Valuing mining companies can be tricky

Just ask shareholders in Ginadlbie Metals and Sundance Resources. An independent expert was unable to value the resources held by Sundance in Cameroon (see Oz article here). This is an example why I typically discourage students from choosing resource companies for the major assignment!

Value vs growth investing

Value investing (looking for low P/E, high dividend yield stocks) can be difficult in a bull market, with valuations on the rise. Anna French in The Australian explains what sorts of firms the fund managers are looking at. Note that the distinction between value and growth is not always clear:

Roger Montgomery, chairman of value manager Clime Asset Management, says value is hard to find but it is not the worst he has seen it. He also has a more flexible definition of value. "Value and growth are two sides of the same coin. You can't estimate the value of a business unless you can confidently assess its growth.

Tax implications for takeover targets

A couple of colleagues (Martin Bugeja and Ray da Silva Rosa) have a paper examining the impact of the change in tax treatment of capital gains in takeovers. From the abstract:

Prior to December 1999, shareholders that sold their shares into Australian takeovers have been taxable on capital gains irrespective of the form of payment. Subsequent to this date shareholders can elect to rollover gains when equity is received as consideration. We examine the effect of this regulatory change on the association between target shareholder capital gains and both takeover premiums and shareholder wealth. Inconsistent with the target shareholder taxation being important the results indicate that target shareholder capital gains are unrelated to takeover premiums and target firm abnormal returns. Additionally, we find that cash consideration increases target shareholder returns for reasons other than taxation.

SSRN link.

Value in mergers?

Where do the value in mergers come from? Here's a paper that has a crack at answering it.

We estimate that tax savings contribute only 1.64% in additional value, while operating synergies account for the remaining 8.38%. Operating synergies are higher in focused mergers, while tax savings constitute a large fraction of the gains in diversifying mergers. The operating synergies are generated primarily by cutbacks in investment expenditures rather than increased operating profits. Overall, the evidence suggests that mergers generate gains by improving resource allocation rather than by reducing tax payments or increasing the market power of the combined firm.

Mergers - how long till the benefits are realised?

We spoke in class this week about the time it might take for merger benefits to be apparent. This is relevant when trying to value any merger or takeover 'synergies', as well as when trying to 'measure' the benefits of mergers or takeovers (using say financial statement data). According to this article, the retail expert Wesfarmers has brought in to advise on the Coles merger thinks turnaround time will be at least 5 years. That seems reasonable to me.

Currency movements and earnings

The Australian dollar has been trending up against the U.S. dollar. That will impact on the Australian dollar value of U.S. earnings reported by companies such as CSL. The CSL chair at the recent AGM stated (link):

However, Ms Alexander said CSL had no plans to hedge its currency exposure, as exchange rate movements did not have an impact on the company's underlying performance.
"Given translation for reporting purposes does not reflect a cash flow, CSL does not consider it appropriate or economic to hedge these earnings," she said.

This implies that the U.S. earnings (or more correctly, the U.S. cash flows) are not 'repatriated' back to Australia, but rather 'kept' in the U.S. If the U.S. dollar cash flows were heading back to Australia, then CSL may be taking more of an interest in hedging.

Mergers and capital gains tax

We were talking in class this week about the tax implications of using cash vs shares in a takeover. Looks like the relative advantage of using shares (i.e., the deferring of a capital gains tax liability) is under threat. Jane Shultz in The Oz writes:

TAX experts expect a major slowdown in takeover activity due to a controversial change in tax law, despite the federal Government yesterday tweaking its announcement in a move likely to save the demerger of James Packer's Publishing & Broadcasting Ltd.

On Friday, Revenue Minister Peter Dutton suddenly announced changes to the tax consolidation regime that significantly increased the amount of capital gains tax payable when assets bought in a scrip-based takeover were on-sold.

Mergers, and Sovereign Wealth Funds

We've discussed in class this week the fact that regulatory requirements can limit merger and acquisition activity. The sorts of regulators involved are the competition regulator (ACCC) and the Foreign Investment Review Board (FIRB). The Group of 7 are currently considering a proposal to limit the investment activities of so-called Sovereign Wealth Funds (i.e., countries, especially those like Singapore and China, who are amassing extremely large amounts of money). Let's keep an eye on this...

Link to Australian article.

UPDATE (19/10/07): I didn't mention the Takeovers Panel (hey, check out the 'old-school' website feel) as one of the relevant regulatory bodies, but should have. One of their current tasks is to decide whether Pallinghurst or Palmary should end up owning Consolidated Minerals. Bryan Frith article on this here.

Earnings management and earnings quality

Kin Lo from the University of British Columbia has posted an easy-to-read (i.e., no statistical analysis) article about earnings quality and earnings management at this SSRN link.

* Photo of UBC by Kevin.Creamer - taken from his Flickr page.

Private equity - Michael Jensen's thoughts

Michael Jensen (Harvard Business School) has a set of slides available from SSRN concerning his thoughts on private equity: in short, he views it as part of a new model of management.

Slides at this link.

The stock market crash 20 years on...

inevitably leads to comparisons with market conditions now. It seems that most commentators think that conditions aren't (yet) as speculative as they were back then. Here's John Spalvins, former CEO of Adsteam:

There's no comparison between today and 20 years ago," says Spalvins.

"The economy is in great shape." Spalvins says that in the late 80s he was concerned about a share market crash a year before it happened.

"Interest rates are low.

