Manage Money and Income Sucessfully

Peter had met with the labor council and brought a proposal back to John. “John, the labor costs on this project are very close. We’ll subsidize the labor cost one cent per labor hour. But if we do this, we want you to sign a project agreement with us. As you know, in a project agreement we’ll ensure that you have the needed labor and we’ll provide you with a no-strike clause. And in return you’ll agree to make this an all-union work site.Additionally,we’ll help reduce the labor cost to make the job cost-competitive with nonunion contractors. Your client needs to have this job completed on time. Going with a nonunion contractor opens you up to risk in this area. Our record proves that if you sign a project agreement with us, you won’t be held up by labor problems.Will you commit to a project agreement?” John thought about it for a few minutes.While the labor would cost slightly more than he wanted, he knew Peter was right about getting the job completed on time. The trades had the resources needed to complete the job. Some nonunion contractors were excellent, but getting enough people on site was always an issue. John asked Peter: “What would I need to do if I were to commit to using all-union labor on this project?” Peter suggested they review a project partnering agreement that the Building and Construction Council had used on other projects. Then, they could decide what to include in or exclude from their agreement. John liked the idea, so they proceeded. The project partnering agreement that Peter showed him was five pages long and included thirteen articles. Each article addressed a term of the agreement. John took a minute to review each article.

Almost all bonds of companies being upgraded into investment grade show a significant spread tightening long before the actual rating action.  Of course at the time of the upgrade technical factors (new previously restricted buyers emerge) tighten the spreads further.

This is an effort to categorize the evaluation of Fallen Angels. Only the most important points are mentioned. In a first step, the analyst has to decide whether the company falls into the category stressed or distressed. The following points should help in the decision-making process. A distressed credit is very likely to default, and break-up value has to be determined. A stressed credit has a realistic chance for a turnaround and one has to estimate how likely this case is.

Companies that have a successful turnaround will show most of the following characteristics:

• Successful deleveraging and improvement of the liquidity situation is realistic.
• Asset Sales can be done in an adequate time and at acceptable levels.
• Debt maturity profile is improved by refinancing (new bank lines and bond issues).
• Additional rights issue is feasible.
• Capital structure option is exercised in favor of bondholders and the equity market rewards these steps as well.
• Corporate actions (reduction of CAPEX, postponement or cancellation of acquisitions, cost cutting, solid management of working capital).
• Change of management.

Adowngrade into high yield may have the following effects:

• Forced selling activities from investment grade accounts
• Direct effect on the financial flexibility of a company (CP program, bank covenants triggered), may result in “financial distress” in a worst-case scenario

The spread behavior prior and after a downgrade into high yield or an upgrade into investment grade is of particular interest. The average spread for 15 companies’ 200 trading days before and after a downgrade into high yield. Day “0” is set as the day where the first downgrade from investment grade into high yield occurred either by Moody’s or S&P. The bonds we chose for this analysis were downgraded between 2002 and 2003 and are presented below.

It is noteworthy that a significant deterioration in spreads occurs long before the actual rating action takes place. At the day “0” obviously in most cases further spread widening/price fall takes place but this can be explained by technical factors. Forced sellers will emerge and in an illiquid market bid-offer spreads can be as wide as 3–4 price points and prices can deteriorate quickly if no buyers arise.

For discouraged investors, other products are available. Closed-end funds (CEFs) are mutual funds that are sold on the exchanges like stocks. Openend mutual funds are sold directly to investors; every dollar invested adds to the assets under management and management fees. After an initial public offering to raise capital, CEFs are bought and sold between investors at whatever price investors are willing to pay. The price of a CEF can be higher or lower than the value of the stock held by the fund. CEF managers are only able to offer new shares if returns have been good and the fund becomes popular. However, the prices of CEFs are volatile.

Closed-end funds are subject to mass psychosis. When certain stocks are hot, CEFs owning those stocks can sell for several times net asset value (NAV). Investors often experience overconfidence and grandiosity. When these stocks are unpopular, CEFs plunge to a fraction of NAV. When CEFs linger below NAV for long periods of time, frustration sets
in. Often shareholder suits are filed to open up the fund and distribute assets at NAV. CEFs are also subject to management changes and style changes. In addition, CEFs are often taken over by outside management companies and converted into larger funds. Spreads and commissions on CEFs are often painful. Closed-end funds are outside the comfort zone of most mutual fund investors.

