Warren Buffet is famously quoted as saying, "If you have been playing poker for half an hour and you still don't know who the patsy is, you're the patsy". Today, we got a glimpse of Buffett playing poker with Bank of America, and at least from my perspective, it seems clear who the patsy in this game is... it is either Bank of America's stockholders or the rest of us who attribute mystical properties (and uncommon ethics) to the Oracle from Omaha...
So, let's recap what happened. It has been a rough few months for Bank of America stock, prior to today. The stock price had halved between November and yesterday:
Macro factors (the Euro crisis and the S&P downgrade) did play a role in the price decline but the company had itself to blame as well. It reported a loss of $8.8 billion for the second quarter of 2011, reflecting payments to settle legal claims related to troubled mortgages.While the stock price decline suggested that the market was increasingly pessimistic about the company's future profitability, the company itself indicated that it was sufficiently capitalized to make it through these travails. Earlier this month, the company announced that it would lay off 3500 employees and cut costs, but evoked little positive response from the market.
Today, we woke up to the news story that Warren Buffett, white knight extraordinaire, had ridden to the rescue of Bank of America. http://on.wsj.com/nUOWBSHere were the terms of the deal:
- Buffett invests $ 5 billion in preferred stock, with a 6% cumulative dividend, redeemable by the company at a 5% premium on face value.
- If Bank of America is unable to pay the preferred dividend, not only do the dividends cumulate but they do so at 8% per annum and the bank is restricted from paying dividends or buying back stock, in the meantime.
- Buffett get options to buy 700 million shares in BofA at $7.14/share, exercisable any time over the next 10 years.
Let's see what Buffett gets out of the deal. Valuing the options with a strike price of $7.14, even using yesterday's low price of $6.40/share, an annualized standard deviation of 50% in the stock price (significantly lower than the 3-year historical standard deviation of 79% and the implied standard deviation in excess of 100% from the option market) and a ten-year maturity, I estimate a value of $4.30/option or an overall value of approximately $ 3 billion (700*4.30) for the options. (I know.. I know.. Buffett does not like using the Black-Scholes model for long term options...Perhaps, he sold Bank of America's managers on the idea of using the famous Buffett-Munger long term option value model to derive a value of zero for these options...) Netting the $ 3 billion value of the options out of the $ 5 billion investment in the preferred stock makes it a $ 2 billion investment, on which $ 300 million is being paid in dividends. That works out to an effective dividend yield of 15% on the investment. By exercising his veto power over dividends and stock buybacks, Buffett can ensure that he is always the first person to be paid after debt holders in the firm. To cap it off, Berkshire Hathaway will be able to exclude 70% of the dividends received from Bank of America in computing taxable income (this is the rule with inter-company dividends), when paying taxes next year. That is an incredibly sweet deal!
What did Bank of America get out of this deal? Let's look at what it did not get first:
1. It did not get Tier 1 capital (the most stringent measure of bank capital), which includes only common equity, and thus does not get any stronger on that dimension. 2. It gets no tax deductions, since preferred dividends are not tax deductible. So, the $ 300 million in dividends will have to be paid out of after-tax income.3. It risks losing flexibility on dividend policy and stock buybacks, as a consequence of the restrictions imposed on this deal. The only conceivable benefit I see accruing from this transaction to the company is that Buffett has provided some cover for the managers of Bank of America to make two arguments: that the bank is not in immediate financial trouble and that it is, in fact, a well managed bank. I, for one, am not willing to accept Buffett's investment (or his words) as proof of either, and the way the deal is structured is not consistent with any of the arguments I have been hearing all day (from those who think it is good for Bank of America stockholders).
• First, let us assume that the bank is not in financial trouble and that the market has run away with its fears over the last few months. But, why would a bank that is not on the verge of collapse agree to raising capital at an after-tax rate of 15% and give up power over its dividend and buyback policy? And given the extremely generous terms offered to Buffett on this deal, how can this action be viewed as an indicator of good management? • Playing devil's advocate, let's look at the other possibility, which is that the bank has been hiding its problems and is in far worse shape than the rest of us think. If so, perhaps the terms of the deal make sense to Buffett (high risk/high return), but the deal still does not make sense to Bank of America. If the bank is in that much trouble, it should be raising tier 1 capital, and adding $ 300 million in preferred dividends to its required payments each year makes no sense. And, if it is in fact the case that the bank is in a lot more trouble that we thought, how can Buffett in good conscience then claim that BofA is a "strong, well-led company"? Either the terms of deal are way too favorable to Mr. Buffett or he is not being forthright in his description of the company... In either case, this does not pass the smell test.
