Archive | May, 2012

On A Lighter Note

28 May

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The Facebook Affect – Part 2

28 May

On Wednesday, May 23, 2012, a group of Facebook shareholders filed a lawsuit in a New York district court alleging that important information about Facebook’s financial outlook was “selectively disclosed” to big banks ahead of the IPO.  The legal action followed a Reuters report posted late Tuesday, which alleges that analysts at lead underwriter, Morgan Stanley, received privileged information about Facebook’s financials – information that would negatively impact its valuation (and its share price) – information that wasn’t shared with main street investors.

As a separate Reuters report noted a few hours later, Morgan Stanley and three other major underwriters – Goldman Sachs, JPMorgan and Bank of America – reduced their earnings outlooks for Facebook to strikingly similar levels ahead of the IPO.

In my mind, there are three issues with which we, as intelligent and informed consumers and investors, need to be concerned:

Valuation

In finance, valuation is the process of estimating what something is worth.  There are a number of methods used to determine the value of a company – comparables, earnings, discounted cash flow, net present value, ratio or multiples and replacement value – all of which fall into 3 basic categories:

1.  Asset-based approaches – Basically these business valuation methods total up all the investments in the business (think assets minus liabilities).  This is often difficult for internet businesses where “value” lies in the product or service, and not in “physical” assets. 

2.  Market value approaches – These approaches to business valuation attempt to establish the value of a business by comparing that business to similar businesses that have recently sold. (Note: think comparables (or comps) in home buying).  Obviously, this method is only going to work well if there are a sufficient number of similar businesses to compare.

3.  Earning value approaches – These business valuation methods are predicated on the idea that a business’s true value lies in its ability to produce wealth in the future.

Most likely the valuation of Facebook is based on the capacity it has to make money due to the incredible amount of targeted traffic that passes through daily – the same reason an ad space in Times Square is worth so much money.  Most social networking sites generate revenue from selling advertising to companies.  Facebook’s unique approach is to have members “like” a particular product, which is then advertised to friends of that member.  Facebook generates 90% of its revenue from advertising.  The remaining 10% of revenue comes from developers on Facebook Platform – a set of tools that enable third-party developers to create applications inside the Facebook environment.  So a valuation would be based on projected earnings from these two sources – in essence it is not based off revenues, but rather the capacity for revenues.  According to pre-IPO reports, Facebook had a $2B revenue figure for 2010 showing a profit for the year of $400 million.  The $38 per share IPO price valued Facebook at $104B.  With shares down 16% at $31.91, some analysts expect the stock could eventually dip to around $24 or $25 a share while some on-line bloggers place its stock value closer to $10 per share.

Exit Strategies

The big question to ask is “Why did Facebook decide to go public at this point in time?” 

Most businesses go public when they want to obtain some additional resources to finance their activities and projects.  With its $1B purchase of Instagram in April, Facebook doesn’t appear to lack capital backing for new projects.

More importantly, Facebook had little choice but to go public due to the Securities and Exchange Commission (SEC). Under the SEC’s rules, a company with more than 500 shareholders must adhere to the same financial record requirements as public companies.  Granted, they could have consolidated shareholders by allowing buyouts – and that drives what I believe is the real reason Facebook went public.

An exit strategy is a means of leaving one’s current situation, either after a predetermined objective has been achieved or as a strategy to mitigate failure.  Early Facebook investors are expected to earn more than 50 times their original investment even with the stock decline – in other words, they are sitting on millions, and in the case of a couple firms, several billion dollars in unrealized gains.  Now I have no issue with making a profit on an investment – profits drive growth and innovation.  What I take issue with is financial chicanery that reaps high payouts for some while and passing the losses onto shareholders, or worse, to the general public in the form of bailouts.

Regulation

The three financial “events” listed in my last blog entry have renewed calls for more regulation of the banking and finance industries.  I refer to them as “events” because even a casual review of banking and finance history shows that they occur too often to be labeled as “scandals” or “debacles.”  Robert J. Samuelson’s Financial Reform’s Big Unknowns, published in April 2010, does an excellent job of examining the regulation debate. http://www.thedailybeast.com/newsweek/2010/04/25/financial-reform-s-big-unknowns.html

This subject requires further examination, but I will reserve that for another entry.  I continue to believe that an informed public is better than any government regulation – and I hope this blog plays a part in that education.     

