No Choice But To Issue Stock

I found this article interesting due to what it suggests about the capital markets in the persisting credit crunch. Nucor, one of the largest steel producers in the U.S. was looking to raise $3 billion to finance its future acquisitions and expansions, but it couldn't; why?

Nucor currently has an investment-grade rating from both Moody's and S&P; a downgrade by either agency would cost Nucor hundreds of millions of dollars in additional financing costs, which is exactly what would happen if it issued $3 billion in debt. As an alternate course of action, the management at Nucor issued only $1 billion and will seek the balance via its first equity issue in a century.

We're talking, here, about a company that is both profitable and stable. A company in an industry with a growing demand for its product. A company that has survived the great depression for goodness sake! Do the rating agencies really believe that the extra debt will result in a default or worse? The truth is more likely that they are reeling from their comedy of errors over the past year and are now more cautious than ever in issuing their credit ratings. Is that fair to the companies that have had no role in the credit crisis and, moreover, have absolutely no exposure to its consequences? ...well, I suppose we just proved that they do have 'some' exposure.

Berkshire Will Not Grow At Rates Previously Seen

According to the man himself, Warren Buffett, you should sell your stock in Berkshire Hathaway if your expectation is to see the kinds of rates of growth that the stock has seen in the past. It's not that he believes it's a bad investment, of course, but rather that it is just so big that it's difficult to make acquisitions that would result in "needle moving" events for the holding company.

Buffett has been circling the globe of late with $35.6 billion in cash looking for deals. When you have that kind of money to spend, only truly sizable deals even show-up on the radar. Moreover, imagine how large a deal would have to be to result in significant move in the stock of Berkshire; these two forces 1) looking for large companies to buy, and 2) the fact that large companies are unlikely to offer significant growth rates, lead to Mr. Buffett's statement and it makes a lot of sense (as do most things that Mr. Buffett says).

If Bear, Then GMAC?

Citigroup, General Motors, Cerberus, JP Morgan Chase... what do they all have in common? GMAC, the lending arm of GM that's suffering from the combination of a credit crisis and spiraling home values. GMAC has come home looking for fresh cash injections twice already this year and nothing seems to help its solvency and, consequently, the faith of the markets in its long-term viability.

The yields on GMAC bonds are currently at about 19%; with the U.S. Treasury rate in the low single-digits, that speaks volumes about the risk investors associate with a stake in the firm. With 27,000 employees and $250 billion in assets, GMAC dwarfs Bear Stearns and that's even bigger than the largest mortgage lender, Countrywide Financial Corp. For the most part, however, we've heard relatively little about the firm or its troubles. With JP Morgan predicting a 100% chance of default on its bonds within the next 5-years, you really do have to have a strong will to invest your nest egg with the management at GMAC. More importantly, however, what sorts of risks does this represent for the financial markets if the Fed was concerned enough to step-in to support JP Morgan's buyout of Bear Stearns?

GM and Cerberus have been doing everything within their power to support the lender, but at some point you have to begin to question when it becomes throwing good money after bad. Then the question becomes what is the potential hazard for the broader economy. Mr. Bernanke and the Fed made it clear that the financial markets could not withstand the collapse of an institution as large as Bear Stearns; what does that suggest about the degrading status of GMAC?

Battle Between Hexion & Huntsman

I've been trying to get my head around the on-going battle between Hexion Specialty Chemicals, owned by Apollo Global Management, and Huntsman Corporation over the apparent failure of the proposed merger between the two. Not surprisingly, a legal battle has emerged from the remains of the deal that was once considered a match made in heaven.

It comes down to financing - there is none. The banks that were signed-on to provide the money for the deal have backed-out as a result of Hexion's inability to meet the solvency requirements stipulated in the deal. While Huntsman has waived those requirements as part of the merger agreement, the banks still require them and are not willing to put-up the money that's needed for the deal to go through. As a result, Huntsman is now suing Hexion for damages. What makes this interesting, however, is that Hexion is claiming (and I have to admit that I'm tempted to agree) that they have not breached the agreement and are therefore not liable for any damages.

The story isn't that simple, of course. The agreement further stipulates that Hexion has to make a best effort to find alternative financing, but how can it realistically do so if it can't meet solvency requirements as defined here:

... (a) the combined entity’s assets will be less than its liabilities; (b) the combined entity will not have the ability to pay its total debts as they become due; and (c) the combined entity will have an unreasonably small amount of capital with which to conduct its business.

Put yourself in the shoes of the banks considering this deal; would you invest? Yeah, me neither. If that's the case, then, how can Hutsman persist with its claims for damages?