I know that there are some who are comparing Buffett's deal with Bank of America to his earlier deal with Goldman Sachs. But there is a key difference. The Goldman deal was entered into at the depths of the banking crisis, and in a period where liquidity had dried up, Buffett was providing capital. Even in that case, you could argue that Goldman Sachs paid a hefty price for taking money from Buffett to shore up their standing... Perhaps, this has become Buffett's competitive advantage. Rather than buy and hold under valued companies, which is what he used to do, he focuses on companies that have lost credibility and he sells them his credibility at a hefty price. I know that Buffett has accumulated a great deal of trust with investors over the decades, but even his stock will run dry at some point in time, especially if he keeps dissembling after each intervention about the company, its management and his own motives.
In summary, is this deal good for Buffett? Absolutely, and I don't begrudge him any money he makes on this deal or the fact that the tax law may work in his favor. Does the deal make sense to Bank of America's stockholders? I don't think so, notwithstanding some of the cheerleading you are hearing from some equity research analysts and the market's positive reaction. Is Bank of America a "strong, well-led" company? Only if you have a very perverse definition of strong and well-led...
Paper Products Limited (PPL / The Company) - Recommend BUY
At current levels of Rs.77.40 per share, Paper Products Limited seems like a good buy to me. According to my model (attached), the DCF valuation ranges between Rs.91 and Rs.100 depending upon assumptions we make primarily about (a) Working Capital - Inventory, DPO, DSO, (2) CAPEX in FY2014 and 2015.
Since PPL is a dividend paying company, one may consider using DDM - Gordon Growth too but I find it unfair to value the company using this method as the company does not pay out a large part of its earnings as dividends. Further, the retained part of earnings are not all used to make investments in order to support on going activities or expansion to support the growth in revenue and sales. The company regularly invests in financial instruments like Mutual Funds and other schemes as well. I believe the DDM/Gordon Growth model should apply to those companies which have a long history of dividend pay outs, and the amount of dividend would be that part of earnings which is not used or retained to make investments for expansion or continuing operations to support revenue stream. In this case, PPL's valuation is at approximately Rs.27 per share which in my opinion is far below the fair value.
The company's shares may seem overvalued compared to its domestic peers but what we need to consider is that PPL has very little debt in its capital while all the other domestic players are highly leveraged with Essel Propack's Debt-to-Equity being above 1. PPL's EBITDA is a mammoth 171 times Interest Expenses as compared to Indian peers' and AMCOR's at below 8 times the same. Clearly there is less risk associated with PPL than there is with its Indian and international competitors.
RISKS:
Input Costs Escalation: In FY2010, input costs rose sharply due to hike in price of raw materials. Although most of the other materials were volatile within a narrow band, PET Films prices rose by more than 150% due to global shortage of supply following shut-down of few major suppliers' units, delay in capacity additions and diversion of thin films to higher value added thick films for electronics industry. Other key raw materials that saw sharp rise in price were inks, adhesives and solvents.
Competition, Margins and Pricing power: In absence of long-term contracts with buyers, PPL seems to be on the disadvantageous side of the negotiation table. Adding to that, competition has been increasing with new players entering and capacity additions with existing ones. In such environment, escalation in raw materials prices and other inputs like fuel and energy costs may undermine margins and cash flows.
Inflation: PPL primarily serves the food processing industry. Due to recent inflation especially in food prices, PPL's customers have become price conscious and initiated cost cuts in their packaging expenses by compromising on packaging quality as well as by putting pressures on packaging suppliers' margins. Additionally they had resorted to reverse auctions, hard negotiations using consultants.