 

 

 

The Facebook Affect

26 May

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af·fect/əˈfekt/

Verb:    

1.  Have an effect on; make a difference to: “the dampness began to affect my health”.

2.  Pretend to have or feel (something): “as usual I affected a supreme unconcern”.

Noun:  

1.  Emotion or desire, esp. as influencing behavior or action.

Synonyms:         

1.  verb.  touch – influence – pretend

2.  noun.  emotion – affection

So despite the excesses that led to the 2008-2009 financial crisis, we have seen a number of high profile (and high dollar value) financial “events” on Wall Street this past year:

  • In late 2011 MF Global filed for bankruptcy after admitting it “misplaced” $1.6B in investors’ money.  Chief Executive Jon Corzine received $8M in compensation the same year.
  • Earlier this month, JPMorgan Chase announced a surprise $2B trading loss on credit derivatives trading, which chief executive Jamie Dimon blamed on “errors, sloppiness and bad judgment” and warned “could get worse”.  Dimon received $23.1M in compensation in 2011, an 11 percent increase from the previous year.
  • And most recently, the much anticipated Facebook IPO fizzles as 101 million shares of the company (valued at $104B) are offered at $38 a share on May 18, 2012.  A week later the stock closes down 16% at $31.91 amid speculation of improper handling of the IPO by Morgan Stanley.  CEO Mark Zuckerberg sells 30.2M shares, making a total (before taxes) of $1.13B.

Let’s explore this latest event a little closer as the IPO was a very public event and yet so many investors still got taken in by the hype…

Indicator 1 – GDP (Gross Domestic Product)

23 May

US GDP 1960-2010

Let’s start with some basics before we move onto analysis…

Gross Domestic Product (or real GDP) is the market value of all goods and services produced in a nation during a specific time period.  It is labeled “real” because each year’s data is adjusted to account for changes in year-to-year prices.  Mathematically, GDP = private consumption + gross investment + government spending + (exports − imports), or GDP = C + I + G + (X – M).  The U.S. Department of Commerce’s Bureau of Economic Analysis (www.bea.gov) releases the data quarterly, including any revisions, within the last week to 10 days of each month following the end of the quarter.

The economy of the United States is the world’s largest national economy.  Its nominal GDP was estimated at over $15 trillion in 2011, approximately a quarter of nominal global GDP.  Its GDP at purchasing power parity is the largest in the world, approximately a fifth of global GDP at purchasing power parity.  Purchasing power parity (PPP) allows us to compare the GDP between countries by taking into account the exchange rates between the two countries.

GDP in the U.S. expanded 2.2% in the first quarter of 2012 over the previous quarter.  Historically, from 1947 until 2011 the U.S. average quarterly GDP Growth was 3.28 percent; reaching an historical high of 17.20 percent in March of 1950 and a record low of -10.40 percent in March of 1958.  As the economy of the U.S. is a mixed (and diverse) economy, it has maintained a stable overall GDP growth rate (as the graph above indicates), a moderate unemployment rate, and high levels of research and capital investment.  It has been the world’s largest national economy (not including colonial empires) since at least the 1890s.  GDP per capita is often considered an indicator of a country’s standard of living but not a measure of personal income.

GDP is important because the Federal Reserve uses data such as the real GDP and other related economic indicators to adjust its monetary policy – specifically, to set the target for the federal funds rate (fed funds rate).  The federal funds rate is the interest rate banks charge one another for short-term loans.  Banks obtain short-term loans to stay in compliance with legally mandated minimum cash reserves or to cover capital needs.  Changes in the federal funds rate influence the money supply, which influence the interest rates in the economy.  Typically, an increase in the federal funds rate puts upward pressure on market interest rates, while a lower federal funds rate puts downward pressure on interest rates.

So let’s put these numbers in context by comparing the economies of the United States and China, and breaking down GDP contribution by sector:

2011

United States

China

GDP

$15.09 Trillion

$12.46 Trillion

GDP Growth

1.7%

9.5%

GDP Per Capita (PPP)

$48,387

$5,184

Labor Force

155 Million

780 Million

% GDP by Sector:

Services

76.7%

43.6%

Industry

22.1%

46.8%

Agriculture

1.2%

9.6%

 

The services sector is the primary economic sector in the U.S – contributing over ¾ towards the GDP. Information, retail, scientific, technical and professional services form the major parts of this sector.  Out of all the services, wholesale and retail trade comes up as the leading business areas.  If net income is taken into consideration, then finance and insurance services feature as the top business option.

