“Comment, question or quotation of the day”

19-12-2018 : “Question from a reader ”

Should we take financial fixed assets in the computation of operating assets?   In the face of financial fixed assets, it is necessary to sort out those which are used for the activity (for example a deposit for a rent of stores, or a non-consolidated participation in its distributor in Saudi Arabia) and those which are non-operating assets (such as L'Oréal's 9% stake in Sanofi) The former is included in the operating asset, not the latter, for the calculation of the ROCE or for the calculation of the entreprise value. But normally, except perhaps for certain large groups, the second case is quite rare. Non-operating financial fixed assets are then to be taken in reduction of the bank and financial debt. Have a nice day  

18-12-2018 : “Daily quote ”

Nobody on Wall Street knows how to predict the financial markets.
Bernard Madoff

17-12-2018 : “Question asked on the Vernimmen.com website ”

Why in a construction company stocks are low and how to track the work-in-progress line that is important?   For a construction company, inventories are often low because it is supplied daily by its dealer in building materials, and it is the one which carries the bulk of inventories in this sector.   It is necessary to monitor over time the evolution of the item Work in progress in relation to the item Customer advances; and when Work in Progress grows faster than or exceeds the Customer Advances line, beware. This is either a sign of poor management, because in this sector customers are asked to pay as work progresses and well-managed companies always charge customers a little in advance of the completion of the work. Or the sign of a fraud if losses on a construction work are hidden by an overstatement of Work in progress, which do not forget, are nothing from an accounting point of view but costs that have been taken out of the P&L account to be written into an asset on the balance sheet, which improves the result in the P&L. Have a nice day.  

13-12-2018 : “Question from a reader ”

In an income statement by function can we say that the costs of sales correspond to the sum of all variable costs?   No, unfortunately, since costs of sales (CGOS) also include fixed costs such as the amortization expense of production machinery. In addition, all variable costs are not in the COGS since the bonuses paid to salesmen are part of the selling and marketing costs whereas they are variable costs since related to the sales. For more details, see Chapter 3 of Vernimmen. Have a nice day.  

11-12-2018 : “Index funds with management costs of 0%? ”

This was launched during the summer by Fidelity, known for its active management and not its passive management skills, to limit its losses of assets under management moving to index funds and ETFs. The success of this first product on the market with management fees of 0% is undeniable: its US equity fund and its non-US equity fund have raised so far more than $2bn in 6 months, a quarter of which for the international fund and 3/4 for the US equity fund, illustrating the domestic bias of investors. It's definitely two loss-leaders products for Fidelity. It is necessary to open an account at Fidelity to be able to subscribe, which allows the asset manager to offer other products more remunerative for it to its new customers, or de-incentives the current ones from moving to the competition. In addition to the volume effect necessary to reduce the costs invoiced to zero, Fidelity relies on indices that it has developed, which avoids having to pay commissions to the owners of indices like Dow Jones or MSCI; and practices securities lending on the shares held by these funds. Securities lending allows Fidelity to receive fees from short-sellers who needs to borrow shares to short-sell them. In a nutshell, it allows other investors to bet down securities prices held by Fidelity on behalf of its customers. . . This is the price to pay for having zero fees. As we say in the United States, there is no free lunch. Have a pleasant day.

10-12-2018 : “Inversion of the curve of interest rates, or have fun to scare? ”


The stock market turmoil of recent days would be due according to some to the reversal of the yield curve in the US, an indicator of a recession to come in 2020.
We will first go to the fact that "the stock market has predicted 9 out of the last 5 recessions" (Paul Samuelson).
We will then move on to the fact that when we look at the current US interest rate curve, we really have a lot of trouble seeing an inversion (see the graph published in the November issue of Vernimmen.comnewsletter n ° 116 or the chart from Six Swiss Exchange). We see for our part a normal curve, that is to say, oriented upwards with increasing maturity. Admittedly, the US 5-year rate has fallen below the 3-year rate, but you have to take a magnifying glass to see it. The difference went from 0.08% in early October to -0.02% yesterday. In short, a pivot of 0.1% while the rate at 5 years yesterday was 2.76%.
Starting from the idea that the current interest rate at 2 years for example is equal to the square root of the product of (1 + the rate at one year) by (1+ the rate anticipated at one year in one year); a normal curve can be explained by an anticipation of rising interest rates in the future (the expected one-year rate for a year is higher than the current one-year rate) because the economic outlay is improving, it is anticipated that central banks will raise their interest rates accordingly to avoid overheating.
Alternatively, the so-called normal steepening of the yield curve can be explained by the presence of increasing risk premiums with the maturity of investments to take into account an investment risk that is naturally stronger in the medium and long term than in the short term.
Conversely, when the slope of the yield curve is reversed, it is because investors expect on the contrary a decline in interest rates to fight in the future against growth becoming anemic, zero or negative, hence an indication of a future recession.
To see a real inverted rate curve, look on the £ or € at the first half of 2008, chapter 19 of your Vernimmen.
Have a nice day.

07-12-2018 : “Question from one of our students ”

What is the difference between the net present value and the present value?   Someone promises to pay you 110 in a year if you pay him 100 today.   With an interest rate of 10%, the present value of this promise is 110 / (1 + 10%) = 100.   The net present value of this promise is equal to the present value of its future cash flows, 100 minus the price you pay today to acquire that promise, 100, here 0. This net present value simply means that this investment (paying 100 today to receive 110 in a year) will bring you exactly the required rate of return, or 10%. You will not do a bad deal or a great deal, you will simply do a fair deal.   If you now want a rate of return of 5%, the promise to receive in one year 100 is worth for you at 5% 110 / 1.05 = 104.8. It's its present value. If you can buy this investment as previously for 100, its net present value is 104.8 - 100 = 4.8. This positive net present value shows that you will make a good deal  because you pay 4.8 less than you could, to make an investment that earns you the rate of return you want, 5% in this example. You will therefore get richer by 4.8. This is also what the net present value measures, your enrichment if everything goes as planned.   For more, see Chapter 16 of the Vernimmen.   Have a nice day.

06-12-2018 : “Daily quote ”

Technology companies should be valued at a discount to the shares of companies like Disney and Coca-Cola, which have long term earnings.             Bill Gates

05-12-2018 : “Question asked on the Vernimmen.com website ”

Why does diversification increase profitability for a same level of risk?   You have a title that earns you 12% for a risk level of 7% for example (standard deviation of its returns).   You have other titles that individually yield 14% with a standard deviation of 8%. More profitable, therefore more risky. Logic.   If you put in a portfolio these last securities, you will have a profitability of 14%, but considering the effect diversification and because the profitability of these titles are not perfectly correlated, you will have, if you combine your wallet well, a risk level not of 8%, but of 7%.   Thus you have increased profitability (14% against 12%) for the same level of risk (7%), choosing riskier securities thus bringing you more profitability but whose risk supplement is eliminated by diversification.   Have a nice day

04-12-2018 : “Question from one of our students ”

I do not understand why,  after the subscription right is separated from the share in a right issue, the share value is equal to the share value minus the value of the subscription right?   Because there can be no miracle in finance! A right of subscription (RS) has value because it allows to subscribe for a price of €100 for example a new share which at the same time is worth €150 and this during 2-3 weeks. Since a RS has value, by detaching it from the share, it reduces the value thereof. So if you had for example 1000 shares worth 150 € and you issue 100 new shares for a price of €100 each, the value of equity, post capital increase, will increase to: 1000 x 150 + 100 x 100 = €160 000 and the number of shares will increase to 1000 + 100 = 1100; hence a value per share, post capital increase, of €160,000 / 100 = €145.45 and no longer €150. The missing €4.55 is the value of the RS. Indeed, it comes from the formula of determining the value of the RS,  RS = (150 - 100) / (1 + 10) = 50/11 = €4,55.  If it was different, there is would have arbitrations that would restore balance.   For more details see chapter 25 of the Vernimmen.   Have a nice day

03-12-2018 : “Quote of the day ”

Any trader contracting with another with a view to trade, must, if he wishes to enjoy profits, show that he is willing to assume a share of the dangers and the costs which affect all sales and purchases. Robert de Courçon

30-11-2018 : “Question from a reader ”

Why are there two ways of calculating return on equity? There are two ways of calculating because there is the calculation that corresponds to the definition of return on equity (Net income / book equity) and the one that explains the building of return on equity from return on capital employed (ROCE) plus a leverage effect (which itself is based on an accounting tautology: total assets = total liabilities + equity). Using the two methods of calculation is interesting, if only to verify that one did not make calculation errors and to understand the source of a return on equity: ROCE or a financial construction due to the leverage effect. The second calculation is complex to implement when there are exceptional items that have been taken away to obtain a recurring return on equity, or when there are shares of results accounted for using the equity method, because the accounting tautology recalled above does not admit the dead end on these two items if one wants to find the same result regardless of the method of calculation. For more details see Chapter 13 of Vernimmen. Have a nice day.

29-11-2018 : “Quote of the day ”

Finance has unsolved problems. Thank God for that! Unfortunately, though, so far it looks as though we will have to solve them ourselves.              Steve Ross

28-11-2018 : “Question from a reader. ”

Why are there two ways of calculating return on equity?   There are two calculations because there is the calculation that corresponds to the definition of return on equity (Net income / book equity) and the one that explains the formation of return on equity from return on capital employed (ROCE) plus a leverage effect. (which itself is based on an accounting tautology: total assets  = total liabilities + equity).   The two methods of calculation are of interest, if only to verify that one did not make calculation errors and to understand the source of a return on equity: ROCE or a financial construction due to the leverage effect. The second calculation is complex to implement when there are exceptional items that have been taken away to obtain a recurring return on equity, or when there are shares of results accounted for using the equity method, because the accounting tautology recalled above does not admit the impasse on these two items if one wants to find the same result regardless of the method of calculation. For more details see Chapter 13 of Vernimmen. Have a nice day.

27-11-2018 : “Quote of the day ”

I don't think that you can ever give shareholders too many treats.         Albert Frère

26-11-2018 : “Question from a student from ICCF@Columbia Business School ”

  Does a share-buyback carried out through a tender offer necessarily entail a compulsory cancellation of the shares bought back? It depends on legal and tax issues. In the USA for example no, as a company can hold a large chunk of its shares with not legal limit whereas in France, a company cannot hold more than 10% of its own shares as treasury stocks and is forced to cancel those above this threshold. And a tender offer is rarely done for less than 10% of the share capital. For more details, see Chapter 37 of Vernimmen. Have a nice day.  

23-11-2018 : “Towards an evolution of notification thresholds for M & A transactions? ”

Generally speaking, the thresholds beyond which acquisitions must be notified to the antitrust authorities for approval are expressed in terms of turnover: €5bn at the European level, $84.4m in the USA, €150m in France, etc. As an exception, Spain has a threshold in terms of cumulative market shares (25%).
Germany has just added a threshold expressed in equity value (and not in entreprise value) of €500m and Austria has done the same (€300m). In 2016, Europe decided not to change its position. France is currently reflecting on the subject after having launched two public consultations on this topic.
The reason is obvious: some companies can be highly valued without making a significant turnover that puts them below the concentration thresholds: in the digital sector of course, but also in pharmaceutical research, automotive parts, etc.
Another trend is to subject to the control of antitrust authorities not only the change of control, but also the acquisition of significant minority stakes. For example, in Germany, for equity investments giving more than 25% of the capital of a company.
Have a nice day.

22-11-2018 : “What’s a debt wall? ”

    A debt wall occurs when finance directors don’t do their jobs properly. When they have allowed large amounts of their firms’ debt to mature in one or two years, when they have failed to act early to spread repayment over several years and they then find themselves up against a wall (there’s no other word for it) and having to rely on the good will of their lenders and the performance of the debt market. The firm does not generate sufficient cash flows and does not have enough liquidity to pay the next instalment on its debt.     More on this topic in the November issue of The Vernimmen.com  newsletter which has just been sent to its subscribers and which is now available on Vernimmen.com. Have a nice day  

21-11-2018 : “Quote of the day ”

In political economy, we strayed from our true path every time we sought to rely on mathematical calculations.           Jean-Baptiste Say

20-11-2018 : “Do you want to better understand how accounting principles can impact on financial management regarding cash management or covering exchange risk? ”

  We devote an article to this topic in the November issue of The Vernimmen.com  newsletter which has just been sent to its subscribers and which is now available on Vernimmen.com. Have a nice day

19-11-2018 : “Quote of the day ”

I don't think money is particularly good for people. I think it probably spoils as many lives as it enhances. It is really the root of evil, isn't it?  John Caudwell, a billionaire

16-11-2018 : “Quote of the day ”

Monopolies are terrible things ... until you have one.   Rupert Murdoch.

15-11-2018 : “Question from a reader ”

I often hear the term Revolving Credit, but I don’t know what it means. Could you shed some light on this matter, as it causes me problems when I’m trying to solve financial problems.   A revolving loan is a line of credit which can be used in successive, renewable draw-downs.   For example, you can use a credit card to buy an oven in a department store, not pay for it immediately, but pay it off in full when you get the money, and then make a second drawdown to buy a washing machine that you’ll pay for later. This credit obviously is not free.   Companies usually make spot draw-downs over periods varying from between one and 12 months. There are also medium term drawdowns that can be used in successive draw-downs.   For more, cheek out chapter 21 of the Vernimmen.   Have a nice day  

14-11-2018 : “Quote of the day ”

If you take money out of your left pocket and put it in your right pocket, you are not richer. Merton Miller

13-11-2018 : “Question from a follower of the Vernimmen.com Facebook page ”

What is the notion of normative? In finance, normative means recurrent, in the normal course of business, without any exceptional events. A normative margin is the sort of margin a company can expect to make on a regular basis. A normative profit is the profit from which the exceptional items have been deducted.
Have a nice day.

12-11-2018 : “Quote of the day ”

Sales are vanity, profits are security, and cash is reality. Jean-Pierre Lac

09-11-2018 : “Maersk and Danske Bank ”

  Denmark is home to the largest group of container ships in the world, Maersk, founded by the family of the same name, which is also the largest company in this small country of just 6 million inhabitants.   Since 1928, the Maersk family has been the largest shareholder (21%) of what has become Denmark's largest bank, Danske Bank. Not stupid indeed to carry out a wealth diversification whereas Maersk is in a very cyclical sector, nor to have a foot in a bank which knows you well to help finance heavy investments, a container carrier being worth a little more than a scooter.   The Estonian subsidiary of Danske Bank, visibly poorly controlled by its parent company, would have in nine years whitewashed several tens of billions of euros (some even speak of €200bn) from countries of the former USSR.   The revelation of this scandal led Danske Bank shareholders to separate from its managing director in September, and most recently from the bank's president. The representative of the Maersk family said: "We are a large shareholder and we have obligations and it’s only fair there are expectations on us. "   Centuries away, we can echo Hamlet that in the Kingdom of Denmark, everything is not rotten, as long as there are shareholders aware of their responsibilities.   Have a nice day  

08-11-2018 : “Quote of the day ”

Never touch a business you don’t know.            Hachinobei Mitsui

07-11-2018 : “Question from a reader ”

Why in calculating free cash flow, do you not take the corporation income tax that is listed on the income statement? The corporation income tax is calculated on the operating result because if one took the corporation income tax that is actually paid from the profit before tax, it would include the impact of the financial structure through the financial charges of the debt that are part of the result before taxes. And this would contradict one of the principles of determining free cash flow, which is that free cash flow is independent of the financial structure. For more details, see chapter 31 of the Vernimmen. In the calculation of the cost of capital, the theoretical corporation income tax thus calculated is reconciled with the corporation income tax actually recorded (this is Chapter 29 of the Vernimmen). Have a nice day.  

06-11-2018 : “Quote of the day ”

There is nothing permanent, except change.  Heraclitus

05-11-2018 : “Question from a Vernimmen user ”

Some practitioners apply a DCF valuation model for different scenarios
(typically bad, average and good) and then to assign weights to the values,
they use the probability allocated to each corresponding scenario.
Therefore, the (expected) value of the company becomes the sum of those
weighted values.
If we consider that the cost of capital already incorporates the variability
(i.e. the stochastic nature) of a company's future cash flows, I feel that
using the two approaches together is not consistent. Moreover, using
scenarios that are company-specific means they are taking specific risks
into account for valuation purpose. Is this consistent with the diversified
investor paradigm?

This method has no theoretical groundings: it is an empirical tool and
nothing more.
If the 3 scenarios are bad, average and good, and if, as is often the case,
bad and good scenarios are obtained by reducing/increasing the average
scenario by around the same percentage, the resulting average of the 3
scenarios is very close to the average scenario, consequently bringing no
additional value to you. However, it does convey the impression that you
seriously studied the various risks the company is exposed to, which is
realistically nothing less than a joke.
The only value this might add is in the event that some threshold effects
were used and different upward and downward sensitivities were added.
What would be clearly wrong would be to discount the average of the 3
scenarios at the risk free rate and not at the WACC, by reasoning that the 3
scenarios capture all future possibilities, thus making the average of the 3
less risky. This is completely wrong but we have observed this being done
several times.  
With all this being said, the average scenario is realistically just another
scenario, which may or may not be slightly more likely than each of the 3
initial scenarios, but which cannot reduce nor eliminate the risk. As such
it is not in contradiction with the diversified investor paradigm.

Have a nice day.

01-11-2018 : “Big Blue acquires Red Hat ”


October 29 IBM announced a $34bn acquisition, its largest ever, fully paid in cash.
Before this acquisition IBM capitalized $116bn, since it capitalizes $107bn, a decrease of 7.5%.
It is true that with an acquisition premium of 63%, a purchase price representing 11.4 times the last known turnover, and 70 times the operating result of Red Hat, IBM did not buy on the cheap!
IBM was the epitome of the US multinational and the first group in the world by its market capitalization in the years sixties and seventies. After a successful transformation from computer manufacturing to IT services in the eighties, IBM has been suffering a lot since 2011 with a steady decline in revenue ($79bn in 2017 versus $107bn in 2011).
Presenting this acquisition as "This is all about growth" is a bit presumptuous, as, even if Red Hat's sales continue to grow at 20% per annum and that of the current IBM is stabilized, the sales gap between the two groups is such ($2.9bn and $79bn) that the growth rate of the new group will be only 0.7% the first year. Not enough to write to his aunt.
Moreover, the financial communication is quite dishonest, emphasizing: "Acquisition will be free cash flow and gross margin accretive within 12 months, accelerate revenue growth and support a solid and growing dividend". This does not require any management talent since Red Hat has higher gross margins than IBM and positive free cash flow, so the growth of these two aggregates, once IBM and Red Hat are combined, is as certain as 2 and 2 are 4.
If IBM has tried to combat the decline in its revenues since 2011 by regularly making acquisitions (for a few $bn per year), this acquisition is much larger and will push its net debt to EBITDA ratio to 4.7 times against 2.8 times in 2017.
If the Red Hat shareholders blushed to the announcement of the acquisition with a 49% increase in their share price, the shareholders of Big Blue seem rather to have a blue fear by losing in two days 2/3 of the control premium paid by IBM. One can understand them.
Have a nice day.