Regulatory risk / Plastic ban on Food Processing Industry
OPPORTUNITIES
India – Economy, infrastructure & Rise in organized retail: Having been partially insulated from global meltdown, India saw a robust GDP growth of near 8% and is expected to see the same in the coming year. Economic Times - "When larger wheels in a machine start rotating, the smaller ones automatically gain momentum. The same is true of the Indian packaging sector too. Strong growth in sectors like fast moving consumer goods, pharmaceuticals, liquor, cosmetics etc. has had a positive rub off on the packaging industry. Growth in consumer goods and organized retailing mainly drives demand for packaging." -
Growing in size of middle class population means shifting form traditional grocery shopping and buying habits at the corner grocery store to supermarkets and organized retail outlets. This adds potential to flexible packaging industry as packaging is and will be an important strategy of product placement on the shelves of such supermarkets and stores where customers walk around and try to judge the contents/product by their packaging and/or brand. It is the least we should remember that PPL's customers are some of the leading FMCG brands who occupy shelves at such supermarkets and stores. The FMCG brands are in general bullish on the scope India offers further through infrastructure development in rural areas and underdeveloped towns which means establishment and growth of organized retail in those areas in the coming decade.Government of India - Ministry of Food Processing's Vision 2015: Although we need to discuss the quantifiable benefits of this plan for PPL, at the first thought PPL should directly and indirectly benefit from this initiative subject to GOI's proper execution of this plan. Under this scheme the Ministry aims to (a) Become the Food Factory of the World, (b) Triple the growth of Food processing industries, (c) Increase the value addition from 20% to 35%, (d) Increase contribution to the world's agri-business from 1.5% to 3%. Further research on the Vision-2015 plan and discussions with the IR/Management of such companies would give us insights into the quantifiable benefits to PPL which may be in the face of Tax exemptions, subsidies, export incentives (kick-backs), minimum pricing power/protection, raw material quotas and rebates, etc.
STRATEGY AND OPERATIONS:
NASP (New Applications, Structures, Products and Processes): In the long run, moving more business to value added segments, Innovation and new products, exploring new markets are seen as critical to profitable growth. The company's endeavor to renew innovation program will continue to be the cornerstone of PPL's strategy. NASP initiatives which contributed to 27.2% of total 2010 sales would get added thrust in the current year and years to come. Organizational measures to further accelerate the NASP efforts are in place with the CEO directly overseeing the company's innovation programs and strategy. PPL has been expanding its supplier base for critical raw materials and introducing alternative materials for its products as part of the innovation drive.
Operations: The Company is making efforts to optimize existing capacity utilization and add units to plants that expect growth in their products. They have seen success in measures to cut operating costs and overhead expenses. To enhance capacity utilization, they initiated de-bottlenecking in supply chain and inventory controls. However, efficient management of Working Capital (Inventory, Receivables and Payables) is critical for favorable valuation in the light of rising materials prices. The DCF Model seems highly sensitive to these assumptions/inputs and further discussion with management regarding this would be vital to arriving at the valuation with more accuracy. Further, the valuation is also highly dependent on the company's ability to preserve or dictate sales margins (Cost + Input or Fixed Price) and Raw materials purchase price in the short and medium terms via contracts or expanding supplier base
Sometimes the general public can get confused in attempting to explain the complexities and the inefficiency of the banking sector when one simple chart brings the message home. A chart like that comes from the latest "Eye on the Market" from JPM's Michael Cembalest, who compares total bank deposits ($8.4 trillion), or bank liabilities, and total bank loan (about $2 trillion less) assets, or sources of cash flows that are supposed to fund bank liabilities and generate retained earnings, while the bank performs credit, maturity and risk transformation: a bank's three key functions. As the chart below shows, perhaps the primary reason why the economy is in its current deplorable state, is that instead of lending dollar for dollar to catch up with deposit growth, banks now rely on roughly $1.7 trillion in excess reserves with the Fed, an amount roughly equal to the difference between total deposits and loans, to plug the credibility gap. This also explains why according to Cembalest one of the expectations by the market from Jackson Hole is that IOER will be cut to 0% to promote bank lending, and thus the conversion of reserves into loans (something which the inflationistas out there will tell you is a big risk to a sudden surge in out of control inflation). So how does the Fed's direct intervention in bank balance sheets look like?