As of 2012, the country remains the world’s largest manufacturer, representing a fifth of the global manufacturing output.  Main industries include petroleum, steel, automobiles, construction machinery, aerospace, agricultural machinery, telecommunications, chemicals, electronics, food processing, consumer goods, lumber, and mining.

Agriculture (despite representing less than 2% of GDP) is a major industry in the United States and the country is a net exporter of food.  With vast tracts of temperate arable land, technologically advanced agribusiness, and agricultural subsidies, the U.S. controls almost half of world grain exports.  Products include wheat, corn, other grains, fruits, vegetables, cotton; beef, pork, poultry, dairy products; forest products; fish.

Remember, our goal in examining these indicators is to gain a better understanding of the economic state of the nation.  A couple questions come to mind:

  1. Is GDP a good measure of economic health?
  2. Can a country based significantly on services sustain economic growth?
  3. Is sustained growth in GDP over a 50+ year period really desirable?

Economic Indicators

12 May

I am often asked, “When is the economy going to recover?”  If you believe an October 2009 survey of 44 professional economic forecasters by the National Association for Business Economics, the recession ended in June 2009.  If you follow Paul Krugman, the Nobel Prize winning economist, we are still in a depression (albeit not as severe as the Great Depression).

In April, the growth forecast (GDP) for 2012 moved up to a range of 2.4% and 2.9%, higher than the 2.2% to 2.7% predicted during the last round of projections in January.  Alternatively, the inflation forecast rose to a range of 1.9% to 2.0%, higher than the 1.4% to 1.8% projected in January.  Unemployment at the end of the year is expected to be around 7.8% to 8.0%, down (yet still high) from an earlier projection of 8.2% to 8.5%.

Subsequently, the Federal Open Market Committee (FOMC), a committee within the Federal Reserve System charged under United States law with overseeing the nation’s open market operations (that is the buying and selling of United States Treasury securities), opted to keep interest rates (and therefore the money supply) unchanged.

So what would an economic recovery look like?  To what level should the economy recover – to pre-recession levels?  To levels achieved before the run up in housing prices?  Or somewhere in between?  While I have found myself responding to such inquires with a very lawyerly “It depends,” the real answer is more honestly, “I don’t know.”

I started the postCynical blog as a means to educate – myself, my friends and my family – in order to make more informed financial and economic decisions.  To that end, I will be dedicating this summer to examining key economic indicators (what they are, what they measure, and why they are important) and how they relate to (or don’t) to the economic health of the nation and the financial decisions we make every day.

Despite assurances that the recession ended in June 2009, I believe we are a long way from recovery. It took nearly 40 years to wind-up the global economy to the levels of wealth, debt and systemic risk that we are now trying to address.  I believe it will be 7 to 8 more years (if we do the right things now) before we see significant recovery and stability.  Let’s explore and examine.

Summer Reading

11 May

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Without the distraction of MBA classes, I have selected 5 books to read over the summer break:

  1. The Naked Economist by Charles Whellan.  This time I’m reading it cover to cover.
  2. American Creation by Joseph Ellis.  The last quarter of the eighteenth century remains the most politically creative era in American history, when a dedicated group of men undertook a bold experiment in political ideals. It was a time of both triumphs and tragedies – all of which contributed to the shaping of our burgeoning nation.
  3. The Ascent of Money by Niall Ferguson. Check out the 4-part PBS series at http://www.pbs.org/wnet/ascentofmoney/.
  4. An Economist Gets Lunch by Tyler Cowen.  Cowen offers lots of mantras for foodies, the dominant mantra reading like this: “Food is a product of economic supply and demand, so try to figure out where the supplies are fresh, the suppliers are creative, and the demanders are informed.”  In his own life, Cowen uses the mantra to experience excellent food wherever he goes – in the Washington, D.C., area where he is on the faculty at George Mason University; in locales across the United States; and around the globe.  Listen is his interview with Russ Roberts (also of GMU) at http://www.econtalk.org/archives/2012/04/cowen_on_food.html.
  5. Iacocca: An Autobiography by Lee Iacocca.  A classic.