“Comment, question or quotation of the 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

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