Full article at
http://www.zerohedge.com/news/charting-biggest-structural-problem-us-banks-and-what-market-expects-jackson-hole-version-n1
__,_._,___
To the Apple Board of Directors and the Apple Community:
I have always said if there ever came a day when I could no longer meet my duties and expectations as Apple's CEO, I would be the first to let you know. Unfortunately, that day has come.
I hereby resign as CEO of Apple. I would like to serve, if the Board sees fit, as Chairman of the Board, director and Apple employee.
As far as my successor goes, I strongly recommend that we execute our succession plan and name Tim Cook as CEO of Apple.
I believe Apple's brightest and most innovative days are ahead of it. And I look forward to watching and contributing to its success in a new role.
I have made some of the best friends of my life at Apple, and I thank you all for the many years of being able to work alongside you.
Steve
And the official Apple press release:
Apple's Board of Directors today announced that Steve Jobs has resigned as Chief Executive Officer, and the Board has named Tim Cook, previously Apple's Chief Operating Officer, as the company's new CEO. Jobs has been elected Chairman of the Board and Cook will join the Board, effective immediately.
"Steve's extraordinary vision and leadership saved Apple and guided it to its position as the world's most innovative and valuable technology company," said Art Levinson, Chairman of Genentech, on behalf of Apple's Board. "Steve has made countless contributions to Apple's success, and he has attracted and inspired Apple's immensely creative employees and world class executive team. In his new role as Chairman of the Board, Steve will continue to serve Apple with his unique insights, creativity and inspiration."
"The Board has complete confidence that Tim is the right person to be our next CEO," added Levinson. "Tim's 13 years of service to Apple have been marked by outstanding performance, and he has demonstrated remarkable talent and sound judgment in everything he does."
Jobs submitted his resignation to the Board today and strongly recommended that the Board implement its succession plan and name Tim Cook as CEO.
As COO, Cook was previously responsible for all of the company's worldwide sales and operations, including end-to-end management of Apple's supply chain, sales activities, and service and support in all markets and countries. He also headed Apple's Macintosh division and played a key role in the continued development of strategic reseller and supplier relationships, ensuring flexibility in response to an increasingly demanding marketplace.
Who says hedge funds are ambivalent about the current market? As of last week, they have not been
more bearish on the S&P since before Lehman. From SocGen: "Hedge funds have opened the biggest net short positions since early 2008, concentrated on the most liquid segment of the market, i.e. the S&P 500. Meanwhile, positioning on small caps hardly moved (slight increase in net shorts on the Russell 2000). Surprisingly, they actually stuck to their net long positions on Technology (Nasdaq)." As usual, the amusingly named "hedge" funds defy their purported nature (as in, to hedge), and merely pursue momentum, and should be more appropriately called "career risk" funds as the only variable is doing precisely what everyone else is doing: remember - to get a bonus at the end of the year, you don't have to outrun the market, you just have to outrun the biggest institutional fool out there. "Hedge funds have closed their net short positions on 10-year Treasuries and strongly diminished their net shorts on the long end (30Y), as recession fears have crunched expectations for higher bond yields, and endorsed by the Fed's announcement that it will keep rates low until at least 2013." Hedge fund infatuation with metals continues: "Hedge funds' enthusiasm for gold and platinum remains strong, as indicated by the high net long positions on these metals. Meanwhile, net long positions on base metals (copper) have been strongly reduced. Net long positions on crude oil remain relatively stable, less impressed by the perceived recession threats." Expect to see numerous short covering sprees until the end of the year, even as the market continues it secular decline back to fair value somewhere around 400.
Full article at
Following years of pandering to client demands, and assigning trillions of dollars in fixed income securities with whatever rating money bought (among other things, a factor to the credit bubble and its subsequent implosion) S&P finally tried to do the right thing and tell the truth. However in this case it picked if not the worst, then certainly the most hypocriticial credit in the world to expose – the US itself. Sure enough two weeks after the downgrade, someone made the phone call and the CEO Deven Sharma is no more. As for the kick square in the gonads: Sherma will be replaced with the COO of…you know it… the bank which demanded tens of billions in secret Fed bailout loans itself, Citibank, and whose existence is inextricably tied to America not seeing any more downgrades ever again.
