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?

RBS - A Disaster Waiting To Happen

The Royal Bank of Scotland were, at one point, the largest bank in the world in terms of assets. They went from being average, to top, to hitting rock bottom in 2008. So what exactly, I hear you ask, was the issue? Well, it didn’t help that the guy in charge, Sir Fred Goodwin, had the nickname ‘Fred the Shred’, kinda shows the strategy he uses. Big contributions to their downfall were both their capital structure and their investing activities.

Royal Bank of Scotland and Bank of Scotland were two big competitors in a relatively small economy, they needed to expand outside of Scotland if they were to get any further than what they had already achieved. This resulted in them working to attempt to merge with Barclays (like that was ever going to happen..) and in 2000 they ended up agreeing a £21billion to buy Natwest. This was after the Bank of Scotland had bid to takeover Natwest, but RBS ended up getting ahead of the deal and making sure it was theirs!

After this, the shareholders voted to elect the new CEO, this is when Fred the Shred was elected. So now they weren’t only in Scotland, they had American branches, insurance groups, they bought smaller local banks and they even went into China! So after the takeover, RBS had access to all deposit accounts at Natwest and yep, they used them! In the three years after 2001, they spent a massive £30 billion (wouldn’t that be nice!), they were then told they couldn’t buy any more, not a surprise really! This is when another big problem started.. They went into mortgages..

This was a bad time to go into mortgages as there were huge problems with them in the US. RBS started putting together mortgages and selling them on to gain some interest. Not really sure this was a smart idea because what if people can’t pay? Okay, so people couldn’t pay. Problem.

RBS didn’t seem to want to face their issues and kept lying about their debt, thinking they could get away with it. Until they had to be bailed out by the tax payer in 2008. That was a short eight years to allow the bank to hit rock bottom. Nothing seemed to work out. It would be nice to think that lessons have been learned from this instance.

Mainly, stop putting yourself at so much risk. There is no problem with liking a bit of risk to try and gain a bigger return, but for a bank there’s only so much risk you can take when you’re dealing with customers deposits. They should have given themselves a safety net instead of throwing everything into these mortgages which were never really going to work out. They also shouldn’t have lied. If they hadn’t, maybe something could have been done about it sooner, instead of it having to be down to the taxpayer to bail out, which just makes things a little bit awkward.

Do you think things have improved after this disaster and that other banks have learned from RBS’ mistakes?

Fantasy of Insider Trading

Fantasy League is such a big game nowadays, everybody seems to be playing it. Whether it is a league amongst friends, joining a celebrity’s league or competing with work colleagues. Some sites offer cash prizes, some are just for fun, so is there a morally wrong way to play Fantasy League?

Generally, the idea is to pick the players you think will get the best results, the best way to do this is to understand how points will be picked up. In my opinion, there is little point in playing defensively in fantasy team, get on some defenders who score some goals! Get attacking midfielders, not those who will pick up a bunch of yellow cards and be suspended a few games into the season. At least this is the approach I took! I’m now sitting 8th out of 20 in my work league and I’m pretty happy with that. I play more for the pride of winning, some people play merely to win cash. Obviously so much can change in a sports season that it is completely unpredictable to work out the best team in order to put yourself at the top end of the table come the end of the season. I’m still regretting my decision to put Courtois in goal after he hasn’t got me a single point due to injury..

When I say it is completely unpredictable, that is what I thought.. Recent news has come out that there has been a spot of insider trading going on within the industry. News broke that an employee at DraftKings, who had access to confidential information, won $350,000 playing fantasy team. Yes, it was on a different website, but the principle still stands that they have been competing against people who were merely using their own knowledge to build a team they thought had potential. The situation could be compared to insider trading within the stock market and market efficiency.

We could consider that general customers of these fantasy sports websites are experiencing weak-form market efficiency. Their knowledge of the sport is what everybody else knows, they have no confidential information that could give them an advantage. The guys at DraftKings, FanDuel and the like are those in the market with semi-strong efficiency. They know more than the standard player, so they automatically have a competitive advantage. Is this fair to the consumers who are paying money to be in with as equal a chance as all of their competitors?

Although there are limited regulations on this game as theoretically the game can not be calculated perfectly as it does in the end, entirely depend on how each player plays and how different teams do in the league, as well as unexpected factors such as injuries. It is considered unfair for sports professionals to be involved in betting websites as they know more about the industry, they see how different players play, how different teams train and have a more in-depth knowledge than the average customer. A sports professional can spend weeks preparing and learning about their competitions’ plays. So if a sports player is not allowed to take part in betting due to their automatic advantage, why would it be fair for someone who works at these fantasy team companies to be allowed to play the same game? After all, they spend each and every day working on the game and understanding the rules and regulations. They would be able to see ways to compete in the leagues and gain more points than their competitors.

I don’t think this is fair practice, I believe that for those members of staff at these companies, they should not be allowed to play in these games. Fair enough, play in those where there is no money involved. But there should be regulations in place which prevent them from giving a disadvantage to those customers who pay and expect fair odds on their fantasy team gaming. What do you guys think?