkswagen are putting aside £4.7 billion to cover the costs of the scandal. £4.7 billion sounds a pretty large amount, especially when you consider the value of VW is ‘only’ about £48 billion. Imagine losing 10% of the business down to a scandal which could so easily have been avoided. Oh, and did I forget to add that there could also potentially be $18 billion in fines from the US also.. I can only praise the new CEO for his courage in taking on that job!

So on one side, VW could be skint soon, they have to do something to sort out the 11 million affected cars that they’ve allowed onto the roads worldwide. Their share prices have also dropped massively (see below), $167.60 on 15th September to a low of $102.00 on 1st October. But on the other hand, who says all press is bad press? Is this scandal something that VW can recover from?

In October the share price has actually risen. Although it’s a relatively small amount and the share price shouldn’t really stay at it’s lowest, that should be more of an immediate response and build back up, as it has done.

This is hardly very ethical practice by an international company who were previously a well-respected company worldwide. Time will tell whether Volkswagen will fully recover from this scandal.

Are Dividends All That Good?

As a shareholder, would you prefer a small dividend or for the company to reinvest that money into a positive NPV project? There are various theories that talk about the importance of dividends to shareholders, but in reality I think I would prefer the knowledge that the business have projects that they can invest into. After all, if they’re not investing, is the company not becoming stagnant? And that’s the last thing you want as a shareholder!

The main corporate aim of a company is to ‘increase shareholder wealth’, generally you’d probably think the best way to do that is to pay out dividends, which is obviously giving money straight to the shareholder - increasing shareholder wealth.. But in the long run, if a company can invest in projects which are going to generate more value for the company, that will surely have more of an impact on the shareholders and increase their wealth more positively in the long run?

It’s basically a question of would you like a small amount of money risk-free now, or would you like the chance to increase that amount of money by having to wait a longer amount of time for it.

Modigliani and Miller (1961) came up with the Dividend Irrelevance Theory, this is basically saying that a dividend payment isn’t the only thing to affect the share price of a company, investing in +NPV projects will increase the value of the company as well. Although, if dividends are never paid out, then what is the point in having shares in the company. So there has to be a mix.

Shareholders benefit when a company invests in +NPV projects as this can lead to higher future dividends, but it also increases the share price of the company so if they were wishing to sell their shares they would have made a nice profit!

Dividends also have an effect on the economy. Andrew Haldane, Bank of England’s Chief Economist has said that companies paying out dividends are slowing down the economy, they are meeting the short-term needs of the shareholder without taking into account the needs of the wider economy. By investing in projects, it means that money is being circulated and generating more value. If companies aren’t investing and are solely paying out dividends, this means that money is just sitting around doing nothing, and certainly not gaining any value..

Overall, I reckon the key is to invest money into new projects. It increases the value of the company, increases shareholder wealth in the long run and gives the economy a good kick!

Do you all agree?