"We have a resources boom ahead of us.

"People don't understand the meaning of the emergence of China and India. They think commodity prices will return to their long-term levels.

"But there is a new ball game in which commodity prices will operate at very high levels because of the ever-increasing demand from China and India."

In the Weekend Australian - link.

More commentary from Anna French:

With the 20-year anniversary of the 1987 share market crash fast approaching, a few investors are skittish about the parallels between then and now - particularly the length of the current boom and the huge share price gains in the lead-up.

During the tech boom it was described as "irrational exuberance" by Robert J. Shiller, who wrote a book of the same name.

Most say "it's different this time" because the resources companies driving the boom actually make money, but investors can still learn lessons from previous wealth-destroying episodes.

Michael West also gets in on the action:

Then, the Asian power funding US deficits was Japan, not China, although US deficits are now in the trillions, not billions.

Interest rates are lower now. They were 11 per cent then, not 7per cent. The price of bullion was lower too, ironically indicating less inflation in the pipeline than the gold price would now suggest.

Price-earnings ratios were 20 times then. Now we talk about EBITDA ratios - they make stocks feel cheaper. But on a like-for-like basis the resource stocks now trade on higher multiples, as do the banks, and the industrials are slightly lower. Then there are the growth stocks and the financial engineers whose PERs are well into the 20s.

Equity yields were lower then. They doubled after The Crash from 2.5 per cent. Now corporate balance sheets are cleaner, and with the exception of the financial engineers, gearing is lower.

Just as the Bonds and Skases were doing then, the Macquaries and Babcocks are doing now, refinancing and revaluing assets, ripping out fees, booking profits barely related to cash flows and wowing all with their brilliance.

Executive pay disclosure

orporations are falling short in explaining to investors how executives are compensated and for what, Securities and Exchange Commission officials said Tuesday in their first review of corporate filings since new pay disclosure rules were put in place.

The S.E.C. called on corporations to give investors more insight into how they made compensation decisions and to ensure that proxies were “clear, concise and understandable.” Corporate boards, regulators said, could also do a better job in discussing how they chose performance targets, severance packages and the peer companies they used as comparisons for their pay practices.

New York Times link.

The same issue continues to apply in Australia.

Equity risk premium in Australia

Here is a link to a paper that provides some information on the returns on stocks, bonds and the equity risk premium in Australia.

Takeovers and disclosures

Paul Kerin in The Australian writes about takeover bids and the fact that management should disclose any offers they receive to their shareholders, and if the bid is rejected, explain why. Ideally companies should have explicit policies in place to deal with these sorts of issues. Link

Collateralised debt obligations (CDOs)

Trying to understand how some of these new fancy financial instruments work? Here's a paper that tries to explain one of the newer things on our radar; the collateralised debt obligation, or CDO. SSRN link here.

From the paper's abstract:

Two recent developments for transferring credit risk are credit derivatives and collateralized debt obligations (CDOs). For financial institutions, credit derivatives allow the transfer of credit risk to another party without the sale of the loan. A CDO is an application of the securitization technology. With the development of the credit derivatives market, CDOs can be created without the actual sale of a pool of loans to an SPE using credit derivatives. CDOs created using credit derivatives are referred to as synthetic CDOs.

In this article, we discuss CDOs. We begin with the basics of CDOs and then discuss synthetic CDOs. The issues for regulators and supervisors of capital markets with respect to CDOs, as well as credit derivatives, are also discussed.

Credit crunch losses

Looks like the losses on the recent 'credit crunch' have topped US$18 billion, according to a report in the Financial Times section of The Australian (link). Most of the major banks in the U.S. are reporting write-downs in the value of their loans. It will be interesting to have a look at the reports of these companies to see how they have gone about the valuation of their loans.

I wonder if things would have been different if the U.S banks had to file half-yearly (as in Australia) rather than quarterly. In particular, I wonder if the banks would have disclosed to the ASX the extent of their write-downs under the Continuous Disclosure obligations.

Wesfarmers, Coles and independent experts

Coles has released the independent expert's report commissioned for the Wesfarmers bid. You can find it at the ASX announcements page (link). You can find an example of the media reaction to it here. Crikey's Adam Schwab gets it about right when he states (link):

Grant Samuel’s full 187-page Independent Expert’s Report on Coles Group was finally released on Monday. The Report notes that while Wesfarmers’ offer “does not deliver a full premium for control” shareholders are better off voting in favour of the deal. Grant Samuel values Coles at between $16.21 and $18.23 per share. The only thing is, the Expert noted that “the valuation range exceeds the price at Grant Samuel would expect Coles Group shares to trade in the absence of the Wesfarmers proposal.”

In short, what Grant Samuel effectively said was that - “We think the company is worth $20 billion – the only problem is, no one who is actually willing to spend money to buy Coles shares thinks that.”

Grant Samuel’s valuation is based on both a discounted cash flow model (which is highly subjective and can be wildly affected by the forecast growth rates and discount rates assumed) and the capitalisation of earnings method (which involves a comparison of multiples such as EBIT, EBITDA and net profit with comparable companies).

We'll have a look at the expert report in detail in class 11.

Why group work?

Marcia Devlin writes in today's Australian (article helpfully not online) about the benefits of group work (timely given the group project is due in a few weeks). Marica is from the University of Melbourne, and has a number of articles at this link that points to her research. An article on group work in particular can be found at this link (14 page PDF).