31-10-2018 : “Quote of the day ”

The man who makes it the habit of his life to go to bed at nine o’ clock, usually gets rich and is always reliable. Of course, going to bed does not make him rich - I merely mean that such a man will in all probability be up early in the morning and do a big day’s work... It’s all a matter of habit, and good habits in America make any man rich. Wealth is a result of habit. 
John Jacob Astor

30-10-2018 : “The value of Uber ”


Although it appears that the most recent transaction recorded to date
concerning Uber is Toyota's acquisition of $500m of new shares in August
2018, thus valuing the global start-up at $72bn; it also seems that Goldman
Sachs and Morgan Stanley recently and quite publicly published valuations of
$120bn in anticipation of an IPO that could occur in early 2019 and for
which they have been hired as advisors.
Three comments:
1. It is extremely difficult to value Uber, a global company that
quickly burns through substantial amounts of cash, and whose economic model
is likely to change dramatically with the advent of autonomous and connected
cars. It is in instances such as these that the words of an entrepreneur who
left school at the age of 14 to build a European group show their innate
wisdom: “the best valuation expert is the one who writes the check” (Guy
Verrecchia, founding president of UGC).
2. US banks never hesitate to post high valuations if it helps to
obtain an IPO mandate, which in this case should take place a few months
later. One must keep in mind that many things can happen in a few months’
time. Those of you who have seen the movie "Pentagon Papers" probably
remember Katharine Graham / Meryl Streep's uncomfortable face when she
discovers that the price of the Washington Post's IPO will be a few dollars
less than what Lazard had lavishly promised.
3. At worst, regardless the outcome, should the IPO eventually be
carried out at, for example, $90bn, then it is an opportunity to portray it
as a good deal for investors since people were quoting valuations of $120bn
a few months prior.
Who told you that finance is not also about marketing?

Have a nice day

29-10-2018 : “Quote of the day ”

In most businesses, the watchword is "The customer is always right". Accountants, however, are charged with telling the customer when he’s wrong. 
Arthur Levitt

26-10-2018 : “Benetton ”

  The death of Gilberto Benetton on Monday gave rise to publications of notes recalling the epic of the 4 brothers and sister Benetton who, starting from nothing in 1965, built a textile empire in the 1980s. And who especially knew how to take a strategic shift in the 1990s, investing cash flows from the textile business in catering concessions (Autogrill), airports (Rome and Nice), and highways (Atlantia) where they constituted the world leader in the sector with the takeover of Abertis. Today, Benetton's textile makes less than 15% of the group's sales. It is surprising that industrialists who have revolutionized their sector in their time converted themselves into concession operators, somehow into rentiers. The key to this evolution is perhaps to look for, as often in family businesses, on the side of the succession of the 4 founders. None of their 13 children wanted to take over the previous generation, and in these conditions invest in concessions is probably not the worst idea that can be for the next generation. Hat low MM. and Mrs. Benetton. Have a pleasant day.

25-10-2018 : “Quote of the day ”

Never go to sleep at night until your debits equal your credits. 
Luca Pacioli

24-10-2018 : “More than 700 participants for the 7th class of ICCF @ HEC Paris ”

Another record broken for this training course launched in 2015, which through 5 months of regular work allows one to master or review the fundamentals of corporate finance: financial analysis, valuation of companies, investment and financing choices. Here is a picture from a masterclass in Paris last week with some of the participants of this totally digital training program. For non-French speakers, my colleagues at Columbia Business School have developed an English version using the same format : ICCF@CBS.   Have a nice day

23-10-2018 : “Quote of the day ”

It's because gold is a currency that it is precious, not the other way round. Michel Foucault

22-10-2018 : “Question from one of our readers ”

What is the difference between the profitability required by investors and the theoretical equilibrium profitability of the CAPM, and how are they each calculated? The profitability required by investors is a general term that can intersect with the profitability required by shareholders, i.e. the cost of equity of the company; the profitability required by the company's lenders, that is, the cost of the debt; or the profitability required by all the investors who finance the business, that is, the cost of capital. These three required rates of return can be measured by the CAPM, see chapter 31 of the Vernimmen on the cost of capital and its calculation by the direct method, even if the CAPM is far more frequently used to calculate the rate of return required by the shareholders.   Have a nice day

11-10-2018 : “Quote of the day ”

No matter how skillful the trading scheme, over the long-haul abnormal returns are sustained only through abnormal exposure to risk. 
Alan Greenspan

10-10-2018 : “Question of a reader ”

Could you explain how to calculate the logarithmic returns of a share portfolio and provide an example?   Assume you have the following share prices: 100 ; 105 ; 110 ; 105 ; 120 ; 125. You transform them by taking their log: 4.605; 4.654 ; 4.700; 4.654; 4.787; 4.828. And then you calculate the returns by the differences of these figures: 4.654 – 4.605 = 0.05, ie 5%; then 4.700 – 4.654 = 0.046; - 0.046; 0.133; 0.041. Then if you wish, you can calculate the average, the standard difference for this series of returns. Have a nice day  

09-10-2018 : “Quote of the day ”

Acquaintance: a person whom we know well enough to borrow from, but not well enough to lend to.
Ambrose Bierce

08-10-2018 : “The active / passive fund management match ”



Morningstar, in a study  on 9,400 active or passive European funds and managing € 2900 billion from June 2008 to June 2018, shows that active managers beat passive competitors in only two out of 49 fund categories in 10 years. Is not a surprise for those of you who believe in the efficiency of the markets in the sense that the Nobel Prize winner Eugène Fama gave (see Chapter 15 of the Vernimmen), or the power of collective intelligence in the processing of a very large number of data.

The inclusion of passive funds rather than the indexes to which they refer makes it possible to take into account their costs, even if they are modest, and therefore to compare the returns net of fees for investors.

On the other hand, the study did not eliminate from its very large sample the false active funds that claim to be active in order to be able to charge high management fees but which, in reality, simply hold a portfolio similar to that of their index, but for some overweights or underweights. Market authorities have recently been hunting them and it is hoped that they will be effective in eliminating this form of white-collar crime.

Have a pleasant day

05-10-2018 : “Quote of the day ”

  When there are no more buyers, all we're left with is sellers. 
Sam Zell  

04-10-2018 : “What would be the right ROCE for the main electricity producer in Niger? ”

We would say that a post-tax ROCE of around 12% would seem to be correct because it would correspond to its cost of capital. We have calculated the cost of capital in the following way. For EDF, the main French producer of electricity, the cost of capital is around 6% with long-term government bonds yielding 0.75%. As in Niger, long-term government bonds in CFA francs yield about 6.5%, we added the differential of about 6% to the cost of capital of EDF. Hence 12%. By offsetting the inflation differential between the two countries of 5% (inflation in Niger) - 1.5% (inflation in France) = 3.5%, this gives a rate of 8.5%, ie 2.5% more than EDF, to consider a political risk that is not this of Europe and which level does not seem shocking to us. Have a nice day

03-10-2018 : “Quote of the day ”

If you think education is expensive, try ignorance! 
Anonymous

02-10-2018 : “Question of one of our readers ”

The ROCE (operating income / operating assets) may improve over a given period simply because of the depreciation that reduces the fixed assets. Therefore, and in order to eliminate the impact of depreciation, would it make sense to calculate the ROCE as EBITDA/ (Gross fixed assets + working capital)? Keep in mind that while the depreciation expense reduces the denominator of ROCE by reducing net fixed assets, it also reduces its numerator the EBIT. So, the impact of depreciation is not unambiguous. Reasoning in gross fixed assets only seems to make sense in the few sectors where the depreciation charge has no financial reality because it does not correspond to a loss of value. They are few in number, for example the hotel industry, rather high-end, or the portfolios of cinema films. For more details, see chapter 13 of Vernimmen. Have a nice day

01-10-2018 : “Quote of the day ”

Provide a short description of a long-term investment. A short-term investment gone wrong!
Anonymous

28-09-2018 : “Question from reader ”

It seems intuitive that the cost of capital for very fast-growing companies is naturally higher than that of a comparable but more established firm given the additional risk that very strong growth forecasts present. How should one take this risk into account? Initially, I tended to adjust (= multiply) the equity market risk premium by the ratio between the expected growth of the project and that of a benchmark of companies in the same sector. Does this method have any value from a theoretical point of view?   We agree with you that a fast-growing company will have a higher capital cost for the reasons you mention. This being said, there is no theoretical basis to multiply the equity market risk premium by the ratio of growth rates. The method you’re using is empirical and mathematical fiddling, but fiddling still the same! The parameter that is impacted by a higher growth rate is the beta of the company as we explain in chapter 18 of the Vernimmen. It is therefore this parameter which must be different from that of a mature company. Similarly, when looking at what cost of capital to expect from a greenfield project as opposed to a mature project in the same sector (ie. oil exploration, or the construction of an EPR reactor versus the purchase of a conventional nuclear power plant), we found a higher cost of capital for the greenfield business of around 2% (see Chapter 29 of the Vernimmen). We would be surprised if in your case the difference were significantly higher.   Have a nice day.

26-09-2018 : “Do you know Ester? ”

This is the European Short-Term Rate that will replace the Eonia from 2020. Calculated by the ECB from the rates of unsecured overnight loans contracted in euros by European banks, it will result from the weighted average of the volumes of the rates observed after elimination of the 25% of the volumes granted at the highest rates and the 25% lowest.

It is therefore much less likely to suffer from the lamentable manipulations observed a few years ago by dishonest banks which made false statements to influence the calculation of the index or hide their real short-term cost of funding. ESTER is in fact calculated on transactions registered with the ECB and not on simple statements made by banks.

Have a pleasant day.

24-09-2018 : “The Vernimmen.com Newsletter of September ”

Why has the average return on a large portfolio of Chinese shares been so poor since the early 2000s (3.7%)? The answer is in the Vernimmen.com Newsletter issue of September available on the vernimmen.com website if you have not received it as one of its subscriber. Poor profitability of listed Chinese groups (35 % of them do not earn their cost of capital) is one answer. Also an article about SPACs in Europe versus the USA.   Have a nice day.

21-09-2018 : “Question from a reader ”

For multi-year projects such as hydroelectric dams, is the project's IRR to be calculated from the year of beginning of construction or when the dam starts to produce electricity, considering capitalization of the capex up to the year of initial production?  An IRR is computed by definition by considering all relevant cash flows as they occur, not capitalizing some at a certain rate. This method would not lead to an IRR as defined and would raise the problem of the capitalization rate. If you would take the cost of the debt that was used to finance the building, you would forget the cost of equity that was used as, at least implicitly, in obtaining the loans. If you would take the cost of capital, this is already better. But what you would get as a solution to your equation would not be an IRR but a Jack-of-all-trade rate, average between the true IRR that you will not know and the cost of capital.  For more details, see chapter 17 of the Vernimmen.

20-09-2018 : “Quote of the day ”

In the short-term, the market is a voting machine .... But long-term, the market is a weighing machine...  Benjamin Graham

19-09-2018 : “Question from a follower of the Vernimmen.com Facebook page ”

If an asset that was 100% financed by debt is sold below its carrying value, does that impact equity? If an asset is sold at a price lower than its carrying amount in the balance sheet, regardless of how it was financed, the company automatically realizes a capital loss, which reduces the equity via the result that is weaker as a result. For more, have a look on Chapter 3 of the Vernimmen. Have a nice day

18-09-2018 : “Quote of the day ”

Most people would rather die than think; in fact, they do so.  Bertrand Russel

17-09-2018 : “What is cash back? ”

    It is a technique that allows an individual to withdraw small amounts of cash at the same time that he or she  pays for his or her purchases by a credit card in a shop. The shop-owner/clerk then gives him, at the same time as the purchases, this sum to his client who is withdrawn from his bank account and transferred to the merchant's bank account. This is an emergency technique, especially useful in rural areas with few ATMs.   It is a new definition in the Vernimmen glossary that you can find on the vernimmen.com website, with hundreds of other financial terms.   Have a nice day

14-09-2018 : “Quote of the day ”

Many economic theories are rendered false because they are based on the assumption that man is a reasonable being.  Auguste Detoeuf

13-09-2018 : “Question from a reader ”

Is a very high EPS in € the sign of a share to buy? While doing a quiz of the vernimmen.com site, I came across a question from a company with a P/E ratio of 4 and I thought that a low EPS meant a very high earnings per share, and therefore a profitability just as high. But the answer says the opposite, speaks of high risks. Why is my reasoning wrong?   It's a classic mistake that you will not do again once you finish reading this post. A very high EPS does not mean anything. Only the growth rate of EPS counts, not its absolute level. Indeed the level of an EPS depends on the choice made by the company of the number of shares. If a group chooses to have a capital made of 1,000 shares and the value of its equity is €10,000,000, each share will be worth €10,000; and if its net profit is €700,000, its EPS will be €700. But this same group could very well have decided to have a number of shares of 100,000; in which case its EPS would have been €7 and the share value €100. In both cases, the P/E ratio is the same at 14.3. In other words, a share worth €10,000 can be as expensive in terms of P/E ratio as another one that is worth €100, or cheaper or more expensive.   This is the same idea as for the currencies: the yen is not weak vis-a-vis the euro simply because it takes several yens to buy a euro; and the pound is not strong against the euro because it takes more than one euro to buy a pound.   Have a nice day

12-09-2018 : “Quote of the day ”

Cash is king  Anonymous

11-09-2018 : “Question from a reader ”

In calculating free cash flow, when should the corporation tax be deducted: After the operating result or after adding back the depreciation allowance?   It does not matter the order of the factors because A + B - C + D = A - C + B + D. On the other hand, it is important to calculate the theoretical tax on the operating result, and not on the EBITDA or the profit before tax. More details if necessary in chapter 31 of the Vernimmen.  

07-09-2018 : “Question from a follower of the Vernimmen.com Facebook page ”

If an asset that was 100% financed by debt is sold below its carrying value, does that impact equity? If an asset is sold at a price lower than its carrying amount in the balance sheet, regardless of how it was financed, the company automatically realizes a capital loss, which reduces the equity via the result that is weaker as a result. For more, have a look on Chapter 3 of the Vernimmen. Have a nice day

06-09-2018 : “Quote of the day ”

Never sell unless there are two buyers.  Eugene Kleiner

05-09-2018 : “M&A rankings: truth or cheating? ”

The Agefi ranking for M&A deals on the French market for the first half of 2018, published before the summer break, shows that 13 banks (sic) advised Unibail-Rodamco or Westfield in their merger which, with nearly € 21 billion, was the biggest transaction of this semester in France. And these 13 banks occupy the top 13 spots in the ranking given the size of this transaction compared to other transactions recorded.   Since it is not true that 13 banks advised both parties (fortunately for the parties who otherwise would have had to charter buses to go to negotiation meetings!), some banks had to issue opinions of fairness (at unbeatable prices, or even for free) or to grant loans to obtain credit for this operation.   As this hypocrisy does not date from today, the best ranking is probably that made on the invoiced fees and not on declared transaction volumes.   Have a nice day

04-09-2018 : “Quote of the day ”

It is extremely difficult to deflate a balloon quietly with a pin  John Kenneth Galbraith (on the 1929 crash)

03-09-2018 : “Solution to the weekend brainstorming problem ”

First a remainder of the problem A friend and an investor asks you about the valuation of a company close to bankruptcy offering prospects for recovery. He is quite embarrassed because between the projections and the situation at this moment, we go from darkness to light !!!!!! How can he proceed to make conclusions that are intellectually honest and meaningful economically and financially? The study carried out by a firm that was handed to him leaves him perplexed: Amount of the book equity: €5000, equity value obtained by discounting cash flows: €12m. He tells you that for him, this approach is an absurdity (to remain courteous and polite). Now the solution
Here are two ideas you could suggest to your friend: 1 / you value the company for the carrying amount of its book equity and give the current shareholders warrants with a nominal exercise price that are exercisable if the company holds the business plan that justifies the value of the discounted free cash flow of € 12 million. 2 / You value the company by discounting free cash flows but you take a discount rate of a venture capital type (40 or 50%) the first years which only falls to 10-15% once that the company is saved from its predicament. For example, the flow of year 5 is disconted as F5 / (1.4 ^ 2x1.1 ^ 3), if it takes two years to turn around the business. Have a nice day.

31-08-2018 : “Brainstorming for the week-end ”

  A friend and an investor asks you about the valuation of a company close to bankruptcy offering prospects for recovery. He is quite embarrassed because between the projections and the situation at this moment, we go from darkness to light !!!!!! How can he proceed to make conclusions that are intellectually honest and meaningful economically and financially? The study carried out by a firm that was handed to him leaves him perplexed: Amount of the book equity: €5000, equity value obtained by discounting cash flows: €12m. He confides that for him, this approach is an absurdity (to remain courteous and polite). Have a nice weekend.

30-08-2018 : “Quote of the day ”

The market is a large movie theatre with a small door. Nassim Nicholas Taleb

28-08-2018 : “Quote of the day ”

Nothing is more practical than a good theory.   Albert Einstein

27-08-2018 : “Answer to last Friday's brainteaser ”

First recall the problem:  You observe the following data for an industrial company in the field of BtoB: Sales: € 9 million Operating result: € 0.9 million Net result: € 0.6m Equity: € 6m Net banking and financial debt: € 0m Fixed assets: € 3 million Stocks:  € 1,5 million Customers: € 0.1 million Suppliers: € 0.9 million What can you deduce about how it is financed? What is striking is the weakness of the customer, line on the balance sheet: one hundred thousand euros for ten million sales, i.e. 3 days of sales outstanding. Impossible, except if the company has securitized or factored the customers' bills and that they are not consolidated back in the balance sheet. In fact, this company, apparently without net banking and financial debts, has financial debts that can be estimated, taking an average payment of 50 days and a 20% VAT, to about € 1.5 million. Have a nice day.  

24-08-2018 : “Weekend brain teaser ”

You observe the following data for an industrial company in the field of BtoB: Sales: € 9 million Operating result: € 0.9 million Net result: € 0.6m Equity: € 6m Net banking and financial debt: € 0m Fixed assets: € 3 million Stocks:  € 1,5 million Customers: € 0.1 million Suppliers: € 0.9 million   What can you deduce about how it is financed?

23-08-2018 : “Question from a reader ”

Can a free cash flow discount method be used to value an investment bank? Yes, but with changes compared to what is done for non-financial companies. Free cash flow will be the amount of net income that can be distributed to shareholders while leaving enough equity in the bank for it to respect its prudential constraints imposed by central banks and the so-called Basel III regulations. And the discount rate will be the cost of equity, as the concept of cost of capital does not make sense for a bank. 
Have a nice day.