Guy Hands on EMI and Leveraged Buyouts

Guy Hands, the British financier and founder of the private equity firm Terra Firma, admits to having his hands full with the turnaround of EMI (the music giant). Having made his fortune in real estate deals across the UK and German and coming from a polished Oxford-educated background, his ideals tend to clash with those in the music business, but business is business and Mr. Hands appears to be resolute in his mission to make his leveraged buyout of EMI, in cooperation with Citigroup, a success.

What I found interesting about this article was Mr. Hands' description of the relationship with Citigroup and how that plays into the future of EMI. "...it's a partnership..." he says; Citigroup has not been able to syndicate the debt used to buy EMI and consequently has to ride-out the rough times experienced by EMI all by its lonesome. Mr Hands adds that he has been working closely with the bank to try and syndicate the loan both to reduce the risk to Citigroup as well as loosen its leverage over EMI.

EMI's business has suffered a great deal over the past decade and Mr. Hands' purchase only helped to reveal how bad it had actually been. From reporting old music (like that of the Beatles) as new music sales, it was successful in hiding its mounting losses in new music business and this is weighing heavily on the shoulders of Terra Firma investors. Mr. Hands purchased the business for its cash flows from old music and those, apparently, are fabulous; unfortunately, its new music business is pulling everything else down.

The music business as a whole is in a tough position with digital music sales from Apple's music store surpassing all others and online music exchanges through illegal file-sharing sites continuing to growth (albeit at slower rates). Mr. Hand, and Terra Firma, has proven his ability to make profits for his investors in the past, but he certainly has his hands full with this project and it will be interesting to see how he pulls this rabbit out of his hat.

Lehman in trouble - $2.8 Billion Loss... and it's UP!

Well it happened, Lehman Brothers released their quarterly earnings report and it did report the big loss that Wall Street was expecting: $2.8 Billion to be exact. What's funny, however, is that it's up by as much as 2% in early trading after the announcement.

Yes, I know that it's all about expectations and not about the absolute numbers, but Lehman didn't announce lower losses than what were expected, it announced exactly what it had suggested earlier and exactly what the Street was expecting. How can its stock price rise so much on news that it did what it said it would do and did what everyone expected it would do?

Lehman in trouble - to post first quarterly loss?

Wall Street is now brimming with rumours about Lehman Brothers' possible issue of new common stock to help it meet its obligations following what many believe will be its first quarterly loss since going public. 

It won't be a small loss either; those in the know are suggesting that it may top as much as $4 billion; with a market capitalization of $18.7 billion, that's a staggering sum of money. Already down about 50% this year, the stock fell another 8% in trading yesterday as these rumours swirled the Street.

From the perspective of an investor on the side lines, I have to say that this is great news - my apologies to the current shareholders. I'm waiting for the opportunity to pounce on the financials, yes - along with millions of others, and news like this along with the downgrades issued by credit ratings agencies this week, things are looking rosy. The question is, of course, when is the right time to buy?

M&As and the Perceived Requirement to Integrate Swiftly

As a MBA you more than likely take one or more strategy classes that address the various aspects of mergers and acquisitions and the logic behind such deals. More than likely, you learn to recite synergy, synergy, synergy. I know I did and that's why I found this article especially interesting.

Of course, we did hear about the many failed M&A deals in the past, but their failure was always accounted for by the lack of synergies, or more generally, other incompatibilities between the two joining companies. This brief case study of the success of Disney's acquisition of Pixar never uses the term synergy - not even once. Instead, it actually goes-on to speak of the importance of communication between company management teams as well as throughout the ranks of employees on both sides of the deal.

Bob Iger, the successor to Michael Eisner, was credited for the success of the deal along with Steve Jobs and summarizes his point of view on M&A deals as follows:

“There is an assumption in the corporate world that you need to integrate swiftly,” Mr. Iger told The Times. “My philosophy is exactly the opposite. You need to be respectful and patient.”

Respectful and patient is exactly what both Disney and Pixar teams were. The letterheads didn't change, nor did the signs on the front of Pixar's buildings. The employee benefit plans didn't change at Pixar and neither were the two companies' email systems integrated. Such tactics, usually taken within weeks, if not days, of the signing of a deal were never done. Instead, the management teams at both companies looked to learn from each other and strengthen each others' businesses.

Pixar has benefited from Disney's marketing and distribution strength while Disney has most notably benefited from the technological strength of Pixar in using computer-generated animation techniques in the latest blockbuster films released since the deal. So much so that while most such deal see the combined value of the companies fall, Disney's stock has grown by as much as 28% in the past year alone. This result is not only interesting for as an exemplar of what a successful deal looks like, but also how it challenges the popular consensus still taught in business schools. I, for one, will be looking closely at the relationship between management teams of a possible deal when making a decision whether or not to invest in the combined entity.