As the FT reports, "The McGraw-Hill board made the decision to replace Mr Sharma at a meeting on Monday, where it also discussed an ongoing strategic review." Alas, this is nothing but a case study of modern corporate reality in America: if you are not with the status quo, you are against it, and you are promptly booted out of it: anyone who does not share the visions of one glorious future built on ponzi schemes, houses of cards, and games of three card monte, will be promptly suicided, either physically or professionally.
We expect that this flagrant example of how the powers that be will deal with any dissenters will instill the fear of god in anyone at either Moodys (or the French sycphants from Fitch) and nobody will ever again menton the words "US" and "downgrade" in the same sentence.
From the FT:
Deven Sharma is stepping down as president of Standard & Poor's only weeks after the rating agency issued an unprecedented downgrade of the credit of the US, according to people familiar with the matter.
Mr Sharma will remain as an adviser to S&P's owner, McGraw-Hill, for four months and leave the company at the end of the year, they said.
Mr Sharma will be replaced as S&P president by Douglas Peterson, chief operating officer of Citibank, the banking unit of Citigroup, they said.
As for the official story:
People close to the company said the search for Mr Sharma's replacement has been going on for six months, and was triggered by the split of its data, pricing and analytics business from its ratings business. The creation of that new group, McGraw-Hill Financial, reduced the scope of Mr Sharma's oversight, they said.
So let us get this straight: in America when you dare to tell the truth, your career is over, while if you are a corrupt, lying, incompetent tax evader you not only get to be Treasury Secretary but likely will be on for life as long as you do the one duty you are entrusted with: pander to the interests of the Too Big To Fail financial institutions
We should be speechless but at this point we are well beyond the point of even caring.
The only question left in this entire farce is how long before S&P issues the following upgrade of the US:
"Great service, AAA+++ rating, immediate payment, would do business again!!!"
If you have Rs 5 lakh to Rs 25 lakh and have been entrusting this money to a portfolio manager, you may not have this luxury for very long if a SEBI proposal becomes a regulation.
SEBI in a concept paper has suggested that the minimum amount for investment under Porfolio Management Services (PMS) could be Rs 25 lakh, and not Rs 5 lakh, as it is at present.
So where will someone with Rs 5 lakh to Rs 25 lakh go for customised investment advice and services?
"Such a change will definitely affect people with these kind of sums to invest. They will have to invest in mutual funds," said Mr Dinesh Thakkar, CMD of Angel Broking.
"Just going to a broker (and not under a PMS scheme) will not get the investor time and involvement that a portfolio needs. So the next route available is the mutual fund, where the money is managed by an expert," he said.
Broking houses, in fact, fear that people with such sums to invest might fall prey to their own employees and franchisees' misguided or self-serving advice.
It is typical for people with Rs 5 lakh and Rs 10 lakh who do not want to invest in mutual funds to ask brokerage employees, or branch employees or franchisees for advice on what to buy and sell. "And these employees might unnecessarily churn their investments just to earn a bit of commission themselves," said the managing director of a large broking firm.
"Under the PMS route, however, their porfolios would be centrally administered at the brokerage. There is a portfolio manager who is accountable, and whose incentives are linked to how well the porfolios do," he said.
'Killed by regulation'
Some brokerages say they are no longer growing their PMS business. "We do not take on any new clients for PMS," said Mr Deven Choksey, head of KR Choksey Securities. This product, anyway, is being killed by regulation, he said.
"Firstly, PMS is not sold scheme-wise, but the reporting on it has to be done scheme-wise. Second, we can't customise the investment according to the risk profile of an investor as SEBI has capped investment in single securities.
"So if a doctor wants to put the bulk of his money in pharma and is willing to risk it, he cannot under PMS. If we are to function like a mutual fund, then what is the point," he said.
Existing PMS customers are serviced, but new customers are given advisory services by his brokerage.
"The low minimum investment amount of Rs 5 lakhs makes these products (referring to PMS) accessible to retail investors without the protection which are available to retail investors under the mutual fund network," said SEBI in its concept paper.
"To the extent that the services under this route resemble fund management instead of customised services, there is need to recognise and regulate them as private pool of capital," says SEBI.
So, where funds are pooled they will have to be registered as Alternative Investment Funds, and where there is customised service for each portfolio this service will come under PMS.