22-08-2018 : “Quote of the day ”

The only thing men get passionate about, besides love, is the question of exchange rates.       Benjamin Disraeli

21-08-2018 : “Quarterly results and short-termism ”

Mr. Trump has asked the SEC to think about changing the results of US listed companies from a quarterly basis to a semi-annual one, overturning a 1970 decision to move to quarterly reporting. This would be an alignment with the European position which has eliminated the obligation to publish quarterly results since 2013. If this measure were adopted by the SEC, and then by the companies (because it is not a question of prohibiting the publication of quarterly results, simply of removing the obligation to publish it. In Europe, many listed groups continue to publish quarterly results), we do not think that the short-termism of some investors would be reduced and its negative effects on the companies neutralized. Indeed, what seems unhealthy to us is not the publication of quarterly results in themselves, but the publication on this occasion of guidances regarding the results of the next quarter. Once these indications are given, the company feels obliged to respect them and can then be led to manage its operations with a goal to 3 months to deliver what it promised whatever happens. Visibility at 3 months is not obvious because if a big customer differs its order by a week, or a supplier delivery for any reason, the activity can be disrupted with a short time to catch up. Hence possible adverse effects such as the reduction of an R & D program to reduce expenses of the current quarter in order to reach the guidance. If someone wants to prohibit something, it would seem to us better to forbid the issuance of short-term guidances to help CFOs who do not feel strong enough to make that decision on their own. Let us remind our readers that the publication of quarterly results by large European listed groups dates back to early 1999 when Paribas and Société Générale, being the object of a hostile dual offer by BNP, began to publish results for the first quarter of 1999 because they were excellent and well beyond the expectations of investors. It was an interested way of breaking an asymmetry of information and, above all, failing to escape a takeover by BNP, to have a share price and / or a price of change of control that reflects the present situation and not the one of six months ago. More recently, last week, the Walmart share price jumped 9.3% on the announcement of better-than-expected quarterly results, especially on grocery sales where it is attacked by Amazon. The publication of Macy's quarterly results resulted in a 16% drop in the price. This shows that these results contain information deemed relevant by investors, even for very large groups. In the absence of these publications, for 3 months buyers of Walmart shares and sellers of Macy's shares would have benefited from a windfall effect to the detriment of their counterparties. Have a nice day.

17-07-2018 : “Quote of the day ”

“Minimising a rate means maximising value, and vice versa. “
Pierre Vernimmen

16-07-2018 : “Solution to the problem of last Friday ”

First recall the problem: You need to value a company in the emerging world whose financial statements do not clearly reflect the reality of things since at least 50% of sales are not declared.   Which valuation method would you use in this case?   The parameters to take into account: - the land and buildings are not valued at market value in the balance sheets but at acquisition price (rather low), - the net results are insignificant due to tax optimization (undeclared sales), - companies are undercapitalized with huge debtors (10 times equity), - inventories seem to properly valued,   Answer: This company should be valued using the sum-of-the-parts method adding the assets valued on the basis of their market value and subtracting the debts. Do not forget to obtain from the seller a guarantee against hidden debts (for example by retaining a part of the price during the period during which the tax administration can come to correct you on the sales made and not declared). Indeed, any other method seems ineffective because of the under declaration of sales which removes all the relevance of the elements of the profit and loss account and the cash flow statement. Hace a nice day.  

13-07-2018 : “weekend brain teaser ”

You need to value a company in the emerging world whose financial statements do not clearly reflect the reality of things since at least 50% of sales are not declared.   Which valuation method would you use in this case?   The parameters to take into account: - the land and buildings are not valued at market value in the balance sheets but at acquisition price (rather low), - the net results are insignificant due to tax optimization (undeclared sales), - companies are undercapitalized with huge debtors (10 times equity), - inventories seem to properly valued, Have a nice week end.

12-07-2018 : “Quote of the day ”

  “Money is like the crowd that piles into a crowded coffee shop, deserting the coffee shop opposite, not because the service is bad, but because its empty. “
Auguste Detoeuf

10-07-2018 : “Quote of the day ”

  “A firm has reached its limit in terms of size when it is as expensive to organise a deal as to do it directly on the market. “
R.H. Coase

09-07-2018 : “Solution to the problem of last Friday ”

First recall the problem: What is the variable which splits the eurostoxx50 groups into two sets, excluding banks, insurance and real estate?   Set 1: AB InBev, Ahold, Airbus, Danone, Eon, Inditex, Enel, Iberdrola, Orange, Saffron, SAP, Telefonica, Volkswagen, Unilever, Vinci, Vivendi.   Set 2: Adidas, ASML, Air Liquide, BASF, Bayer, BMW, CRH, Daimler, Deutsche Post, Deutsche Telekom, Engie, Eni, Essilor, Fresenius, L'Oreal, LVMH, Nokia, Philips, San Gobain, Sanofi, Schneider , Siemens, Total.   Answer: the working capital! The first group includes companies with a negative working capital, the second group with a positive working capital. 16 against 23. Companies with a negative working capital are to be found not only in retail because the working capital is also the expression of the balance of power in the value chain. Better to be a supplier of L'Oréal rather than Airbus if cash is not your strong point!   Have a nice day.

06-07-2018 : “Weekend brain teaser ”

What is the variable which splits the eurostoxx50 groups into two sets, excluding banks, insurance and real estate?   Set 1: AB InBev, Ahold, Airbus, Danone, Eon, Inditex, Enel, Iberdrola, Orange, Saffron, SAP, Telefonica, Volkswagen, Unilever, Vinci, Vivendi.   Set 2: Adidas, ASML, Air Liquide, BASF, Bayer, BMW, CRH, Daimler, Deutsche Post, Deutsche Telekom, Engie, Eni, Essilor, Fresenius, L'Oreal, LVMH, Nokia, Philips, San Gobain, Sanofi, Schneider , Siemens, Total.   To help you, read chapters 4 and 11 of the Vernimmen.   Have a nice day.

05-07-2018 : “Quote of the day ”

  “You don't solve a problem by setting it aside.” 
Winston Churchill

04-07-2018 : “ Can you explain to me what is the meaning of a capital reduction by exchange of securities for a holding company? ”

  A holding company proposes to its shareholders, or some of them, to exchange shares it holds in the capital of one of its subsidiaries for shares of its own capital which it will then cancel. This is a way to allow its shareholders to find liquidity if the shares of the subsidiary are more liquid (because they are listed for example) than those of the holding company; and / or a way for it to sell the securities of the subsidiary; and / or a way for a shareholder of the holding company, which will not participate in this offer, to increase its stake in the capital of the holding company. Have a nice day  

03-07-2018 : “Quote of the day ”

  “There is more to life than just money... There is more money! “
Georges Bourdoiseau  

03-07-2018 : “Dell, a successful LBO ”

  In 2013, Michael Dell and Silver Lake had taken private Dell from the Stock Exchange for $ 25bn, of which its founding president then held 14% (a $ 3.5bn stake). The debt contracted was approximately $ 14 billion. Yesterday, the Dell IPO was announced with a stake for its founder between 47% and 54% for a group value of about $ 70 billion, giving a $ 35 bn fortune to the eponymous founder, i.e. 10 times its 2013 investment. The IRR over 5 years is . . .  58 % per year. Beauty of the leverage effect  that works well and allows an entrepreneur to regain control of his group. In France, after several consecutive LBOs and a remarkable job, Frédéric Sanchez and his team managed to take control of Fives, an industrial engineering group, one of France's least known success stories. For a leverage effect that works in the wrong direction, see the restructuring announced last week of Orchestra's financing, a company listed on the stock market, but with a debt level similar to the one of an LBO, which is significantly diluting its founder. Have a nice day.

02-07-2018 : “What is a normative margin? ”

The notion of normative is clear, the level of margin which a company should reach under normal conditions of activity, without exceptional element; but its implementation is difficult because there is a lot of subjectivity in this calculation. This involves studying the margins of competitors and its own over a fairly long period (the entire duration of a cycle for a cyclical industry). Very often there is a certain dose of optimism in this determination which leads to defining normative margins which are more objectives to be achieved in a few years (and which one never reaches) than a normal level of margin, cleared from non-recurring or non-durable items. Have a nice day.

28-06-2018 : “Quote of the day ”

The rich man vanquishes time and time vanquishes the poor man. Irish proverb

27-06-2018 : “Chanel dividend policy ”

  And here is an assignment that deserves the best grade!   "The mandate entrusted to me by Alain Wertheimer (the shareholder of Chanel) is to have no debt, to prioritize financing investments and maintain the structure of the balance sheet. The policy of dividends is a consequence of these priorities. " Philippe Blondiaux, CFO of Chanel. Les Echos. June 22, 2018   And, in this logic, 2017 dividends were reduced from $591M to $109M, for a 2017 net income of $1.79bn, up 19%.   Shareholders do not ask for dividends, they ask first that the company finds investments that earn at least their cost of capital. It is true that it is easier to implement this sensible dividend policy when the company is unlisted or listed but a dominant shareholder who can impose it on certain investors who confuse dividends and value creation.   Have a nice day

26-06-2018 : “Quote of the day ”

In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.
Rudiger Dornsbusch

25-06-2018 : “Hermès exceptional dividend ”

Hermès paid an exceptional dividend of € 5 per share, which was voted by its shareholders at the annual meeting of June 5, 2018. On this occasion, the CFO said: "This exceptional dividend is intended to distribute a portion of the large cash available: 3 billion euros.” The chairman of the Supervisory Board added: "The exceptional dividend rewards the loyalty of the shareholders. But the best reward is really the evolution of the share itself.” Of these three sentences, one is inaccurate. Which one? The second. In the same way that if you take out a reward on your child's saving’s account, paying a dividend, even an exceptional one, has never enriched a shareholder because the counterpart of this dividend, as well as any dividends anyway, is a mechanical decline in the value of the share of the same amount, which is logical since the company, by paying a dividend, is deprived of an asset, so its value has declined. The day Hermes paid its exceptional dividend, the price fell in value. Conclusion: You may be chairman of the supervisory board of one of the world's most successful groups and have a loophole in finance. But as finance is not the alpha and the omega of the business world, it does not matter that much. Especially since the insistence of some shareholders to claim dividends shows that reading chapter 36 of Vernimmen would do them good. Have a nice day.

22-06-2018 : “Quote of the day ”

“A source of financing is considered cheap only if its net present value is negative”.  Pierre Vernimmen

21-06-2018 : “Another IPO cancelled at the very last minute ”

Delachaux, the rail equipment supplier, which was to be listed on the stock market at the beginning of this week, to allow the LBO fund CVC to sell most of its stake of 49.9%, has announced last Thursday that it gives up its IPO because the Canadian investment fund CDPQ has just acquired the participation of CVC. This is a new illustration of the rise of these new players on the LBO scene that we highlighted in the June issue of the  Vernimmen.com newsletter and that upsets the scene of medium-sized LBOs, and that of IPOs.  The June issue has just been sent to its subscribers and is also available on the vernimmen.com website. Have a nice day

21-06-2018 : “General Electric is expelled from the Dow Jones Index: Sic transit gloria mundi ”

Founding member in 1896 and continuously since 1907. It is replaced by the chain of pharmacies and drugstores Walgreens Boots Alliance (which shows that it is possible to do better than resist to the Amazon wave in retail). In 2002 and 2005, GE was still the world's largest market capitalization with around $300bn (versus $112bn now and versus a $500bn brief apex) and above all, a universally admired management model. But a conglomerate can only stay on the top if all its divisions remain at the top and the top management is able to make the right choices of division bosses. Necessarily temporary, and GE has taken the path of deconglomerisation, as Siemens, Fiat, Kering, Philips have done, shedding, selling and demerging assets, hence a lower price. We take this opportunity to remind you that the Dow Jones index has a great media recognition but that it is almost not used in the financial industry, serving as a support to index funds for only $29bn against nearly $10000bn for the S & P 500. The reason for this lack of interest of financial people: its weighting, not by market capitalizations or free floats, but by stock prices, much simpler to calculate the index by hand in the good old days, but which does not give a true and fair view of the market gyrations. For more details, see the Vernimmen.com Newsletter #21 of December 2006. Have a nice day. PS: If Apple is a member of the DJ (it pushed out another historical pillar, AT&T), Amazon is not there.

20-06-2018 : “Quote of the day ”

“Man is but the only true wealth.”  Jean Bodin

19-06-2018 : “Hermès exceptional dividend ”

Hermès paid an exceptional dividend of € 5 per share, which was voted by its shareholders at the annual meeting of June 5, 2018. On this occasion, the CFO said: "This exceptional dividend is intended to distribute a portion of the large cash available: 3 billion euros.” The Chairman of the Supervisory Board added: "The exceptional dividend rewards the loyalty of the shareholders. But the best reward is really the evolution of the share itself.” Of these three sentences, one is inaccurate. Which one? The second. In the same way that if you take out a reward on your child's saving’s account, paying a dividend, even an exceptional one, has never enriched a shareholder because the counterpart of this dividend, as well as any dividends anyway, is a mechanical decline in the value of the share of the same amount, which is logical since the company, by paying a dividend, is deprived of an asset, so its value has declined. The day Hermes paid its exceptional dividend, the price fell in value. Conclusion: You may be chairman of the supervisory board of one of the world's most successful groups and have a loophole in finance. But as finance is not the alpha and the omega of the business world, it does not matter. Especially since the insistence of some shareholders to claim dividends shows that reading chapter 36 of Vernimmen would do them good. Have a nice day.

18-06-2018 : “Quote of the day ”

“The trees don't reach the sky” 
Proverb

15-06-2018 : “Quote of the day ”

“Nothing is self-evident. Nothing just gets given. Everything has to be built up.”  Gaston Bachelard

14-06-2018 : “The annual report of WPP ”

Every year we read annual reports, those of the companies of which we are shareholders, those of the companies in which we could become shareholders, those of the companies of which a deal or a situation serves us to write a case for our students; and that of WPP.   Why the one of WPP? Because this marketing group inserts each year in its annual report a section of fifteen or so pages that talk about the recent global trends in consumption and the upcoming trends over the next 5-10 years. And marketing is a reflection of our times.   Unfortunately, this year it disappeared, probably with the sudden departure of its founding president, Martin Sorrell, who wrote it.   This year two striking points:   1 / In the summary of the financial results, 5 aggregates (operating result, profit before tax, current result, net result and EPS) are presented twice, under IFRS and under headline, which does not simplify the reading of the accounts. Worldwide, companies feel the need, to respect the principle of good information, to correct the IFRS standards. As a result, WPP 2017 EPS is up 6.4% in headline and not 31.9% as published under IFRS. The IASB would do well to seriously tackle this issue, which undermines the credibility of its standards.   2 / A summary table that combines the return on equity and the cost of capital. One would expect a comparison between ROE and the cost of equity because the two data are comparable and homogeneous, measuring what is required by shareholders on one side (the cost of equity) and on the other one what is obtained (return on equity). Not with the cost of capital which is comparable to ROCE. WPP is performing well enough (16.9% return on equity with net debt representing twice the EBITDA) to allow it to display consistent figures.   Have a nice day.  

13-06-2018 : “Quote of the day ”

“We always overlook the fact that working has become a leisure activity.” 
Mark Abrams

12-06-2018 : “Hermès joins the CAC40 ”

Impressive success: €60bn of market capitalization, 10% more than AXA, 10% less than BNP Paribas; with only €5.5 billion in turnover and 13,500 employees, but it is true a current operating margin of. . . 35%. And a 2017 P/E ratio of 50 times (when one loves, one does not count!). It should be noted that Hermès replaces the world leader in cement  LafargeHolcim in the CAC40. Finally, one of our favorite quotes we ask readers of Chapter 42 of the Vernimmen to comment. To a financial analyst who asked him at the time of the IPO in 1993 what would be his financial strategy, J.-L. Dumas (president of Hermes) replied "Let my grandchildren be proud of me". Mr. Dumas, rest in peace, you grandchildren can be proud of you. Hats off. Have a nice day

11-06-2018 : “Quote of the day ”

“The stock market is not slave to the time told by clocks.”  Benoît Mandelbrot

08-06-2018 : “Question from a German reader ”

In the formula of return on capital employed, it is necessary to subtract from the operating result the theoretical tax (say 30 % for Germany). If a company has significant tax loss carryforwards, should a lower rate be retained or is it preferable to calculate a customized rate such as taxes / operating income? It seems more appropriate at this level to think with a normal tax rate, which does not take into account tax losses carried forward because sooner or later they will eventually run out. Moreover, in order to compare with non loss-making companies, it avoids showing any over-returns that are not real one. Companies that have experienced difficulties and which have legally removed entire sections of their equity (the losses are accounted for by a decrease in equity without the shareholders having given up asking for a rate of return on this fraction of their investment), allowing them to publish better rates of return, have enough advantages and it is not fair to add more! Have a nice day

07-06-2018 : “Quote of the day ”

  “The fact that it is impossible to predict future prices on the basis of studies of past and present prices is a sign, not of the failure of economic laws, but on the contrary, their triumph, when competition is free.” 
Paul Samuelson

06-06-2018 : “Question from a Vernimmen reader ”

Why is book equity including this year net income used in computing return on equity? Knowing that the result of the year does not contribute to its own realization. It's a matter of convention and simplicity. It would be more rigorous to exclude from book equity the result of the year because, as you point out, it did not contribute to his own realization. But it is one more calculation for the ROE which would also induce more complicated additional calculations for the calculation of the ROCE to which the return on equity is often compared. In doing so, the ROE is slightly underestimated, but this is not a serious problem because the error is quite small (in the order of the rate of return itself) and the cost of equity, to which ROE is also compared, is not also absolutely accurate (roughly the same level of uncertainty). This illustrates the fact that in finance too, as in many other fields, the effort (of calculation here) must be measured according to the interest or not in obtaining a precise figure. Have a nice day.

25-05-2018 : “Quote of the day ”

“Harry Roberts and I run an average of 4 miles a day. Harry runs 8.” 
Merton Miller

24-05-2018 : “Why do companies feel the need to develop alternative performance indicators to IFRS's? ”

A study by Mazars shows, on a sample of 86 European groups, 7 different names for the operating result (operating result, EBIT, result of operations, etc.) and the use by 39 of 51 industrial groups to adjusted operating profit. Of course, let's not be naive. If companies do it, it is to try to present their results in the best possible light. But it is also to respect the principle of good information as the IASB that produces the IFRS has abdicated its responsibilities in this area. Thus the deletion in the IFRS of the distinction between current and exceptional items, on the pretext that it is a question of judgment (as if the establishment of the accounts did not require any judgment on the part of those who produce them) necessarily drives the readers of accounts interested in this information (unlike the IASB) to seek it in one way or another, and companies to assist them in this task by developing performance indicators that overcome the shortcomings of IFRS.   If the alternative performance indicators are presented by the listed companies with pre-eminence over the IFRS indicators, in contradiction with the recommendations of the European securities regulator (ESMA), it is not the companies that are at fault, but fundamentally the IASB which has chosen to devote its energy over the past decade to unhelpful standards (such as the one on leases), rather than dealing with serious issues like this one. And it is not for lack of having been warned on many sides, including ours on several occasions. Over the years, the IASB has, with full knowledge of the facts, taken the risk of delegitimizing accounting. And the risk materializes.   Blaming companies to adapt, it is a bit as if, during strikes in public transportation systems, customers  would be criticized to develop car-sharing or teleworking ...!   Have a nice day.