A feeling of complete powerlessness is unusual. We all like to feel that life is moving along in a positive, predictable fashion. For most, a sense of control over his or her own destiny is important. Unfortunately, savings, investing, and speculating are all affected by elements beyond our control.

At times, these elements produce extreme results. When the stock market dropped 90 percent between 1929 and 1933, the sense of powerlessness was so great that a whole generation vowed never to buy a single share again. Those left out of the great tech bubble that ended in March 2000 felt equally powerless as they saw friends or acquaintances become instant millionaires.

Powerlessness is most extreme in stock investing, but it is found in real estate booms and busts, bond defaults, and other investments. Powerlessness is paralyzing for the majority of investors. Market shocks cause a few investors to panic; most sit on the sidelines experiencing a sense of powerlessness as prices gyrate wildly. Anxiety, numbness, and depression are common manifestations of the sense of powerlessness.

A restructuring solution that is based on erroneous or unreliable information is unlikely to succeed. Every attempt should be made to establish the exact financial position of the company, as well as the credibility of any financial projections. Often this is very difficult and takes considerable time, partly because the lack of reliable information usually contributes to the company’s problems in the first place. Banks must invest all the time that is necessary to obtain reliable information at the outset of the restructuring. It is usually necessary to verify any information produced by the company independently to achieve this. Also, the sharing of information amongst stakeholders promotes trust in the loan workout process.

Anticipation and planning

An experienced banker can anticipate problems and take corrective action before it becomes necessary. To be able to do so, the banker must have sufficient dedicated time and resources to consider all possible options and approach loan workouts in a methodical way. The planning process should also incorporate contingency plans to be implemented in the event of unexpected outcomes. Planning also enables a bank’s resources to be deployed efficiently.

Trademarks and trade names are a second class of identifiable intellectual property. Trademark law is intended to prevent consumer confusion as to the source of products or services. The great names of the old economy are largely trademarked: Coca-Cola, McDonald’s, Xerox, Sears, Gillette, DuPont, and Kodak all inspire trust on a global basis. They create shareholder value above the intrinsic value of the goods and services in the marketplace.

The proliferation of web sites has made trade names even more important in the New Economy. Witness the flood of dotcom advertising during the Christmas season of 1999 aimed at creating brand awareness. The very names America Online and AOL, Amazon, Yahoo!, and eBay are now important commercial franchises. The traffic that comes with consumer awareness generates real options to supply new services on these sites and thus leverages value beyond that earned from the existing services.

Trademarks can be used commercially almost as aggressively as patents. Monsanto spent millions to establish the Nutrasweet trademark and required soft drink suppliers such as Coca-Cola and PepsiCo to put the Nutrasweet swirl logo on every can and bottle. They succeeded, despite considerable resentment from their customers, because of their patent position on the composition of matter. The objective was to use the trademark to differentiate Nutrasweet from generic aspartame and to protect its market position after the patent expired. The strategy appeared to work for a while, but the swirl now has been harder to find on the cans of the major soft drink brands.

The case for continuous innovation is powerful. The key idea is that a company in time calibrates the slope of its technological Scurve in financial terms.3 It gains that knowledge through an analysis of the costs of its R&D programs, counting both successes and failures. At the same time, it learns the impact of improved performance on sales growth and margins. The combination tells it how fast it can move up the S-curve for a given level of technology spending.

Faster growth and higher margins translate directly into value. A higher, sustainable growth of free cash flow significantly boosts discounted cash flow (DCF) valuations. And higher margins improve return on invested capital. The combination of high returns and high growth rates can produce sensational gains in economic value.

Of course, an R&D investment reduces free cash flow in the short term, as in the Boeing case, so it is necessary to factor in R&D productivity to determine whether the long-term growth creates more value than the short-term penalty extracts. Several metrics have been proposed for measuring R&D productivity. In The Valuation of Technology, I proposed using a growth-related measure: the ratio of annual new product sales to the portion of the R&D budget dedicated to innovative new products.

Other companies have developed algorithms for calculating return on investment (ROI) on R&D investment. In the long term, however, R&D productivity cannot be expected to remain constant. As one mines out the more attractive opportunities at the foot of the S-curve and as its slope flattens, it makes sense to reduce R&D and to eliminate programs that no longer add value.