2016_08_30 - Market Musings

As a reminder these market musings serve to provide insight into what is driving the markets and also cover issues specific to a number of businesses as we see fit. 

Markets:

1. The Fed - Deja Vu All Over Again

Well, here we go again. As they say on draft day, "the Federal Reserve is on the clock". The Federal Reserve held their annual meeting at Jackson Hole last week and gave their speeches which were meant to prepare the market for rates to increase. The market swung around a whole lot intra-day and then...well nothing really.

The Fed really wants us to believe they are going to have two more increases this year. Those would be in September and December. It's highly unusual to raise rates two months before a Presidential election. In fact, since the Federal Reserve started publicly announcing its rate changes in 1990 it has never happened. There is of course a first time for everything and caution should abound for investors given that the market is pricing in virtually no chance of this occurring.

In the meantime the spectacle must go on and we will have wild swings based on what they determine to do. Friday, September 2, 2016, should be an interesting day as the employment report for August comes out showing how many jobs were created. Fed watchers believe the employment report is Ms. Yellen's (the Fed Chair) most important data point. Just to throw in one more twist the market is closed on Monday, September 5, 2016. If something dramatic happens on a Friday before a three day weekend it tends to be exacerbated that next Tuesday.

2. M&A - Still Rocking and Rolling

As you know we like to track M&A and the IPO markets as they provide signs of frothiness or despair and it's also just a lot of fun to watch who's buying who and who's coming public. Being "public" has a big of a stigma these days and yet the vast majority of the largest businesses in the world are public due to the access to capital and liquidity. This isn't going to change. You may have heard about the number of public companies decreasing significantly...that is true but it the smallest companies not the largest that have decreased the number of public companies.

Dealogic has a great report on the first half of 2016 M&A here. The first chart is pretty telling:

Source: Dealogic

Source: Dealogic

The net, net of it is that M&A is doing quite well. Companies continue to take advantage of cheap debt to effectively "buy growth". It will be interesting to see how this cheap debt and buy growth narrative changes if and when rates start to rise. People tend to forget that the debt used for deals either has to be refinanced or paid down. Companies don't typically pay down a lot of debt unless they have to or they have conservative management and conservative management teams generally don't take on a lot of debt. So what happens when that 4% debt has to be refi'd at 7-8%?

One deal announced today caught our attention. Ritchie Brothers (RBA), the largest live-auctioneer acquired Iron Planet, one of the largest online-auctioneer companies. RBA is up significantly on the deal because frankly it makes a whole heck of a lot of business sense to put these companies together. Something doesn't sell well live, let's do it online with a larger number of buyers, etc. This also reflects what happens when a respected management team does a deal.

We are no experts in this space but given how active the regulators have been lately you would think they would give it a hard look. You have the leading live and leading online auctioneers coming together. There is certainly nothing wrong with this but I am sure they will give it a good scrub. This leads us to our final talking point on M&A.

Here is the chart of withdrawn M&A (primarily due to regulators):

Source: Dealogic

Source: Dealogic

As you can see withdrawn M&A this year is substantial. Why are the deals being blocked?

  1. Some of them were inversions where companies change their domicile to a more favorable tax location. The Treasury has clamped down on what is allowed here. This caused a number of deals to fall through
  2. Some of them were truly audacious deals where the combination would create massive companies with more market power than is appropriate. Comcast/TWC was a good example there. Health insurers are another
  3. This is the last year of President Obama's presidency and it appears they are throwing their weight around a bit more. This isn't overly unusual. In the last year of a Republican presidency companies will work very hard to get their deals done while the regulators look more favorably on their deals

Other times, such as we saw today with Mondelez and Hershey, the family/board simply won't sell the company even with what appears to be a generous offer. I'm time-stamping this right now, we will see a deal or at least an offer within 12 months. The arbs are not happy here with the stock down 12% today as of this writing. Patience should pay off although the return won't be gigantic. 

3. When Hedge Funds Go Wild

For those of you who don't follow the feud between Bill Ackman and Carl Icahn, this one is a doozy. To simplify the story, Mr. Ackman is short Herbalife (HLF), Mr. Icahn is long HLF. On Friday the WSJ reported that Icahn was looking to sell out of his stake. The stock tanked. After the market closed Friday Mr. Icahn announced not only did he not sell any shares he actually bought a couple million more. And he issued a nasty statement about Bill Ackman via Twitter. It's all ego and drama but the odds that (i) Mr. Icahn was looking to sell, (ii) it came out and the stock tanked and (iii) Mr. Icahn then decided to load up to spite Bill Ackman, are a lot higher than you would think. It will be fun to watch it play out although we don't have any exposure to the overall situation.  

Business:

1. The US Treasury is very upset with the Europeans for taxing US companies...

One of my favorite quotes of all time came today from the US Treasury Department regarding a European ruling that Apple owes $14B in back taxes due to some shall we say interesting tax agreements in Ireland. Anyways here is the article and the quote:

The U.S. Treasury Department has sharply criticized the EU’s tax investigations, arguing that the bloc unfairly targets American companies and acts inconsistently with international tax norms.

On Tuesday, a spokesperson said the Treasury Department was disappointed with the commission’s decision and reiterated that “retroactive tax assessments by the commission are unfair, contrary to well-established legal principles, and call into question the tax rules of individual Member States.”
— WSJ

Now let's remember a few things about the US Treasury:

  1. They tax businesses based on world wide income unless the money is not repatriated (brought home) meaning US headquartered businesses leave trillions of dollars overseas to avoid taxation
  2. The US corporate tax rate at 35% is the highest out there. Sure the average company tends to pay in the 20%s due to loopholes. The only reason these loopholes have to exist and millions/billions spent on tax lawyers and CPAs is because that rate is 35%. 

It's all completely ridiculous. At some point we are going to reform this whole thing.

2. Levered, Commoditized & Oversupplied Businesses are Difficult

It's always a good thing to be reminded of this. 2016 has had plenty of these reminders, primarily in the energy space. One of the most difficult businesses in the world is the shipping industry. The shipping industry suffers from (i) oversupply (too many ships / too much overall tonnage), (ii) too much debt and (iii) slowing growth.

Today we saw the ninth largest shipping company, Hanjin Shipping, will no longer be supported by its creditors and will likely need to file for bankruptcy. Meanwhile its competitors work out alliances with each other to try to cut costs and keep base rates at a profitable level. A lot of money can be made in the shipping industry with the right conditions and certainly some families have created dynastic wealth, but it's best for those of us who are not experts to learn from the industry dynamics and stay out of the way.