16-05-2018 : “Quote of the day ”

  “Cash is Truth” 
Anonymous

15-05-2018 : “Question from a reader ”

WeWork's high yield debt has lost 5% in one week.
 If Entreprise Value = Value of Debt + Value of Equity and if Debt Value decreases ...:
 - either Entreprise Value decreases too, and the equity value decreases.
- but if Entreprise Value remains stable, does this mean that the equity value is increasing?
 There is something that I don’t understand ...


There are only 3 possible reasons for the decrease in the value of a company's debt:

- Either interest rates in the economy jumped sharply.

- Either the shareholders have made decisions which despoil the interests of lenders, such as paying a massive dividend that significantly weakens the solvency of the company.

- Or, and this is by far the most frequent case so much the second is unlikely in our time and in our far-off lands of the Far West of the 19th century: investors have revised downward their expectations of free cash flows generated by the company, for example following a result publication, and they think that the value of the entreprise value has decreased as a result. In this case, the equity value will have fallen even further, since equity is riskier than debt.

Have a nice day

14-05-2018 : “Quote of the day ”

  “Time is money “
Popular saying

11-05-2018 : ““Fillette à la corbeille fleurie” by Picasso ”

“Fillette à la corbeille fleurie” is a painting by Picasso (blue period, but announcing the pink period) that he, penniless and refusing to exhibit in salons, sold in 1905 to American collectors living in Paris Léo and Gertrude Stein for 150 francs of the time. Acquired in 1968 by Peggy and David Rockefeller, it was recently sold for $ 115 million, showing an IRR of 14.4% per annum, over the period of 113 years. Power of compound interests over a long period. Ironically, it was sold by Christie's in the Rockefeller Center in New York, which the family had built in the late 1920s and 1930s for a total of $ 250 million at the time. Approximately twice the current face price of this painting. The Rockefeller family came from France (Rocquefeuille), which they left when the Edict of Nantes was revoked to emigrate to Germany, and then to the United States. They contributed financially to the restoration of the Reims cathedral after WW1, of the castles of Versailles and Fontainebleau, and the construction of the International City in Paris (student housing). David Rockefeller (who died at the age of 101 in 2017), who was the president of Chase Manhattan Bank in the 1970s, helped to lift the Caribbean island of Saint Barthelemy out of extreme poverty by revealing its tourist potential. The reading of his memoirs is extremely interesting. Have a nice day

10-05-2018 : “Quote of the day ”

  “You can't have your cake and eat it.” 
Popular saying

07-05-2018 : “Question asked during a recruitment interview: ”

  What is the cost of capital of the Caisse des dépôts (The French sovereign wealth fund)? Question asked by Edouard Philippe, Prime Minister of France to the candidate Eric Lombard who answered: I do not know. This did not prevent him from getting the job. Like what in this type of situation, the franchise is paying. It is true that the cost of capital of the Caisse des Dépôts is not easy to calculate given the diversity of its businesses: social housing, diversified portfolio of shares, BPI France, controlled subsidiaries in regional planning, infrastructure and public transport with very long-term investments. As any reader of the Vernimmen knows (Chapter 29), there are as many capital costs in a group as different lines of business, plus one for the global cost of capital. Presumably, the Prime Minister was interested in the cost of capital for the very long-term investments of Caisse des Dépôts. For this, we advise him to read The Vernimmen.com Newsletter of May 2018 (which is not yet finalized and not yet published) and which will contain an article on this subject. Finally, we are happy to see that the Prime Minister of a country knows what the cost of capital is! Have a nice day  

04-05-2018 : “Question from one of our students ”

What are the due diligence done before an IPO? A company that goes public is surrounded by financial, accounting and legal advice and they do due diligences because it is primarily a regulatory obligation. Then, these diligences on the activity, the company, on its strategic and financial perspectives, on the accounts and on the legal aspects make it possible to draft the documents related to the offer which are made public later (prospectus, press releases ...). These documents engage the responsibility of the company vis-à-vis potential investors. Every detail of these documents is subject to verification and must be true and fair. Due diligence will be finalized with the issuance of legal opinions issued by legal counsel and certifications by banks and auditors. Compared to due diligence conducted during an acquisition, these are much broader, detailed and formal. The interests of market investors are protected in this way to avoid investment decisions based on false or inaccurate information. This practice is even more reinforced in the event of an offer in the United States. Have a nice day.

03-05-2018 : “Quote of the day ”

“The financial manager does not create value, he shares it.”  Pierre Vernimmen

27-04-2018 : “Question from a participant of the ICCF @ Columbia Business School ”

How to account for non-operating assets in the DCF( discounted cash flow) method? since their results are not taken into account in the operating flows, while they belong to the company.   Hello, They will be taken into account in the bridge from entreprise value to the equity value by reducing the amount of net banking and financial debt. This will inflates the value of equity. This is logical because these assets are real and must be taken into account somewhere, and it is here that they must be taken into account, since the flows / results they generate have not been taken into account as they are not included in the business plan.  Have a nice day

26-04-2018 : “Quote of the day ”

Economics is the only field where two people can share the Nobel prize for saying opposing things (Myrdhal and Hayek).
Roberto Alazar

25-04-2018 : “Question from a participant of ICCF @ Columbia Business School ”

    Why limit yourself to linear regressions in estimating multiples? Can not we use exponential or logarithmic or other regressions?   It is rarely used in practice for two reasons.   The first is that everyone does not master the sophisticated mathematical tool that are the exponential or logarithmic regressions.   The second because Cum hoc ergo propter hoc (correlation is not reason). In other words, one can have a good correlation without having a clear and understandable rationality between the two factors. Emile Durkheim showed that there was a good correlation between piano sales and suicide rates. Yet it is difficult to understand why these two variables would be related. The correlation that we see mathematically between multiples and growth rates is all the more relevant as it is easy to explain, not mathematically, why this linear correlation. It's almost common sense. The bar in the field of evaluation would be singularly raised if one were to try to explain why a regression is relevant in a logarithmic or exponential format and not a linear format.   Have a nice day  

24-04-2018 : “Quote of the day ”

You can't compare apples with pears. Popular saying

23-04-2018 : “Question from a Facebook follower ”

Could you please tell us what is the use we can made of knowing that a stock index such as the Dow Jones or the FT100 was up or down by 0.3 %t today ?   Sincerely not much. A bit like when you are told in the evening that it was sunny all day. This would be more useful information if it could be reliably given the day before for the next day!   More seriously, for many people a rise in share prices is considered as good news and a drop a bad one. Either because they personally have a portfolio of listed shares and if a particular index has risen, they feel wealthier; or because they deduce that a raising stock market is an evidence that the economy is doing well, which is not statistically always proven.   That said, the variations over a much longer period than the day are more interesting, because one can have 20 days upward of 0.2%, and a fall of 5% a day, which make that over the course of the month share prices have decreased, contrary to what the sum of daily impressions might suggest. Unfortunately, these are rarely given in general news media.   Have a nice day  

20-04-2018 : “Question from a Facebook follower ”

Are financial charges fixed or variable? In general, financial expenses are considered as fixed costs, as financial charges do not vary with the activity, at least for the range of activity variations for which the fixed costs remain fixed. If we want to refine, and the information is available, we can consider that the financial costs of debt financing investments (therefore medium / long-term debts) are fixed costs, but that the interests of the debts financing working capital are variable costs, because if the working capital varies as a result of a change in activity, the change in working capital will induce a variation in the short term part of bank or financial debts that finance it, and therefore a variation in interests paid. Have a nice day  

19-04-2018 : “Quote of the day ”

  “Nothing is ever created, nothing is ever lost, everything just changes.” 
Lavoisier

18-04-2018 : “Do you want to refine your resume? ”

Do you want to refine your resume? Get advice from a former investment banker, professor at HEC Paris, at http://www.vernimmen.com/Read/Articles_on_financials.php Have a nice day

17-04-2018 : “Quote of the day ”

  “When the figures don't verify the theory, then the figures are wrong.” 
Eugene Fama

16-04-2018 : “Question from a reader ”

What are the financial, tax and legal constraints involved in a merger between the company under LBO and its holding company? Financial constraints: if there are minority shareholders in the company under LBO, a merger will dilute the stake of the holding company’s shareholders significantly. This is because the holding company’s debt has made the value of its equity small compared with the equity value of the company under LBO;  Legal constraints: in addition to standard merger procedures (EGM, report by special mergers auditor), a merger soon after an LBO may give rise to legal issues in certain European countries for companies which are forbidden to provided guarantees to lenders financing the buyback of its own shares. In an LBO, the LBO holding company has given securities on its stake in the company under LBO and in the event of a quick merger, the debts of the holding company will appear on the balance sheet of the company under LBO.  Tax constraints – if the two companies are merged, in some countries the tax authorities might contest the deductibility of the interest expense on loans initially contracted by the holding company on the grounds that the company under LBO has no interest in merging and that the merger was forced on it by its majority shareholder, the holding company.  For more information, see chapter 46 of the Vernimmen.

13-04-2018 : “Quote of the day ”

"The only cause of the depression is prosperity."   Joseph Schumpeter

12-04-2018 : “Can we say that if ROCE is higher than WACC, then the return on equity is higher than the cost of equity? ”

Yes, there is no doubt about that and it can be seen in the following way:   If the ROCE is higher than the WACC, then the entreprise value is higher than the carrying amount of the operating assets.   Since the value of the net debt has no reason to be greater than its carrying amount simply because the ROCE is higher than the WACC (since the debt does not participate in the creation of value beyond  the interest rate paid), and since the value of equity is equal to the entreprise value less the value of the net debt, the surplus between the entreprise value and the carrying amount of operating assets, benefits only to shareholders and not to debt holders.   Therefore, the value of equity is greater than the book value of equity as it is equal to the book value + this surplus.   And if the value of equity is greater than its book value, it is that the return on equity is higher than the cost of equity.   For more see, chapter 26 of the Vernimmen.   Have a nice day.

11-04-2018 : “Quote of the day ”

  “Options or you pay your money and you live on tenterhooks!” 
Pierre Vernimmen

10-04-2018 : “Question from one of our follower: If there are so many advantages with tap issues, why is it not used all the time frequent issuers are interested in tap issues? ”

As a reminder a tap issue is a new issue of a bond with the same characteristic than another bond issued a while ago, sold at the market price and which enlarges the size of the initial issue.   When you are not a frequent issuer, you may only issue a bond every 2-4 years because your financing needs are not that high. Having issued 3 years ago a 5-year bond, either you tap your initial issue but the maturity of the new bond will be 5 - 3 = 2 years which is pretty short and may create a future liquidity problem in your balance sheet if you finance long term capex with the proceeds; or you issue a new bond for 5 or 7 years for example. Most unfrequent issuer will choose the latter option and will not tap their initial bond.   For frequent issuers like governments, large corporates, etc. that issue bonds every quarter or semester, this is less of a problem, at least for the first years after the issue of a long term bond. They can do tap issues several times in a row, but after a while, they will stop for this liquidity problem as the maturity of the initial bond is fixed and cannot be changed.   Have a nice day  

09-04-2018 : “Solution to the problem of last Friday ”

Hello,   The problem was: A business generates an annual free cash flow of 200 that does not grow anymore. Its cost of capital is 10%. Its discounted cash flow value is therefore 200/10% = 2,000. But it turns out that this business is made up of two divisions, one of which generates a cash flow of 100 which increases by 5% per year and the other of 100 which decreases by 5% per year. Since both have the same cost of capital of 10%, the first division is worth 100 / (10% - 5%) = 2000 and the second 100 / (10% - - 5%) = 667. So thus analyzed, this company is worth 2,000 + 667 = 2,667. Everything well weighed, is this company worth 2,000 or 2,667?   And the answer is: As you have understood, this problem is based on a sophism, that is to say a false reasoning that has the appearance of the true. In this case, it is wrong to say that it is equivalent to having a business that grows by 0% or two divisions of identical size that grow by 5% and -5%, although it is true that 5% - 5% = 0%. Indeed, very quickly the two divisions will no longer generate the same free cash flow due to their divergent growth rate. For example after 5 years, the free cash flow of the first is 128 and that of the second of 77. So it will no longer be possible to say that the growth rate of the group is the average between 5% and -5%, i.e. 0%. This will be the weighted average of 5% and -5%, but with different weights from the initial 50% -50%. Moreover, in the long term, the growth rate of the group will converge towards 5%, since by dint of - 5% per year, the second division will disappear: thus in year 50, its free cash flow will be 8 against 1,147 for the first division. A few years later, then it will remain only the first division that will become alone the group as a whole, and the group will grow by 5% a year. So using the discount of free cash flows method, our group is worth 2,667 and not 2,000. But for that the financial director will need to do work of education by communicating precisely on the performances of the two divisions, even by proceeding to the IPO of the first one, or simply splitting the group into two parts (demerger) to avoid significant underestimation (25% in our example). Have a nice day  

06-04-2018 : “Problem for the weekend ”

Hello, A business generates an annual free cash flow of 200 that does not grow anymore. Its cost of capital is 10%. Its discounted cash flow value is therefore 200/10% = 2,000. But it turns out that this business is made up of two divisions, one of which generates a cash flow of 100 which increases by 5% per year and the other of 100 which decreases by 5% per year. Since both have the same cost of capital of 10%, the first division is worth 100 / (10% - 5%) = 2000 and the second 100 / (10% - - 5%) = 667. So thus analyzed, this company is worth 2,000 + 667 = 2,667. Everything well weighed, is this company worth 2,000 or 2,667? Answer next Monday. Have a nice day.  

05-04-2018 : “The cause or the consequence? ”

A few days ago a financial news agency reported that: "Investors are flocking to the title of the temporary working group after the announcement of a sharp rise in its dividend."   If it were enough to raise its share price by 8.8% to increase its dividend, even strongly, many groups would regularly increase their dividends!   In fact, if the share price of CRIT, the company in question, rose 8.8% in one session, it is rather to put on the account of announced results better than expected: investors expected an EBITDA between €128m and €145m ; CRIT announced €150m, ie + 20%. It is this growth in earnings beyond the expectations of investors that triggered the rise in prices, especially since the increase in the dividend, starting from very very low and multiplied by 11, is a signal that the managers of CRIT are at comfortable with the current outlook of their business.   Even with a payout ratio of 58%, CRIT is safe from need, as its cash net of any bank or financial debt represents 20% of its market capitalization. And it's all equity, which CRIT no longer needs, that can be reinvested by investors in companies that they need equity.   Have a nice day  

04-04-2018 : “Question from a participant of the ICCF @ Columbia Business School ”

Between the variance and the standard deviation, what is the relevant indicator to assess the dispersion of the profitability of an investment? Hello, the one that is most often used is the standard deviation because it is of order one (like x) and not of order two (like x ^ 2 and like the variance), which has two advantages: the standard deviation is more meaningful than the variance when it is compared to what it must be compared to, ie the average. Indeed we compare meters with meters and not meters with square meters. Moreover, this simplifies the equations between risk (represented by the standard deviation of order one) and profitability (the average, also of order one). The variance is it of order 2 (the average of the squares of the deviations to the average). For more, see chapter 18 of the Vernimmen. Have a nice day.  

03-04-2018 : “Quote of the day ”

  “The power of money leads us to the gloomiest of aristocracies, the locked safe.” Balzac

02-04-2018 : “Solution to the problem of last Friday ”

Reminder of the problem: A holds 49.4% of X and has 2 out of 5 directors. B holds 50.6% of X and holds 3 directorships and appoints the chairman. The appointment or dismissal of the Chief Executive Officer, the Chief Financial Officer, the adoption or amendment of the budget or business plan, as well as the decisions of indebtedness, investments, acquisitions or disposals of assets require the agreement of A.   Does B have to consolidate X by global integration or by proportional integration under IFRS rules? And A by proportional integration or equity method?   Answer: A does not control X because he needs A to be able to take most important decisions in S. So for both A and B, it is the proportional integration that is necessary.   Have a nice day

30-03-2018 : “Problem for the week-end ”

A holds 49.4% of X and has 2 out of 5 directors. B holds 50.6% of X and holds 3 directorships and appoints the chairman. The appointment or dismissal of the Chief Executive Officer, the Chief Financial Officer, the adoption or amendment of the budget or business plan, as well as the decisions of indebtedness, investments, acquisitions or disposals of assets require the agreement of A.   Does B have to consolidate X by global integration or by proportional integration under IFRS rules? And A by proportional integration or equity method?   Have a nice day

29-03-2018 : “Question from a participant of ICCF@Columbia Business School: ”

What is the best method for calculating operating assets: the sum of equity and net financial and banking debts or the sum of fixed assets (Non-current assets) and working capital?   The best is to calculate it using both methods to verify that your calculation is correct, which is the case when you find the same figure for the operating assets computed as fixed assets + working capital or as equity + net bank and financial debts. Indeed, starting from a balanced balance sheet (assets = equity + liabilities), you must find the same figure for operating assets, unless you have forgotten figures or counted some twice. The calculation by shareholders' equity + net banking and financial debt is probably marginally a little faster, but it may lead you to believe that the amount of operating assets depends on the amount of debt and equity while in fact depending on the amount of the working capital and fixed assets. For complicated points you will be guided by chapter 7 of Vernimmen which will not leave you unarmed in front of unusual accounting items. Have a nice day  

28-03-2018 : “Quote of the day ”

Well, the thing about private equity is that it is kind of private. Edward Bramson

27-03-2018 : “What are financial synergies? ”

  For us there are like Jupiter or Danae: a myth and nothing real. Let’s illustrate what they are supposed to be. If your cost of capital is 10 % and you acquire a company with a cost of capital of 8 % (and for the sake of simplicity of a similar size), the global cost of capital of the new group will not be lower than 9 % (the average of 10% and 8%) as investors do not remunerate a reduction in specific risk as they can diversify it away at no cost for them. Another example. If your cost of debt is 2 % and you buy a company with a cost of debt of 7% because it is very risky/indebted, the cost of debt of your group post this acquisition is unlikely to stay at 2 % as lenders will soon realize that you are now a bit riskier than before this acquisition. Obviously, if the size of this acquisition is very small compared to the size of your company, lenders will not notice and you may go on with a cost of debt of 2% and replace a 7% debt with a 2% debt and reaps a 5% saving in interest costs. But as the size of this acquisition is very small compared to you, the savings will be peanuts for you, and you do not care. When sizes are not that dissimilar, for example 10 and 3; and not 10 and 0,5; one may believe that shareholders or lenders will not notice. May be for a few weeks or a few months. Over a longer period of time, this would a bet against the collective intelligence of the market participants, the kind of bets hard to win and very frequently lost. Given our experience in M&A, financial synergies are the last trick used by advisors to justify the interest of an acquisition when the value of operating synergies are not enough to justify the kind of control premium needed to make a deal happen and M&A success fees paid, not to mention bonuses for advisors a few months after. It is not always easy to judge a few hours after the announcement of an M&A deal whether it will leads to value creation or to value destruction. But one thing is sure, if the press release mentions financial synergies, insiders think it is a value destructing deal. And if insiders think it is a value destructing deal, it is very unlikely to create value. Have a nice day.  

26-03-2018 : “Solution to the problem of last Friday ”

Reminder of the problem You are a shareholder of a promising start-up and have subscribed to a convertible bond issue to be converted into shares of the next round of financing at a discount of 15% on the issue price of the shares of that next round of financing. Unfortunately, a material error was made in the minutes of the meeting authorizing the future issue of shares resulting from the conversion of convertible bonds, by providing for a number of shares issued in this respect equal to the number of convertible bonds, and not at that number divided by 1 minus the 15% discount. This kind of thing happens and nobody saw it at the moment. Fortunately for you, the convertible bonds contract is very clear and provides for a conversion of the bonds on the basis of the new share price discounted by 15%. Your lawyer, very embarrassed to say the least, offers to correct the situation by having a new resolution cancelling the first one and stating that convertion will take place on the basis of the amount of convertible bonds, increased by 15% and divided by the price of the new shares.   Solution : Give your lawyer a Vernimmen! It's not the same multiplying by 1.15 or dividing by 1-15%. In the first case, you get 15% more shares, in the second 17.65%. You get robbed of 2.65% / 17.65% = 15% of your yield. This is the classic problem of the so-called outside calculations (I multiply by 15%) and so-called calculations within (I divide by 1 - 15%), also known by this type of problems: if a value has dropped by 20 %, it is not enough that it goes up 20% later on to find its starting point, an increase of 25% is needed. Have a nice day.

23-03-2018 : “Problem for the week end ”

  You are a shareholder of a promising start-up and have subscribed to a convertible bond that will be converted into new shares during the next round of financing at a discount of 15% on the issue price of the shares of that next round of financing. Unfortunately, a material error was made in the minutes of the meeting authorizing the future issue of shares resulting from the conversion of convertible bonds, by providing for a number of shares issued in this respect equal to the number of convertible bonds, and not at that number divided by 1 minus the 15% discount. This kind of thing happens and nobody saw it at the moment. Fortunately for you, the convertible bonds contract is very clear and mention for a conversion of the bonds on the basis of the new share price discounted by 15%. Your lawyer, very embarrassed, offers to correct the situation by converting on the basis of the amount of convertible bonds, increased by 15% and divided by the price of the new shares.   What do you think of his/her suggestion? Have a nice day

22-03-2018 : “Quote of the day ”

“Managers and shareholders should remember that accounting supports analysis, but can in no way replace it” 
Warren Buffett

21-03-2018 : “Question of the day ”

When an investment bank underwrites an issue of new shares, it charges the issuing company a commission. How is this commission analysed using options theory? The commission represents the price of the put option that the company buys from the bank. In effect, the company is buying the right to sell the newly issued shares to the bank at the guaranteed price if nobody in the public wants to buy them. For more, see chapter 34 of the Vernimmen. Have a nice day.    

20-03-2018 : “Quote of the day ”

Auri sacra fames! (that accursed hunger for gold!) Virgil

19-03-2018 : “Solution to the problem of last Friday ”

Reminder of the problem Company X is 50% owned by the company P, 25% by the company R and 25% by the company S.   Main decisions are taken by a majority of 70% in X.   Can P, which de facto has a right of veto over X, under IFRS, consolidate his participation according to the method of proportional integration, because it would share the control of X with other shareholders?   Answer: No, because control sharing is with well-defined partners. But here P can share control with R, or S or R and S, but nothing says that it's always with the same partner. So P will have to consolidate X by equity method.   Have a nice day PS: IFRS still has a consolidation system similar to proportional consolidation when the parent companies have a direct right to some of the assets and liabilities on a pro rata share of the liabilities. Its terms of use are much stricter than before, so that it is little used, but it still exists. For more details, see Chapter 6 of Vernimmen.

16-03-2018 : “Problem for the week-end ”

Company X is 50% owned by the company P, 25% by the company R and 25% by the company S.   Main decisions are taken by a majority of 70% in X.   Can P, which de facto has a right of veto over X, under IFRS, consolidate his participation according to the method of proportional integration, because it would share the control of X with other shareholders?       Have a nice day  

15-03-2018 : “Quote of the day ”

“A bird in the hand is worth two in the bush” 
Aesop

14-03-2018 : “Question of the day ”

 For company’s classified as “cyclical stocks”, how do you work out the payout and dividend yield that would be best suited to maximising the share price, especially at the bottom of the cycle? For cyclical stocks, the payout rate doesn’t mean much. What is important is the amount of the dividend per share, which companies do their best not to cut. This is what causes very erratic payout rates – very low when the economic situation is good, very high at the bottom of a cycle. At best, they’ll aim at an average payout rate over the whole cycle, which doesn’t mean much as the cycle could be very long. The worst thing a company can do is to try and keep up paying an unrealistic dividend, given the cyclical nature of the economy. Investors won’t believe that it can be maintained over the long term, and will judge the managers to be lacking in responsibility. Finally, it would appear to be very difficult for a company to aim to achieve a given dividend yield, as this is set by the investor on the basis of a valuation of the share, and not the company. There is no payout rate that can maximise the value of the share. There is the rule of paying out all surplus cash to shareholders whenever the company cannot identify investment projects that would bring in at least the cost of capital. For more information, see chapters 36 and 37 of the Vernimmen. 

13-03-2018 : “Quote of the day ”

“The role of accountants is to record, not to value - this task falls to investors and managers” 
Warren Buffett

12-03-2018 : “Question from one of on followers on Facebook ”

What do you think of the apparently growing interest of investors for start-ups ... given the failure rate so high, I do not understand the craze for such a risky investment ... what is your opinion on this topic ?   In a way, it's the same principle as for a lottery where you can win 100 M € and lose your bet of 100 €. Even if there is only one winner at 100 M €, many people will participate, even if they know that their probability of winning is very very low, they simply overestimate it. Here everyone dreams of funding the next Facebook.   Have a nice day

12-03-2018 : “Can we say that if ROCE is higher than WACC, then the return on equity is higher than the cost of equity? ”

Yes, there is no doubt about that and it can be seen in the following way:   If the ROCE is higher than the WACC, then the entreprise value is higher than the carrying amount of the operating assets.   Since the value of the net debt has no reason to be greater than its carrying amount simply because the ROCE is higher than the WACC (since the debt does not participate in the creation of value beyond  the interest rate paid), and since the value of equity is equal to the entreprise value less the value of the net debt, the surplus between the entreprise value and the carrying amount of operating assets, benefits only to shareholders and not to debt holders.   Therefore, the value of equity is greater than the book value of equity as it is equal to the book value + this surplus.   And if the value of equity is greater than its book value, it is that the return on equity is higher than the cost of equity.   For more see, chapter 26 of the Vernimmen.   Have a nice day.

09-03-2018 : “What is the average control premium paid in takeovers, and what are the factors that determine this premium? ”

The average premium paid in takeovers is around 25 to 30%. This is obviously just an average, and premiums can be much larger or smaller. 
The theoretical basis for this control premium is the present value of synergies (increase in sales, reduction in costs, etc.) that the link-up should generate.  
The acquiring company is thus prepared to pay a premium, as it will manage the target is such a way as to ensure that the profits made by the business combination of the target and the acquiring company will be higher after the link-up than they are today. 

For more information, see chapter 31 of the Vernimmen 

08-03-2018 : “Quote of the day ”

“Managers and investors should understand that accounting data are a beginning and not an end in valuing a firm” Warren Buffett

07-03-2018 : “Why does a share buyback result in an increase in EPS when inverse P/E is higher than the cost of debt after tax? ”

P/E is equal to the value of shares divided by net profits. Inverse P/E corresponds to an instantaneous book return on an investment.  

If a company is worth 100 with net profits of 5, its P/E is 20. The inverse of 20 is 5%, which is the return you get when you pay 100 per share, while the net profit for the shareholder is 5. 
If the company buys its own shares for 100, it gets an instantaneous book return on this investment of 5%, and if it can borrow at 3% after tax to do so, it makes a profit, which explains why in this situation EPS increases. 
But this is purely arithmetic, and depends only on P/E and the after tax interest rate at which the company can borrow, which is not proof of the creation of value. 

For more information, see chapter 37 of the Vernimmen. 

06-03-2018 : “Quote of the day ”

“Above all, it is better to think than to follow.” 
Warren Buffett

06-03-2018 : “AXA buys XL for € 12.4bn and is down on the stock market by € 5.9bn: the price of not respecting its word? ”

  Yesterday with the announcement of this deal, which increases the insurance assets of AXA (in business damage insurance) and reduces the weight of those in the management of savings in accordance with the strategy announced, the share price fell by 9.7%. The premium paid is not low (about 40% on an average over several months, or € 3.5 billion), but there are also synergies (announced at $0.4bn per year, which does not seem excessive). Without taking it into account, it is therefore € 2.4 billion in value loss because a few months ago the president of AXA announced not wanting to do large acquisitions, but simply some between 1 and 3 billion €. Those of you with some gray hairs remember that AXA's acquisition of Equitable in the United States in 1991 also caused a lot of disruption to the stock market. This is the deal that allowed AXA to stop being a group focused on France, and to successfully take on a global scale. What the stock market, not stubborn, recognized afterwards. In short, opportunities are made to be seized and there are only fools who do not change their minds. If AXA succeeds in this integration, investors will show it quickly after this bust of anger. Have a nice day  

05-03-2018 : “Question from a Facebook follower ”

What is a cyclical sector? A cyclical sector is characterized by an activity that increases or decreases substantially more than the general economy. We can see it by looking at the evolutions of the turnover over a long period of time or by thinking in a room. In general, when the selling price of the goods or services is high, the sector is cyclical because in the event of a bad economic situation, certain customers will no longer have the financial means to buy the good or the service and will postpone purchases until the economic situation improves. Thus shipbuilding is a cyclical activity, because the freight lines stop ordering new boats when their activity falters and start again ordering new boats only when their market has been on the rise for a while. If the market is aftermarket (customers buy the product to replace a previous version they have already purchased in the past), it is more likely to be cyclical because customers will postpone their renewal decision when the conditions will be difficult and will make live a few years more the current product. Think about the automobile in the western world. But it is the opposite in emerging countries where the market is a market of original equipment. Have a nice day.  

01-03-2018 : “Quote of the day ”

Before you make your fortune, you first have to build a road.   Chinese proverb

28-02-2018 : “Question from a Facebook follower ”

In financial analysis, does not a perimeter effect induce a volume effect?   Yes but it is not to be confused with a volume effect.   A volume effect is due to customers buying more or less products / services compared to last year. The change in scope is due to the acquisition or sale of subsidiaries.   The assessment of the change in volume must be done at constant perimeter so as not to disturb the basis of comparison. Indeed, we could have a progression in volume which would be, at first analysis, seen as positive (the customers buying us more), but which would correspond to a fall of activity if one realized that it is integrally and even beyond this explained by an acquisition: in fact the customers buy us less and it is only because the company has acquired a competitor that one sees a progression in volume.   For more details, see Chapter 9 of Vernimmen Have a nice day  

27-02-2018 : “Quote of the day ”

The greatest failure for an investor is not to failing to invest in a promising start-up, but failing even to have come across it. Antoine Freysz

26-02-2018 : “Question from one of our readers ”

What is the difference between dilution of control and dilution of EPS in a capital increase? Let's assume you own 50% of the share capital of a company. There is a capital increase that you do not follow and your percentage in this company falls, for example, to 40%. So you have been diluted in control of 20%, from 50% to 40%. The dilution of the control has nothing to do with the dilution of the EPS which reflects the evolution of the EPS between before and after the capital increase. If your EPS goes from €2 before the capital increase to €1.86 after the capital increase because the funds raised on this occasion are not invested immediately or have a lower return in the first place, we say that EPS was diluted by 7%. For more details, your Chapter 26 of Vernimmen. Have a nice day.  

23-02-2018 : “Quote of the day ”

Things can only be predicted after they've happened. 
Eugene Ionesco

22-02-2018 : “Question from one of our readers ”

I do not understand what is the risk of reinvesting coupons on a fixed-rate bond. When valuing a bond, implicitly it is assumed that the coupons received before maturity are reinvested until the maturity of the bond at the rate of return of the bond. Take the example of a bond that yields 8% over another two years. The market rate is 8%. The bond is then worth 100, ie 8 / (1 + 8%) + 108 / (1 + 8%)^2, which also corresponds, by multiplying the first term in the numerator and the denominator by (1 + 8%) : 100 = 8 x (1 + 8%) / (1 + 8%)^2 + 108 / (1 + 8%)^2, which is also equivalent to: 100 = (8 x (1 + 8%) + 108) / (1 + 8%)^2 and we can see that we need to capitalize the first flow of 8 at 8% over the second year to find a value of the bond of 100. That said, rates can change over the period. If they go up, you will be able to reinvest your coupon at more than 8% and if you can wait for the repayment of the bond without having to sell it before, you will have obtained a return of more than 8% on your investment. But if the rates go down, you will reinvest your coupon at less than 8% and if you wait for the bond to be repaid but can not sell it before, you will get a return of less than 8% on your investment. This is known as reinvestment risk on a fixed rate bond. For more details, see Chapter 20 of Vernimmen. Have a nice day.  

21-02-2018 : “Quote of the day ”

There is nothing more unbearable than the regularity of the exceptional.
Cioran

20-02-2018 : “Question from one of our readers ”

Question asked on the Vernimmen.com website. For the sake of consistency and homogeneity, in calculating the turnover of the ratios for suppliers and inventories, why do not we report these two items to turnover? Indeed, one expresses the working capital according to the turnover, the customer ratio according to the turnover, why it is not the same with the ratio for suppliers and inventories? What we are trying to measure with the ratio of suppliers is the average time with which they are paid, to get an idea of ​​the balance of power that may exist between the company and its suppliers and to have over time a idea of ​​the evolution in a positive or negative sense of this ratio. Imagine that the company buys products for 40 every day and sells its finished product for 100 per day. Imagine that sales and supplies are regular throughout the year. Finally, imagine that the company pays its suppliers on average 40 days, which is quite commonplace in Europe. As of December 31st, there will be 40 days of purchases in the supplier post representing the last 40 days of purchases not yet settled at the end of the year, ie 40 x 40 = 1600. If you make the supplier ratio in days of purchases , and putting aside the VAT, you will have: 1600 / (365 x 40) x 365 = 40 days. If you do it in relation to turnover, you will have 1600 / (365 x 100) x 365 = 16 days. The reality is 40 days, not 16 days, and you could draw erroneous conclusions from this 16 days assuming, for example, that suppliers would not trust the company, that it would have a bad payment history, or that it pays them quickly to have a lower purchase cost, etc. which would be rantings. We do not seek the homogeneity of a ratio to another ratio (between the ratio of customer and supplier delays, for example), we look for a homogeneity, for a given ratio, between its numerator and its denominator. Indeed the outstanding customers is due to the act of selling, i.e. the turnover. It is therefore normal that one uses then at the denominator the turnover. But for the suppliers, their amount is not related to the sales but to purchases, it is therefore the line purchases which is used in the denominator. The reasoning is the same for inventories. Sometimes it is not possible to find the accounting line purchases because the income statement is presented by function and not by nature. We can then be led to use turnover as the denominator in the ratio of suppliers, but it is a second-best that then allows comments for trends but not for absolute level. For more details, see chapter 11 of Vernimmen. Have a nice day.  

16-02-2018 : “Quote of the day ”

We don't seek enough information out of statistics, and we demand too many conclusions from them. 
Auguste Detoeuf

15-02-2018 : “Question from one of our readers ”

How to account for the effects of proportional consolidation in DCF or multiples method?
Do nothing special because everything has been integrated proportionally to the company's share in this subsidiary. There is therefore no minority interest to be valued and deducted from entreprise value. For more details, see Chapter 31 of the Vernimmen.
Have a nice day  

14-02-2018 : “Quote of the day ”

Buy low, sell high, play golf 
Anonymous

13-02-2018 : “Question from one of our readers ”

Why, in measuring a company's debt level and sustainability, is the net debt / operating cash-flow ratio not used instead of the Net Debt / EBITDA ratio? The net debt \ EBITDA ratio is better than the D \ operating cash-flow ratio from a conceptual point of view because the operating cash-flow is a cash-flow unlike the EBITDA and debts are repaid with cash. However, it suffers from two defects that make it practically not used in practice. The ratio net debt / EBITDA is popular, as it is very simple to calculate. Removing the change from working capital to EBITDA significantly increases the calculation time and requires 2 balance sheets instead of one. Moreover, because of changes in the working capital, the operating cash flow is much more volatile than the EBITDA. The net debt / EBITDA ratio would therefore be more volatile over time than the debt / EBITDA ratio, which is unacceptable for a "quick and dirty" indicator that should not vary substantially from one year to the next in order to be compared to a critical level that moves very little over time. Have a nice day

12-02-2018 : “Quote of the day ”

The single cause of the crisis is prosperity. 
Clément Juglar

09-02-2018 : “Question from one of our readers ”

How to account for the effects of proportional consolidation in DCF or multiples method? Do nothing special because everything has been integrated proportionally to the company's share in this subsidiary. There is therefore no minority interest to be valued and deducted from entreprise value. For more details, see Chapter 31 of the Vernimmen. Have a nice day  

02-02-2018 : “Question from one of our readers ”

 cannot understand why the more costs are included in the value of inventories, the greater the result of the year. An inventory of finished products (but this is also true for an inventory of raw materials), is the sum of costs that the company has incurred during this exercise to produce those finished products, but which cannot be left in the profit and loss account of this year as these costs were included in products that were not sold that year, but that should be sold in the following year. In fact, the income statement gives the result on the products SOLD this year, not on the products MANUFACTURED this year. Thus the cost of the raw materials and the share of the wages of the production workers who manufactured these yet-to-be-sold products will appear on the asset side of the balance sheet in the form of inventories of finished products, and no longert in the income statement as costs. So the more costs I add to my inventory, the more costs I take out of the income statement and put on the asset side of the balance sheet under the headline finished goods item. And the more costs I take out of the income statement, the higher the net income. For more details, see Chapter 7 of Vernimmen. Have a nice day.

01-02-2018 : “Quote the day ”

"Banks have a primary duty to be cautious, since it is other people's money that they lending." Michel Cicurel   Have a nice day!

31-01-2018 : “Question from one of our readers ”

Is the choice of the FIFO method (first in, first out) more advantageous than that of the LIFO method (last in, first out) to reduce my working capital (WC)?  It is necessary to see the WC, before being an equation of accounting items (stocks + customers - suppliers), above all like a cash lag between the moment when I pay my suppliers of all orders and the moment when I am paid by my clients. Under these conditions, the way in which I subsequently record inventories in FIFO or LIFO does not have an impact on the WC that pre-exists to its accounting measure, since it is fundamentally a cash lag. In some countries (like France), the tax authorities do not authorize the LIFO. Under IFRS, LIFO is also not allowed. So you have no choice. It is only in the USA where the accounting standards accept LIFO that the subject can arise. But it is only when the price variations of the elements of the inventories are important that the subject LIFO versus FIFO is really at stake. With the generally low inflation we are experiencing, this debate has little intensity, except in sub-sectors with volatile commodity prices. For more details, see Chapter 7 and 11 of Vernimmen . Have a nice day  

30-01-2018 : “Quote of the day ”

"The richer you are, the harder it is to know how much you are worth." Felix Dennis, a British multimillionaire Have a nice day !  

29-01-2018 : “Question from one of our readers ”

Why do stock option holders prefer that their company, if it is to redistribute cash, do so by share buy-backs on the market rather than by a public takeover bid or extraordinary dividends? The share-buy-back by purchasing shares on the stock market gives the impression that the share price must necessarily rise because there is one more buyer on the market. So stock options will have more value. But academic research has never shown that this supposed increase is real and significant in its amount. Conversely, the tender offer, which is generally made, with a premium over the stock market price of 10 to 15%, leads to a fall in post-tender shares prices, as well as for the extraordinary dividend when paid. And there is no automatic adjustment of the exercise price of the stock option in any of those two devices. Hence a certain impoverishment for their holders. For more details, see Chapter 37 of Vernimmen . Have a nice day.  

26-01-2018 : “Quote of the say ”

"One of the innate features of a bubble is that is will explode when one least expects it, and in a much more violent manner than one anticipated." Jean-Pierre Petit

25-01-2018 : “Question from one of our readers ”

Why is cash flow calculated excluding capital gains and losses on disposal? The logic is that the capital gains and losses are implicitly already taken into account in the selling prices of fixed assets sold that appear below in the cash-flow statement table (in the investment function). So we can not include them in the cash-flow too, otherwise those capital gains or losses would be counted twice. This allows to have a more stable cash-flow, that is to say, less likely to vary greatly because, most often, exceptional elements are non recurrent. For more details, see chapter 5 of Vernimmen. Have a nice day.  

24-01-2018 : “Quote of the day ”

"Banks have a primary duty to be cautious, since it is other people's money that they lending." Michel Cicurel

23-01-2018 : “Question from one of our readers ”

Why do you prefer the presentation of the cash-flow statement that ends up with the variation of the net debt rather than the variation of the available cash? The variation of the available cash, which is often the last line of the cash-flow statement established in an accounting logic, is not a relevant financial criterion because it can easily be modified thanks to window dressing. As an example, you pull out at the end of the year on a short-term credit line and use these funds to place them in your bank account. You will thus make appear a rise in cash available which can reassure the ill-informed reader, but which is completely artificial. By reasoning in the last line of the cash-flow statement with the variation of the net debt , one avoids this flaw and at a glance one knows if the company increased its net debt or reduced it over the past period, what we do not know by looking at changes in the available cash. For more details, see Chapter 5 of the Vernimmen. Have a nice day.  

22-01-2018 : “Why are US banks now announcing losses related to the lowering of the corporate tax rate from 35 % down to 21 % when this is a favorable measure for them? ”

In fact, those which have tax loss carryforwards and which activated them on the assets side of their balance sheet are in this situation. Indeed, when they recorded a pre-tax loss in the past, of 100 for example, they were able to reduce it to 65 by accounting for a future tax credit of 100 x 35% = 35 (taking into account the corporate tax rate of 35%). This was of course conditional on the expectation that, in the future, their earnings would be large enough to be offset against this loss of 100, thus saving them future taxes for 35. They then recorded among their assets in their balance sheet a deferred tax asset of 35. With a corporate tax rate that drops to 21%, the amount of deferred tax assets becomes false, since carryforward losses will no longer generate a tax saving of 35% of their amount, but simply 21% . Therefore, these deferred tax assets must be depreciated by 40% of their amounts ((1- 21/35) .Therefore the losses published at this time which concern only past estimates of future tax savings. For more details on deferred taxes, see Chapter 7 of Vernimmen. Have a nice day.

19-01-2018 : “Question from one of our readers ”

What is the difference between Roce (Retun on capital employed) and WACC (the cost of capital)?
On the one hand, there is what you ask for and on the other, what you get.
In exchange for the funds that they entrust to the company, investors want to obtain a minimum return that compensates them for the risk taken on their investment in the company: it is the cost of capital.
On the other hand, the company yields a certain rate of return on its operating assets, which have been financed entirely by funds provided by investors: this is ROCE.
There is no mathematical relationship between the cost of capital and ROCE. The first is a financial concept (required rate of return), the second is an accounting concept (achieved rate of return). On the other hand, their difference (ROCE - cost of capital) gives birth to the value created by the company (when ROCE > capital cost over time) or the value destroyed by the company (when ROCE < cost of capital over time).
For more see chapter 27 of the Vernimmen.
Have a nice day

18-01-2018 : “Understand who can! ”

A broker, certainly not one of the most important one, but the only one to follow this mid cap listed in Paris, has revised down its annual sales forecast now counting on €618m in 2017/2018 against €634 m. In addition, this broker targets an EBITDA of €38.2m, or 6.2% of sales, against a target of 6.5% set by the company. This broker maintained its Neutral recommendation while lowering its target price from 6 to 5.80€. So far, so good. The current share price is €3.50, offering, if you believe in the work of this broker, a potential price increase of 66% (sic). In these circumstances, why not a Purchase recommendation? Are there so many undervalued companies in its universe of analysis that a mere 66% increase to a target price deserves only a Neutral recommendation? Or does it want to please at the same time the savvy investor who understands that a recommendation Neutral means in plain English Sell, and the mid cap management who would not appreciate a Sell recommendation and could cut all investment banking business with this broker? As for the target price of €5.80, is it there to amuse the gallery and flatter the midcap, while deceiving the confident but inexperienced investor? In other words, does the investment banking business that this broker provides to the midcap, in addition to its financial analysis work, disturb its view? But has it forgotten the deontology and the rules of management of conflicts of interest between its interests (as an investment banker of this midcap) and as a professional financial analysist to its clients, the investors who read its works ? Have a nice day.

17-01-2018 : “Question from one of our readers ”

I just answered the first question of the quiz on vernimmen.com
Q1. In the absence of a corporate tax, does the rate of depreciation have any influence on cashflow? The answer is no. I do not understand the answer because cashflow = net income + depreciation + sundry other items. So if the rate of depreciation evolves, depreciation will evolve and there will be an impact on the cashflow?
You must understand that net income itself is affected by the amount of depreciation since in the absence of corporation tax, net income is equal to EBITDA - depreciation + financial result + exceptional result. Therefore cashflow is equal to: EBITDA - depreciation + financial result + exceptional result + depreciation + sundry other items = EBITDA + financial result + exceptional result + sundry other items, which is an indifferent balance to depreciation.
Have a nice day.

16-01-2018 : “Quote of the day ”

"No generation can contract debts greater than can be paid during the course of its own existence. " Thomas Jefferson

15-01-2018 : “An unexpected and positive side effect of a financial krach. ”

Until 1882, Paul Gauguin worked as a broker on the Paris Stock Exchange and was an artist in his spare time. The crash of the financial groupe Union Générale in January 1882, and the fall of the Stock Exchange that followed after a few years of irrational exuberance, made him lose his job and he decided to devote himself entirely to his artistic career. The Paul Gauguin exhibition at the Grand Palais in Paris, which inspired this note, closes its doors on January 22nd.   Have a nice visit and have a nice day.  

12-01-2018 : “There are no miracles in finance. ”

  Total had announced that it would continue to pay the same dividend per share despite lower earnings and free cash flows due to falling oil prices. The oil group had succeeded in doing so by proposing to its shareholders to receive their dividend, at their discretion, in Total shares issued with a discount of 5% on the share price or in cash. Every quarter, nearly two-thirds of its shareholders opted for the dividend in Total shares, because pocketing a 5% discount is not something most investors refuse. Those in need of cash resale the shares thus obtained. And Total has thus saved in cash for quarters almost two thirds of its dividend. For the first time at the end of 2017, Total offered to pay its quarterly dividend in cash or in Total shares, but without the 5% discount. Guess what ? Total has just indicated that the proportion of shareholders who, in these circumstances, opted for the scrip dividend has fallen to 21%. Shareholders know how to count. . . If the price of a barrel does not relapse, it is likely that the next step for Total will be to pay a dividend entirely in cash. You may be wondering why Total had to use this scheme to post a constant dividend per share, but paid for a very significant portion in shares issued with a discount on prices, rather than lowering its dividend and paying it in cash only to the level of free cash flow generated after oil price decline. The answer is that in the small world of super majors oil companies, 4 Anglo-Saxon and Total, shareholders, often Anglo-Saxon pension funds, are there to receive dividends that will allow them to pay regular pensions to their pensioners . Any decline in the facial dividend would have been ill taken, breaking the bond of trust that dates back to 1981, the last time Total lowered its dividend. In the same vein Shell's CEO (Ben van Beurden) declared: "The dividend is a sacred element at Shell, I will do everything to protect it" and he used the same trick as Total to maintain constant its dividend per share despite a collapse of 60% in the oil price.
All this may seem artificial to you, but who would have told you that behavioral finance did not exist? Have a nice day.  

11-01-2018 : “Quote of the day ”

"The richer you are, the harder it is to know how much you are worth." Felix Dennis, a British multimillionaire Have a nice day !

10-01-2018 : “Question from a reader ”

I just answered the first question of the quiz on vernimmen.com Q1. In the absence of a corporate tax, does the rate of depreciation have any influence on  cashflow? The answer is no. I do not understand the answer because cashflow = net income + depreciation + sundry other items. So if the rate of depreciation evolves, depreciation will evolve and there will be an impact on the cashflow? You must understand that net income itself is affected by the amount of depreciation since in the absence of corporation tax, net income is equal to EBITDA - depreciation + financial result + exceptional result. Therefore cashflow is equal to: EBITDA - depreciation + financial result + exceptional result + depreciation + sundry other items = EBITDA + financial result + exceptional result + sundry other items, which is an indifferent balance to depreciation. Have a nice day.

09-01-2018 : “Quote of the day ”

“The “Vernimmen” is the perfect reference corporate finance book. I used it in my classes, looked back into it during my internships, use it again now to deep dive into corporate finance for my thesis and know I will keep interacting with it later in my career.”
André Geha, Graduate Student at MIT Sloan  

08-01-2018 : “Question from one of our reader ”

Why is a bond's sensitivity to market fluctuations higher for long-term bonds, and why is it stronger for bonds paying a low interest rate too? Imagine the bond as a wooden stick, with which you will leverage by leaning on a stone, to lift a large object. This wooden stick is all the longer as the residual life of this obligation is long. If this stick is short, that is to say that your bond has a short residual life, it will be difficult to move the object in question, because a short stick does not leverage much. Your bond therefore has a low sensitivity. If the stick is long because the reimbursement flow is far, it is easier to move the object. The sensitivity of the bond is therefore stronger. Now let us continue the analogy to understand the influence of the intermediate flows, that is to say the interest paid on the bond, for a given duration of the latter and therefore for a given length of the stick. The interest payments will be spread over the length of the stick as weight and will be all the more so heavy as the interest rate of the bond is high. If these weights are heavy, they will hinder the movement of stick which, because of this, will move less the object to lift. The sensitivity of the bond will be low. If now the interest paid by the bond is low, the weights on the stick will be small and will not interfere much; leverage will thus be stronger than before and the sensitivity of the bond will be high. If this literary and analogical explanation did not convince you, you still have to make simulations from the modeling of the value of a bond on an excel file to experiment this double relation. Or to resume your mathematics classes to see that the first derivative of the sensitivity in relation to the maturity is positive, and negative in relation to the bond interest rate. Have a nice day.  

05-01-2018 : “Intel ”

The reaction of Intel's stock price and that of its competitors the day before yesterday is an excellent illustration of the theory of portfolio and that of efficient markets. When Intel's share price declines by more than 5% in response to product security concerns, its rivals rise at the same time as investors immediately anticipate that Intel customers will switch suppliers. Not putting all your eggs in one basket for those who want to limit the specific risk of a share is not a bad (or recent) idea! Have a nice day.  

04-01-2018 : “Question from one of our reader ”


I have to value an industrial company that will make a big investment for the launch of a new factory from 2022 that will replace the current plant.
The investment in the coming years (from today to 2021) is so heavy that the company has significant negative free cash flows that are not compensated by the activity in the current premises and are slightly compensated by the terminal value.
Even by making a cash flow fade over the next few years, this does not bring out with a positive valuation.
Should we do some corrections? Which valuation approach would you adopt in such a situation? Have you take into account the resale value of the current plant once the new plant is operational in your flows? Check your calculations again. If your flows do not change, it means that this new plant is unprofitable and likely to sink the company. It may be necessary to ask the question of the relevance of this investment rather than the valuation of this company. Have a nice day.

03-01-2018 : “Mergers and acquisitions in 2017. ”

  4th year of the high cycle phase of this highly cyclical activity and highly correlated with stock market indices (see the first graph of chapter 44 of Vernimmen, which goes back to 1986). The United States are still impressive with a volume of transactions almost double those in Europe ($1635bn against $861bn) when their GDP is only 10% higher. Happy American M&A bankers who benefit in addition of a lower level of competition compared to Europe. Asia again in front of Europe ($939bn) for the third year in a row.   Have a nice day  

02-01-2018 : “While visiting the temporary exhibition at the Jacquemart-André museum in Paris, dedicated to the Hansen Collection of French paintings, you may wonder why ”

While visiting the temporary exhibition at the Jacquemart-André museum in Paris, dedicated to the Hansen Collection of French paintings, you may wonder why Wilhelm Hansen had to sell half of his collection in 1922 because of the bankruptcy of his bank, Danish Landmansbank. Indeed, the causal link is not obvious. In fact, the bankruptcy of the lender does not directly concern the borrower, who remains of course debtor of his debt, except for the cash he may have entrusted to him. In fact, along with other collectors and art dealers, Wilhelm Hansen had formed a consortium able to buy entire collections of paintings to keep the ones they were interested in and sell the others. To finance themselves, they had been indebted, in the short term to the Landmansbank, which regularly renewed the loan while it was in activity. When it went bankrupt, its liquidator demanded, of course, repayment of the short-term credit when it was due. And since the guarantee (the paintings) were not particularly liquid (oils as well as pastels), Hansen and his associates, who held to their honor, sold the paintings rather than defaulting.   All this could have been avoided, my wife said to me with good common sense, if they had run into long term debt. The problem is that banks at that time only lent in the short term because they had only short-term resources. The banking transformation was still in its infancy. Have a nice day and a happy New Year.  

29-12-2017 : “Quote of the day ”

"Capitalism, as Marx has understood so well, is not destined to survive." Nikita Krouchtchev

28-12-2017 : “Question from a participant to the ICCF@Columbia Business School ”

  I do not understand why overvaluing stocks of raw materials is inflating net income artificially? Think about the balance sheet, it's easier on this point. If, on the assets side, the inventories value is fictitiously increased, then in the liabilities and equity side, because it is necessary to keep the balance sheet balanced, the only item which will be inflated correlatively is equity, via the net income, which is higher this exercise. As a matter of fact, we bought for 100 what we will value in stock at the end of the year for a fraudulent amount of 110 for example, hence a fictitious profit of 10. This is done to the detriment of next year net income where the cost of the raw material will have increased, reducing margins, since corresponding to the price in stock of the raw material which price was fraudulently inflated this year. For more details, see Chapter 7 of Vernimmen. Have a nice day.  

27-12-2017 : “Quote of the day ”

"Dividend - procedure used to get at profits, when all other procedures have been exhausted." Auguste Detoeuf

26-12-2017 : “We are pleased to announce that the fifth edition of The Vernimmen is now available from all good bookstores and on-line retailers. ”

With thousands of copies of the latest edition sold, Corporate Finance, Theory and Practice is one of the most popular financial textbook, thanks to its four unique features:  • A balanced blend of theory and practice: authors hold academic positions at top ranking business schools and are also investment banker, private equity investor or sit on the boards of listed and unlisted companies.  • A presentation of concepts that explain situations, followed by a discussion of techniques in a direct and succinct style.  • Content enriched by the www.vernimmen. com website, which is one of the leading finance teaching sites worldwide.  • Free monthly updates on finance through The Vernimmen.comNewsletters, with over 70,000 subscribers.  For this edition a new chapter was created. It is devoted to managing operational real estate and should help you to answer the frequently asked question: Should the company own or rent its operational building? This not of small importance and will be particularly helpful as companies following IFRS or US GAAP will soon be required to account for operational leases in the same way as financial leases are accounted for. The summary of this new chapter is available on http://www.vernimmen.com/Vernimmen/Summaries_of_chapters.php We have also done a major updating job to create a tool that is accurate, reliable, comprehensive and relevant. We have included the very latest accounting standards, most statistics and graphs are from end 2016, the latest innovations in financial practice are discussed and the latest financial theories are presented. To make sure that you get the most out of your Vernimmen, each chapter ends with a summary, a series of problems and questions (832) (solutions provided). For those interested in exploring the topics discussed in greater depth, there is an end-of-chapter bibliography and suggestions for further reading, covering fundamental research papers, articles in the press and published books. A large number of graphics and tables (over 100) have been included in both the appendix and in the body of the text which can be used for comparative analyses. There are over 3,500 entries in the index.  To have a look on the contents of the 2017 edition of the Vernimmen go on page http://www.vernimmen.com/Vernimmen/2017_Edition.php and to buy the 2017 edition of The Vernimmen, go on page https://www.amazon.co.uk/gp/product/1119424488/ref=as_li_tl… What they said about 2017 edition of The Vernimmen:  “I discovered finance with ‘The Vernimmen’ about 30 years ago. Since then the different versions have accompanied me throughout my career and throughout the world. Not only was the alignment of the successive editions looking good in my different offices but I must confess I have opened and cherished each of them. Whether an investment banker, a CFO in a universal bank or more simply a world banker…”
Bertrand Badré, Former Managing Director and CFO of the World Bank “What sets the Vernimmen apart from other textbooks is its integration of practice and current affairs in a rigorous theoretical framework. Recipes and pontification are replaced by a scientific approach. And, thanks to the Newsletter, this is done practically in real time!”
Christophe Evers, Professor of Finance at the Solvay Brussels School, Executive Director of Texaf “I always use the paper edition of the Vernimmen, which is clear and comprehensive, as a reference tool. The site is well designed, always up-to-date and also extremely useful for explaining financial concepts simply and intelligently to non-financial colleagues.”
Laurence Debroux, Member of the Executive Board / CFO of Heineken “Corporate Finance is a very useful reference book for students and practitioners, it will help both to understand the principles of the financial markets and their practical application in today's complex environment. The book's approach is both logical and sequential and presents some interesting cases that make study easier and more stimulating.”
Gabriele Galateri, Chairman of Generali, former chairman of Telecom Italia and Mediobanca, former CEO of FIAT "Vernimmen provided people like me who were new to the world corporate finance a perfect mix of theory and practical examples to help them develop long lasting financial concepts. The book is a written manual for finance, explaining the fundamentals in a very thought provoking way, making it intriguing to delve into the complexities. This book is a must have in your personal library as you will refer back to it even after years."
Sharat Gangwani, Business Response Analyst at Citadel LLC “The “Vernimmen” is the perfect reference corporate finance book. I used it in my classes, looked back into it during my internships, use it again now to deep dive into corporate finance for my thesis and know I will keep interacting with it later in my career.”
André Geha, Graduate Student at MIT Sloan “Vernimmen's Corporate Finance is an outstanding clear and complete manual, a wonderful merger of practice and theory. Its coverage of the market aspects of corporate finance distinguishes its content, but its treatment of all the material makes it essential reading for the student, financier or industrialist.”
Howard Jones, Senior Research Fellow in Finance at Saïd Business School, University of Oxford “The Vernimmen: proof that an outstanding teaching approach and genuine accessibility are fully compatible with comprehensive and sharp analyses.”
Christian Mulliez, Executive Vice-President and Chief Financial Officer L’Oréal “The book itself covers all the important techniques that a financial manager must have in his repertoire of tools. The exposition is clear and concise and, most importantly, relies on commonsense reasoning throughout. This is not a book with obscure formulae, yet is still rigorous and at the same time a model of clarity.”
Richard Roll, Joel Fried Professor of Applied Finance at UCLA Anderson

22-12-2017 : “American tax reform ”


We will comment 3 points:
1 / The United States becomes the 3rd largest country to limit the tax deductibility of financial expenses. After France which limits the deductibility of financial expenses greater than €3m to 75% of their amount, the United States joins Germany by refusing tax deductibility for financial expenses that exceed 30% of EBITDA.
From a financial point of view, there is no reason for the state to encourage a specific tax reduction (the deductibility of financial charges) for companies to prefer a source of financing (indebtedness) to the detriment of another (equity), especially when excessive indebtedness generally increases business difficulties. For more details, see The Vernimmen.com Newsletter n° 62, November 2011. 2 / The United States abandons their worldwide tax system for corporate income tax that taxes foreign affiliates of US groups on their profits made abroad when they were repatriated to the United States in the form of dividends, which are then taxed for the difference between the US 35% rate and the local rate. As the US 35% rate was one of the highest in the world (see The Vernimmen.com Newsletter n° 105, July 2017), the consequence of this system was the incentive not to repatriate to the United States the profits of foreign subsidiaries that are not reinvested locally and to accumulate piles of cash abroad, as famously illustrated by Apple (see The Vernimmen.com Newsletter n°75, July 2013); all while waiting for a measure of grace, as there was in the past, allowing an exceptional repatriation during a few months with a very reduced taxation. Alternatively, some US companies were being absorbed by a foreign company in order to evade the US tax system for their foreign affiliates. We have seen merger-acquisition transactions mainly explained by tax considerations, which does not seem very healthy (see The Vernimmen.com Newsletter n°83, September 2014).
The lowering of the corporate tax rate from 35% to 21% of course made this global profit regime essentially ineffective since most of the world's major countries have a tax rate close to or higher than 21% (the United Kingdom and Switzerland are exceptions). 3 / The non-real estate capital expenditures of US companies become fully deductible from the base of their corporate income tax until 2022. No need to wait several years by the technique of depreciation to obtain this outcome. Have a nice day    

21-12-2017 : “Can the decision to split the share price of a publicly traded company have an impact on the value of that company? ”

In all rationality no. If you multiply the number of your shares by 10, normally the share price is divided by 10 at the same time. In fact, whatever the number of shares in which a cake is cut, the size of the cake does not change. However, it can rarely happen that there is an increase in the total value of shares because a large split makes the purchase of this share accessible to a larger number of small shareholders. In addition to Berkshire Hathaway's A shares currently quoted at $ 298,200 each, B shares are listed, which represent 1 / 1,500 of the A shares and are worth $ 198.98 at the same time against a theoretical value of 298 200/1500 = $ 198.80. But you see that the gap is small. Have a nice day

20-12-2017 : “Quote of the day ”

"Dividend - procedure used to get at profits, when all other procedures have been exhausted." Auguste Detoeuf

19-12-2017 : “Question from one of our readers ”

What is the difference between refinancing and restructuring a debt?   The refinancing of a debt is simply the issuance of a new loan to finance the repayment of the previous loan in due time.   The restructuring of a debt is the modification of the terms of an existing debt: duration, interest rate, covenants,  because the company can not cope in time with the deadlines of this debt, or because the situation of the company or the loan market has improved and the company wants to take advantage of it (lower interest rate, possibility of going into debt over longer terms, less stringent covenants, etc.) to improve the conditions of its debt. Have a nice day.   Have a good day.

18-12-2017 : “Quote of the day ”

"The ultimate risk is not taking a risk." James Goldsmith

15-12-2017 : “Question from one the follower of the Vernimmen Facebook page ”

What is the difference between Roce (Retun on capital employed) and WACC (the cost of capital)? On the one hand, there is what you ask for and on the other, what you get. In exchange for the funds that they entrust to the company, investors want to obtain a minimum return that compensates them for the risk taken on their investment in the company: it is the cost of capital. On the other hand, the company yields a certain rate of return on its operating assets, which have been financed entirely by funds provided by investors: this is ROCE. There is no mathematical relationship between the cost of capital and ROCE. The first is a financial concept (required rate of return), the second is an accounting concept (achieved rate of return). On the other hand, their difference (ROCE - cost of capital) gives birth to the value created by the company (when ROCE > capital cost over time) or the value destroyed by the company (when ROCE < cost of capital over time). For more see chapter 27 of the Vernimmen. Have a nice day  

14-12-2017 : “Quote the day ”

"Selling is good. Getting paid is better." Proverb

13-12-2017 : “Question from a Facebook follower ”

  It is a start-up in the field of research that carries out the popularization of scientific articles on behalf of publishers or large groups. The company issues 10,000 shares for 15% of the capital, their issue price is € 283. I am about to invest € 10,000 because I believe in business but I would like to be sure that the issue price is consistent. What questions to ask for this? If the company is a real start up with just 1/2 years of activity, the proposed price is staggering because if this company issues 10,000 shares for 15% to 283 € the action means that the company is looking to to raise € 2.83 million, which is important at this stage, for a pre-money valuation of 10,000 / 15% x 283 - 2.8 M = €16 million, which is 3 to 6 times higher than usual for a company at this stage of development. For more see chapter 40 of the Vernimmen. Have a nice day  

13-12-2017 : “Atos offer on Gemalto ”

  With a share price increasing from €20 to €80 between early 2008 and mid 2014, Gemalto has been both an industrial and a stock market success story. Then the successful machine has stopped with, in recent quarters, 4 successive warnings on the results and a price that has fallen gradually since mid-2015 to €33 before yesterday. On the contrary, Atos saw its share price increases from €35 in 2008 to €125 yesterday, witnessing a very successful organic and external growth strategy. With a full cash offer of €46, a premium of 44% on the last price, but 0% on the Gemalto prices of mid August before a new warning on the results, there is no doubt that Gemalto will lose its independence. The only question left is who will be its buyer. By setting the price of Gemalto yesterday at €45.6, just below Atos' offer at €46, investors say they do not believe in the possibility of a counter-offer more advantageous for them. Dura lex sed lex. Have a nice day.  

12-12-2017 : “Quote of the day ”

"The richer you are, the harder it is to know how much you are worth." Felix Dennis, a British multimillionaire

11-12-2017 : “Question from a Facebook follower ”

I have to value an industrial company that will make a big investment for the launch of a new factory from 2022 that will replace the current plant. The investment in the coming years (from today to 2021) is so heavy that the company has significant negative free cash flows that are not compensated by the activity in the current premises and are slightly compensated by the terminal value. Even by making a cash flow fade over the next few years, this does not bring out with a positive valuation. Should we do some corrections? Which valuation approach would you adopt in such a situation?   Have you take into account the resale value of the current plant once the new plant is operational in your flows?   Check your calculations again.   If your flows do not change, it means that this new plant is unprofitable and likely to sink the company. It may be necessary to ask the question of the relevance of this investment rather than the valuation of this company.   Have a nice day.  

08-12-2017 : “Question from one of our readers ”

What is the difference between refinancing and restructuring a debt?   The refinancing of a debt is simply the issuance of a new loan to finance the repayment of the previous loan in due time.   The restructuring of a debt is the modification of the terms of an existing debt: duration, interest rate, covenants,  because the company can not cope in time with the deadlines of this debt, or because the situation of the company or the loan market has improved and the company wants to take advantage of it (lower interest rate, possibility of going into debt over longer terms, less stringent covenants, etc.) to improve the conditions of its debt. Have a nice day.   Have a good day.

06-12-2017 : “Question from one of our readers ”

  If I raise €1m from investors, and these €1m are wired at once, but are not spent at once, rather progressively in the project, is the C0 (flow initial) in the NPV or IRR equation corresponds to the amount given to me at once (€1m)? When calculating the NPV for the investor, you must take into account the investor's investment at the moment when the investor wires the funds, whether the company uses these funds immediately or later is of no importance. If the company does not need the money right away, it penalizes the NPV and the IRR of the investor. This is why investment funds usually require an investment commitment from investors and call the funds as they invest them, so investors do not have to wire money that will be stay idle on a bank account. Investment funds may even differ calling investors for liquidity for a few months by getting into short term debt to make investments while waiting to call the funds of investors. (See the letter Vernimmen.net n ° 97 of October 2016). Have a nice day.  

04-12-2017 : “Question from a reader ”

What is the impact of the outsourcing of some of the businesses of the company on its cost of capital? Especially in the automotive industry, with OEMs?
In general, outsourcing reduces the cost of capital because it transforms fixed and variable costs into only variable costs. If the company has less fixed costs, it will be less sensitive to the economic situation and therefore its beta and its cost of capital will be lower (see section 18.5 of Vernimmen).
That said, the experience of 2008 showed that if the supplier goes bankrupt, the car manufacturer is in a very bad situation because in general it has a limited number of suppliers. It is therefore obliged to help it, at least temporarily, to avoid being no longer supplied. Outsourcing in this extreme context is therefore a little illusory.
Have a nice day.

01-12-2017 : “Quote of the day ”

"Beware of small differences between large numbers." Adage

30-11-2017 : “Question from one of our readers ”

Is it relevant to compare the expenses of an income statement by nature to production rather than turnover? This is fair for income statements presented by nature, since the expenses of this income statement are the expenses corresponding, not to the turnover (products sold), but to the production (products that have been produced), with a regularization through inventory changes to fall back on an operating result which corresponds well to the difference between the turnover and the cost of the products sold (and not only produced). For more details, see Chapter 3 of Vernimmen ).
Have a nice day

29-11-2017 : “Quote of the day ”

"If you see a Swiss banker jumping out of a window, then jump out after him. There must be money in it." Voltaire

28-11-2017 : “Answer to yesterday's brainstorming problem (mentioned at the end of this post) ”

  The decisions for which A's agreement is required are the most important decisions for a company. They can only be taken if A and B agree. Therefore A and B are in joint control over X. For more details, review chapter 6 of Vernimmen 2018. The problem A holds 49.5% of X of which the remaining 50.5% are held by B. A is represented on the board of X by 2 directors and B by 3. The decisions of the board of directors are taken by a simple majority except for the approval or the modification of the budgets or the business plan, for the investments and the financings, for the acquisitions or disposals not envisaged in the business plan. , and for appointments and dismissals of officers, decisions for which A's agreement is required. Is A in a position of joint control or significant influence over X?  

27-11-2017 : “Brainstorming ”

  A holds 49.5% of X of which the remaining 50.5% are held by B. A is represented on the board of X by 2 directors and B by 3. The decisions of the board of directors are taken by a simple majority except for the approval or the modification of the budgets or the business plan, for the investments and the financings, for the acquisitions or disposals not envisaged in the business plan, and for appointments and dismissals of officers where the approval of A is requested. Is A in a position of joint control or significant influence over X? See you tomorrow for the answer. Have a nice day.  

24-11-2017 : “Quote of the day ”

"If you're not prepared to hold a share for ten years, you shouldn't hold it for ten minutes." Warren Buffett

23-11-2017 : “Question from one of our readers ”

When a company has cash that is restricted, for example, as a collateral on a loan, do you consider it as cash in the net bank and financial debt calculations? And for the liquidity ratio? In the liquidity ratios, it must be excluded because this cash is blocked as a collateral for a credit elsewhere. It can not serve twice. For net debt, it is necessary to be consistent and take this restricted cash into account since it is a partial counterpart of a bank or financial debt. Have a nice day

22-11-2017 : “Quote of the day ”

"God doesn't play dice." Albert Einstein

21-11-2017 : “Question asked during a recruitment interview for a financial analyst position ”

What is the relationship between the profitability and solvency of a company?
There is a definite correlation between the two, although it is not absolute. Indeed, if a company is profitable, that is to say if it generates a return on capital employed above its cost of capital, its assets will have a certain value and probably higher than their carrying value for which they appear on its balance sheet. In addition, its profitability will enable it to generate positive net results that will allow it, except if it distributes them in full as dividends, to reinforce the share of its equity in the balance sheet and thus improve its solvency.
For more details, read or reread Chapter 14 of the Vernimmen.
Have a nice day

20-11-2017 : “Quote of the day ”

"It is the size of the pizza that matters, not how many slices you cut it into." Merton Miller

17-11-2017 : “Salvator Mundi ”

Imagine that Leonardo da Vinci sold his work to Louis XII and his wife Anne of Brittany who had ordered it to celebrate the taking of Milan for € 100,000 at the time, which does not seem expensive given his already high reputation at the time.
Capitalized at 1.64% per year, you find at the end of 507 years (one estimates the date of realization of the work between 1506 and 1513),. . . $ 450 million, i.e. the price paid yesterday.
First conclusion: at $ 450M, and even if we did not participate in the auction that started at $ 70M, the buyer does not seem to be a bad deal for the only one of the 15 paintings by Leonard de Vinci that is not in a museum.
Second conclusion: Be wary of long-term capitalizations that ignore wars, revolutions, inflationary flares, changes of tastes and other scourges.
Third conclusion: Going to the Louvre in Paris and Abu Dhabi, you will see 5 paintings by the master, including the wonderful Madonna and Child with Saint Anne. It There is more in life than just finance!
Have a nice day

16-11-2017 : “Question ”

An experiment was recently carried out where a child, an astrologer and a financial analyst were each given €10,000 to invest for eight years. Who do you think achieved the best results? The child. If markets are really efficient, the answer is completely random.  For more, see chapter 15 of the Vernimmen.

15-11-2017 : “Solution to the problem of yesterday ”

Yesterday's brainstorming problem is reminded at the end of this post A can not make decisions alone, he only has blocking power. He is not in exclusive control. There is no shareholders' pact; several combinations of shareholders are possible to reach the majority with A or without A. There is therefore no joint control of A on B. It simply has a notable influence on B, which it will have to consolidate by equity method. If you want to review your consolidation techniques, chapter 6 of Vernimmen 2018 is for you. Have a good day A holds 42% of B whose shareholders' balance consists of investors each holding between 1.6% and 14.5% of the capital. A is represented on the board of directors by 5 directors out of 12. There is no shareholder agreement or agreement between A and B. A 2/3 majority is required for key decisions: budget, significant investments, acquisition. A is in a situation of exclusive control, joint or in significant influence over B, in view of the consolidation rules set out in Chapter 6 of the Vernimmen.

14-11-2017 : “Brainstorming ”

A holds 42% of B whose shareholders' balance consists of investors each holding between 1.6% and 14.5% of the capital.
A is represented on the board of directors by 5 directors out of 12. There is no shareholder agreement or agreement between A and B. A 2/3 majority is required for key decisions: budget, significant investments, acquisitions.
Is A in a situation of exclusive control, joint control or in significant influence over B, in view of the consolidation rules set out in Chapter 6 of the Vernimmen?
We will give the answer tomorrow
Have a nice day

09-11-2017 : “Question from one of our reader ”

When a company has cash that is restricted, for example, as a collateral on a loan, do you consider it as cash in the net bank and financial debt calculations? And for the liquidity ratio?   In the liquidity ratios, it must be excluded because this cash is blocked as a collateral for a credit elsewhere. It can not serve twice.   For net debt, it is necessary to be consistent and take this restricted cash into account since it is a partial counterpart of a bank or financial debt.   Have a nice day  

07-11-2017 : “Quote of the day ”

From what we can identify, the only reason today people buy or sell Bitcoin is to make money, which is the very definition of speculation, and the very definition of a bubble. It has no use.

06-11-2017 : “The misfortune of Altice ”

Its share price collapsed by 22.6% on Friday lowering its market capitalization from €21.9bn to €16.9bn. All this for quarterly results 1.8% below expectations both in terms of sales and gross operating surplus.
Excessive do you find? Remember that for a highly indebted company like Altice - its net bank and financial debt totals € 50.1bn, or 5.3 times the 2017 EBITDA - the leverage effect also applies in value. The 22.6% fall in the value of Altice's equity corresponds to a fall of only 7% in the value of its entreprise value. This is because the value of the debt remains constant, which increases at the level of equity the decline in the entreprise value.
Have a nice day  

02-11-2017 : “Question asked during a recruitment interview for a financial analyst position: What is the relationship between the profitability and solvency of a company ”

Do shareholders and lenders carry out financial analysis in the same way? Yes, because a company that creates value (for shareholders) will be solvent (for lenders).  For more, see chapter 8 of the Vernimmen.

01-11-2017 : “Quote of the day ”

Having money means having all possibilities in your hand. Lacking money means remaining a prisoner of an eternal present, hindered by your own needs. Pascal Bruckner

31-10-2017 : “Question asked during a recruitment interview for a financial analyst position: What is the relationship between the profitability and solvency of a company ”

There is a definite correlation between the two, although it is not absolute. Indeed, if a company is profitable, that is to say if it generates a return on capital employed above its cost of capital, its assets will have a certain value and probably higher than their carrying value for which they appear on its balance sheet. In addition, its profitability will enable it to generate positive net results that will allow it, except if it distributes them in full as dividends, to reinforce the share of its equity in the balance sheet and thus improve its solvency.
For more details, read or reread Chapter 14 of the Vernimmen.
Have a nice day

30-10-2017 : “Quote of the day ”

Whoever condemns money condemns people to servitude and is the accomplice of their downtrodden condition. Pascal Bruckner

27-10-2017 : “How do you explain that a company can have an entreprise value greater than the book amount of its operating assets, while its return on capital employed is lower than its cost of capital? ”

  This means that the market sees more than the tip of his nose! That is, investors anticipate that the ROCE of this company will improve in the years to come and exceed the cost of capital. Remember that ROCE is only valid for the year for which it is calculated, whereas the entreprise value takes account of all future free cash flows generated by the operating assets.   Haven nice day  

26-10-2017 : “Quote of the day ”

Today's economic agent is swimming in irrational waters with a few moments of lucidity, when he or she takes the time to think. Dominique Fiers

25-10-2017 : “Question ”

When a company is listed on the stock market, shareholders bring in equity that I would call "new". But what happens to the equity already held by the company before the IPO: is this converted into shares? The IPO of a company can be done in two ways, or by a mix of these two ways:
Either the company proceeds with a capital increase by issuing new shares that are sold to investors who become shareholders of the company on that occasion. The company gets the proceeds of the share issue and increases its equity in the balance sheet for the same amount.
Either the current shareholders sell existing shares to investors who become shareholders of the company on that occasion. In this case, the company's balance sheet is not changed.
In any event, the equity of the company, whether listed or not, is made up of shares and the IPO does not change this situation. Simply with the IPO, these shares are listed and potentially sellable or very easily buyable.
Have a nice day.

24-10-2017 : “Quote of the day ”

"Every day I see a whole host of investment opportunities unfolding before me and my only problem is to distinguish the good ones to be seized from the bad ones to be shunned."  Antoine Riboud

23-10-2017 : “Question ”

When we calculate the pay out ratio, should we compute:   (dividends paid + share buybacks) / net income   or rather   (dividends paid + share buybacks - share issues) / net income   Yes for the second possibility if the capital increases are only the result of the exercise of stock options, which dilutive effect is often neutralized by making share repurchases for the same amount.   Have a nice day.  

20-10-2017 : “Citation du jour ”

"L'économie est le seul domaine où deux personnes peuvent se partager le prix Nobel en ayant affirmé des choses opposées (Myrdal et Hayek)." Roberto Alazar

19-10-2017 : “Can the equity market risk premium be negative? The Financial Times has written that over the past 130 years, it has been negative about one in four times. ”

  We love the FT to which one of us has subscribed since the age of 19. Yet on this point, we do not agree with them. In fact, they calculated the market risk premium by computing it as 1 / PE ratio - risk free money rate. This assumes that the value of a share is determined by Gordon Shapiro's method V = pay-out ratio x EPS / (k-g) This assumes that the future growth rate, g, is constant. This is not always true, and even often false. Therefore, based on a practical but false methodology (quick and dirty), it is not surprising that the results quoted by the FT are false. In fact, when you use a methodology that is correct, but much more complex to implement, you will find very very rarely negative equity risk premiums. For example, since 1986, the starting date for the European and American risk premium graph that we give in Chapter 19 of the Vernimmen, none of the risk premiums is negative. The proportion quoted without the FT is therefore completely false. Have a nice day.  

18-10-2017 : “Citation du jour ”

"Si vous prenez de l'argent dans votre poche droite pour la mettre dans votre poche gauche, vous n'êtes pas plus riche pour autant." Merton Miller

18-10-2017 : “Quote of the day ”

Whoever condemns money condemns people to servitude and is the accomplice of their downtrodden condition. Pascal Bruckner 

17-10-2017 : “How long has PwC audited the accounts of Goldman Sachs? ”

  For 91 years, since 1926, sic. Certainly it can be assumed that it is no longer with the same members of PwC. . . As for Wells Fargo, it has been 86 years since it was faithful to KPMG (since 1931), a recent auditor of Citigroup, for only 48 years (1969). Deloitte is a bit new to Morgan Stanley (20 years since 1997). This could change under influence. . . of European regulations which impose a change every 20 years and to open the auditors' mandate to competition at least every 10 years. This is rather healthy, at least in principle, to have an outside look that changes regularly and a competition that can play truly. The most virtuous countries in governance are not always those who claim to be. Have a nice day  

16-10-2017 : “Report sine die of the Aramco IPO? ”

  This is what the Financial Times thinks and it is not a huge surprise. Which investor, in a pure financial logic, would like to become shareholder of a group with a small free float (5 to 10%), alongside an undemocratic state with decision-making processes at least opaque and with a monstrous conflict of interest because of the oil tax, by far the first resource of Arabia? Not to mention a sector which, due to the energy transition, may have to leave a significant part of its assets in the ground forever. Last but not least, the difficulty of carrying out a process of making Aramco a truly independent public company offering normal guarantees of internal governance and reporting at a point in the stock market cycle of which we take no great risk to say that it is more close to its end than its beginning. Have a nice day.  

13-10-2017 : “Is it necessary or not to put the real estate business in the company to sell it? ”

It is up to you to see whether the selling shareholders want to keep the operating real estate on their own and to invoice the operating company for rents, providing them with some income at the risk of losing one day the tenant and have to find another, or even have to redeploy the building to bring it into line with the needs of a new tenant that may be different from the previous tenant.
It also depends on whether or not the buyer wants to own the operating property. Sometimes the inevitable price increase of the company owning its real estate can make it more difficult for a buyer to buy, and you lose in competitive intensity in the sales process, or you may even lose your only buyer.
The last chapter of the Vernimmen coming edition is devoted to the financial management of real estate operating assets.
Have a nice day

12-10-2017 : “Quote of the day ”

"Money ...... is the oil which renders the motion of the wheels [of trade] more smooth and easy." David Hume

11-10-2017 : “How to value a company that owns its operating real estate assets by using the multiple method? ”

  Using the opco propco method which is set out in the last chapter of the new Vernimmen devoted to the financial management of operating real estate assets. It assumes that the company is divided into two parts: an operational part (opco) which leases the operating property from the other part, the property part (propco), at a market price. The value of your company's equity is then the sum of the equity value of the two parties. For the operational part, its EBITDA is reduced by the rent it pays (usually fictitiously) to the real estate part. To find its entreprise value, you must multiply its EBITDA by the multiple of EBITDA of comparable companies that do not own their operating real estate assets. You then subtract net bank and financial debt (excluding the share that finances real estate, if there is one). If the comparables differ by their real estate policy, some owning the real estate, others leasing it, you must use multiples of the EBITDA before rent (the EBITDAR) that you apply to the EBITDAR of the opco part. For the real estate part, you value real estate on the basis of an appraisal / sales price per square meter and you deduct the real estate debt to obtain the value of the equity. The value of your company's equity is then the sum of the equity values ​​of the two parties. More in the last chapter of the new edition of the Vernimmen which has just been published. Have a nice day.  

10-10-2017 : “Quote of the day ”

"Every day I see a whole host of investment opportunities unfolding before me and my only problem is to distinguish the good ones to be seized from the bad ones to be shunned."  Antoine Riboud

10-10-2017 : “Richard Thaler, 2017 Nobel Prize for Economics ”

Behavioral finance is thus rewarded through one of its pioneers. Even if its applications in corporate finance are limited to this day, behavioral finance has figured prominently in the Vernimmen for years (chapter 15 for those who would have forgotten).
It will be noted that he teaches in Chicago like Eugene Fama, designer of the theory of efficient markets and Nobel Prize in 2013 for views very different from those of Richard Thaler. A demonstration of how academic freedom within the same institution is a real source of wealth.
Michael Jensen has not (yet) received the Nobel Prize (for his work on agency theory and governance) among the founding fathers of today's finance.
Have a nice day.

09-10-2017 : “I do not understand the concept of beta of debt. ”

  To simplify, one can say that when one is a shareholder of a company, one runs two risks: the risk of its economic activity and the risk of its financial structure which results from the choices that it made to finance itself with more or less debt. While it may be assumed that the risk of a firm's business is virtually the same for all firms operating in a given industry, the risk of the financial structure differs as from one business to another just like their different financial structures. In other words, the beta of equity (or the beta of the shares of a company that is synonymous) depends on the risk of the operations that runs this company in relation to the average risk of the economy in general and the risk of its financial structure (which depends on the level of debt in the financing of assets). To calculate the unlevered beta is to find within the beta of the stock, the share due to the operating risk by setting aside the part of risk due to the financial structure of the company. In other words, it is calculating what would be the beta of the shares of this company as if it had neither debts nor net cash. Hence the term unlevered beta. Indeed, if the company has zero net debt, the beta of its equity (or that of its shares which is synonymous) corresponds only to the risk of the operating activity or the risk of its operating assets. It is therefore the beta of the operating asset. If the equity beta measures the sensitivity of a share's value to market fluctuations, the beta of operating assets (the unlevered beta) measures the sensitivity of fluctuations in the value of the operating assets relative to market fluctuations. Have a nice day  

06-10-2017 : “Quote of the day ”

History has shown that control divorced from consequence will end badly. Some shareholders from Facebook

05-10-2017 : “Question ”

What problems arise when measuring financial equilibrium? That’s a tough question as there is no equilibrium in the true sense of the word in corporate finance. As Modigliani and Miller have shown, there is no optimum financial structure (split of financing of capital employed between debt and equity). All financial structures have their place and whether they are acceptable or not depends only on the level of risk that the shareholders are prepared to run. A highly geared company will thus be more profitable, all other things being equal, than a company without debts, but it will also carry more risk. Neither situation is better than the other – they are simply equivalent with different risk/reward ratios.
In the short term, we could describe financial equilibrium as the ability of a company to meet its debts at all times. It’s thus essentially a liquidity problem.This will depend on:
- the amount of short term liabilities relative to the amount of short term assets – if you have short term liabilities of 10, and short term assets of 7, and you cannot either reschedule your debts or raise new funds, you may as well file for bankruptcy.  
- how quickly your assets become liquid and how soon you have to pay off your debts. This information is not made public and external analysts are hard pressed to estimate it. Internally, it’s the ABC of any finance director’s key indicators.  For more information, see chapter 35 of the Vernimmen.

04-10-2017 : “Quote of the day ”

Avarice starts where poverty ends Balzac

03-10-2017 : “Solution to the problem of yesterday ”

When you buy an investment project at its net present value, and if the actual flows are in line with forecasts, your IRR is by construction the discount rate used to calculate the net present value, i.e. 6% in our example. And the net present value of the investment of buying the right to make an investment at a price equal to the net present value of that investment is of course zero. This does not mean that you have destroyed value; it means that you have earned the cost of capital of the investment, neither more nor less.
The idea is that the NPV represents not only the value created by an investment, but also the additional price that one could pay to make the investment while being adequately remunerated in relation to the risk taken.
For more details, see Chapter 16 of Vernimmen .
Have a nice day.

02-10-2017 : “Problem ”

You have identified an industrial investment project that you have secured the right to realize and whose net present value at 6% is €15m. You finally decide not to carry out this project because of lack of financial resources, but to sell it to a third party who acquires the right to carry out this project for €15m.
For this third party, what should be the net present value of this project all included and what will the IRR be if the reality is in line with expectations?
The answer will be tomorrow.
Have a nice day.

29-09-2017 : “Quote of the day ”

"One doesn't die from having debts, one dies from no longer being able to incur them."   Louis Ferdinand Céline

28-09-2017 : “Can we say that if ROCE is higher than WACC, then the return on equity is higher than the cost of equity? ”

Yes, there is no doubt about that and it can be seen in the following way:   If the ROCE is higher than the WACC, then the entreprise value is higher than the carrying amount of the operating assets.   Since the value of the net debt has no reason to be greater than its carrying amount simply because the ROCE is higher than the WACC (since the debt does not participate in the creation of value beyond  the interest rate paid), and since the value of equity is equal to the entreprise value less the value of the net debt, the surplus between the entreprise value and the carrying amount of operating assets, benefits only to shareholders and not to debt holders.   Therefore, the value of equity is greater than the book value of equity as it is equal to the book value + this surplus.   And if the value of equity is greater than its book value, it is that the return on equity is higher than the cost of equity.   For more see, chapter 26 of the Vernimmen.   Have a nice day.

27-09-2017 : “Quote of the day ”

"One doesn't die from having debts, one dies from no longer being able to incur them."   Louis Ferdinand Céline

26-09-2017 : “Question asked during a recruitment interview for trainees. What is the impact of a credit sale of 100 on the 3 main financial statements? ”

On the income statement, there was an increase in sales by the amount of sales (VAT excluded), a decrease in inventories of finished goods for an amount equal to the cost of production of the object thus sold and an increase in the profit before tax for the amount of the difference between the sales and the production cost. The corporate income tax increases by the corporate income tax generated by this sale and the net result by the amount of the net result generated by this sale.   On the balance sheet, the receivables increase by the amount of the sale inclusive of VAT, inventories of finished products decrease by the production cost of the object sold and on the liability and equity side, the equity increases by the amount of the net result generated by this sale. Lastly, debts to the state increases by the VAT collected on this sale as well as the corporate income tax generated by this sale.   On the cash flow statement, the net income or the cash flow from operations are increased by the net income generated by the sale. The change in working capital is increased by the same amount  (sales including VAT - cost of production which reduces inventories - VAT collected - corporate tax payable), so that the impact on the cash flow from operations is nil; which is logical as the customer has not yet paid, the impact on the cash of the company of this sale on credit is nil.   Have a nice day!

25-09-2017 : “So typically American! ”

Facebook had plans to distribute new non-voting shares to its shareholders allowing Mr. Zuckerberg to continue to sell Facebook shares without falling below 50% of the voting rights; a level of votes he gets thanks to a third category of shares with 10 voting rights per share. The country that prides itself on being the champion of good governance is far from putting it into practice at home (one seventh of the S & P 500 members have several classes of shares with your different rights).
Shareholders took the case to court and Facebook has just withdrawn its project. If in France, everything ends with songs according to the Canadian proverb, in the United States, it is with a trial that everything ends!
To get the week off to a good start, remember that since July the SP500 index manager no longer accepts multi-class stock companies in its index; even if those already in the index can keep them in place.
Have a nice day (with songs and without being sued if possible ...).

22-09-2017 : “Quote of the day ”

"I've reluctantly discarded the notion of my continuing to manage the portfolio after my death - abandoning my hope to give new meaning to the term "thinking outside the box."   Warren Buffett

21-09-2017 : “Toshiba sells its memory chip division to a consortium led by Bain Capital for $ 19 billion ”

LBOs of this size have not been seen for a long time, the big LBOs in recent years have been around $ 5 billion. But we are very far from historical records, since for example the 10 th biggest LBO in history was $ 27 billion in size. At 3.5 times EBITDA, the price reflects both the situation of a seller forced to sell to escape the worst (due to its losses in its nuclear division) and a cyclical sector with heavy investments that makes that only a fraction of EBITDA is available to service debt. Its listed Asian competitor, SK Hynix, is currently valued 3 times EBITDA. Have a nice day

21-09-2017 : “Can we say that if ROCE is higher than WACC, then the return on equity is higher than the cost of equity? ”

Yes, there is no doubt about that and it can be seen in the following way:   If the ROCE is higher than the WACC, then the entreprise value is higher than the carrying amount of the operating assets.   Since the value of the net debt has no reason to be greater than its carrying amount simply because the ROCE is higher than the WACC (since the debt does not participate in the creation of value beyond  the interest rate paid), and since the value of equity is equal to the entreprise value less the value of the net debt, the surplus between the entreprise value and the carrying amount of operating assets, benefits only to shareholders and not to debt holders.   Therefore, the value of equity is greater than the book value of equity as it is equal to the book value + this surplus.   And if the value of equity is greater than its book value, it is that the return on equity is higher than the cost of equity.   For more see, chapter 26 of the Vernimmen.   Have a nice day.

20-09-2017 : “Quote of the day ”

"The only cause of the depression is prosperity."   Joseph Schumpeter

18-09-2017 : “A moment of brainstorming to start the week on the right foot ”

  Is it true that a 1 % increase in interest rates on a 10-year bond yielding a 1 % nominal interest rate, while the market rate is 1 %, causes the bond price to fall more than the same rate 1 % increase on a 10-year bond yielding a nominal interest rate of 6 %, while the market rate is 6 %?   Is the difference in impact of the same order as the difference in market rates (1 % versus 6 %)? Smaller ? Bigger ?   Same place, same hour tomorrow for answers.   Have a nice day  

15-09-2017 : “Question from one of our follower: If there are so many advantages with tap issues, why is it not used all the time frequent issuers are interested in tap issues? ”

A s reminder a tap issue is a new issue of a bond with the same characteristic than another bond issued a while ago, sold at the market price and which enlarges the size of the initial issue.   When you are not a frequent issuer, you may only issue a bond every 2-4 years because your financing needs are not that high. Having issued 3 years ago a 5-year bond, either you tap your initial issue but the maturity of the new bond will be 5 - 3 = 2 years which is pretty short and may create a future liquidity problem in your balance sheet if you finance long term capex with the proceeds; or you issue a new bond for 5 or 7 years for example. Most unfrequent issuer will choose the latter option and will not tap their initial bond.   For frequent issuers like governments, large corporates, etc. that issue bonds every quarter or semester, this is less of a problem, at least for the first years after the issue of a long term bond. They can do tap issues several times in a row, but after a while, they will stop for this liquidity problem as the maturity of the initial bond is fixed and cannot be changed.   Have a nice day  

15-09-2017 : “Question from one of our follower: If there are so many advantages with tap issues, why is it not used all the time frequent issuers are interested in tap issues? ”

As a reminder a tap issue is a new issue of a bond with the same characteristic than another bond issued a while ago, sold at the market price and which enlarges the size of the initial issue.   When you are not a frequent issuer, you may only issue a bond every 2-4 years because your financing needs are not that high. Having issued 3 years ago a 5-year bond, either you tap your initial issue but the maturity of the new bond will be 5 - 3 = 2 years which is pretty short and may create a future liquidity problem in your balance sheet if you finance long term capex with the proceeds; or you issue a new bond for 5 or 7 years for example. Most unfrequent issuer will choose the latter option and will not tap their initial bond.   For frequent issuers like governments, large corporates, etc. that issue bonds every quarter or semester, this is less of a problem, at least for the first years after the issue of a long term bond. They can do tap issues several times in a row, but after a while, they will stop for this liquidity problem as the maturity of the initial bond is fixed and cannot be changed.   Have a nice day