I must admit to being unimpressed with Sam Zell’s bid for Tribune. I can’t remember the last time someone put up so little money for so great an asset, aside for when I was the juniormost member of the AIG team considering whether to take over The Equitable. (AXA walked away with it, and the untold story is how AIG botched the whole thing.)
The skinny is this: Tribune the company borrows money, and gives it to the ESOP [employee stock ownership plan] to buy up the shares of Tribune. Sam Zell provides a small amount of subordinated financing ($325 million) to Tribune to help make this happen, and receives a warrant to purchase 40% of the company for $500 million. If the true value of the company is $8 billion, this is one sweet deal for Zell. Imagine getting interests in a company worth $3.2 billion, and only having to put up $825 million for that right.
Now, Tribune in its soon to be levered state might not be worth that much, to Zell, or to the employees. This deal presumes a lot in terms of the future profitability of Tribune. Will they be able to carry the debt load?Those that have read me for a while (at RealMoney) know that I am a bear on the newspapers, and most non-internet media businesses. The internet is destroying the margins that support newspapers in three ways:
- Classified ads are more effective over the web
- Advertising on the web is more targeted
- Why subscribe to a paper, when the data is freely available online?
Now in each area a newspaper is still useful, but enough erosion occurs to ruin the economics. I doubt you can turn around a newspaper; perhaps you can create ancillary businesses off of proprietary content, but try to get people to pay for it, or stream a ton of traffic to get ad revenue.
As for the use of the ESOP to finance the takeover, it puts a gun to the heads of employees, who can only vaguely affect firm performance. Any value that they had built up in the ESOP is now at greater risk. If they succeed, they could make quite a bit (while Sam Zell makes proportionately more. If Tribune fails, the ESOP will be worthless, for any who were relying on it. (I realize some older workers can diversify some, but that’s not enough.) Sam Zell would lose his investment, but he can afford that easily. The proportionate impact to workers whose largest asset might be the ESOP would be much worse.
If I were a Tribune worker, I would urge the ESOP to vote down the deal. The downside is more significant than the upside.
Around the world, broad measures of money are moving higher as goods price inflation moves higher. China and India come to mind here. Economic liberalization has brought benefits for both the nations that liberalized, and those that trade with them.
As such, tightening measures by developing country central banks are to be expected. As an example consider this article by Andy Mukherjee of Bloomberg. There’s a lot of excess credit out there, and central banks are half-heartedly trying to extinguish it.
Goods price inflation is moving higher globally, and global short rates are rising as a result. When do we hit the tipping point, and what nations/sectors will have the worst of it once deflation or stagflation takes hold? I’m not sure, but those that are running a current account surplus should do better.
I should mention that Assurant has been added to the S&P 500. Could not happen to a more deserving company; they are truly innovators in the insurance industry.
And now, more on indicators, bullish, bearish, and otherwise:
- Low quality stocks outperformed in the first quarter, according to Merrill Lynch. That’s bullish in the short run, but not the intermediate term.
- LBO volume and private equity volume continue unabated.
- Economy feels like stagflation-lite. Low positive growth, and rising inflation.
- Inflation is rising globally, particularly in India and China.
- Mortgage interest payments in the US are a record high (since 1989) compared to Disposable Personal Income.
- Corporate credit metrics are deteriorating for both junk and high grade corporate debt, but are not critical yet.
- Equity REITs seem to be rolling over.
That’s all for now. Tomorrow is another day.
Full Disclosure: long AIZ
Usually I look at my indicators at the beginning of a month. If I look at them more frequently, the changes are too small, and I don’t get the signal. In no particular order, here are my thoughts, both Bullish and Bearish:
- Contrary to what the bear in Barron’s said this weekend, the chart for the Merger Fund is bullish. They paid a dividend at year end, and the current chart shows that arbs are making money, which is bullish.
- ECRI’s indicators are forecasting growth up, and inflation down.
- Both emerging market stocks an bonds have bounced back well.
- Earnings yields are still high relative to Treasuries, though if profit margins mean-revert, this argument is hooey.
- ISI Group’s broadline retailer’s survey is showing some life.
- Securitization of subprime loans, and CDOs containing tranches of subprime deals rated less than AA, are not getting done. These assets are getting sold to financial intermediaries that have adequate balance sheets to fund them.
- From Alan Abelson’s column in Barron’s this weekend, Henry Kauffman uses a concept akin to my “bicycle stability versus table stability” to discuss liquidity. The former is access to credit, while the latter is excess high quality assets that are readily salable.
- Imposing tariffs on China is a real dumbkopf move. Eventually that will bite into the capital flow that keeps our interest rates so low, in addition to decreasing the benefits from the global division of labor.
- M3 is falling, and significantly. The banks are pulling back from landing, and credit availability is shrinking. My M3 proxy is the total liabilities of the banking system. Works very well.
- Fed funds continues to miss on the high side, since the FOMC meeting. The monetary base has gone flat, and there has been only one permanent open market operation this year, on 2/26.
- Financial stocks are lagging the market.
- The yield curve is still flat.
- Equity REITs don’t yield enough relative to Treasuries.
- Housing prices are falling nationwide.
- Asset price changes are increasingly in two camps: safe and risky. Correlations within the two camps are high and positive. Correlations of the two camps are very negative.
- Inflation remains high over the Fed’s comfort zone.
Neutral, or You Call It
- Implied volatilities have bounced up, but are still low.
- Corporate bond spreads have bounced up, but are still low.
- Implied 5 year inflation, five years forward, has been in a channel between 2.2% and 2.8% for the last four years.
- TED spreads are higher, but still low.
- The swap curve gained slope after the recent mini-crisis.
- The FOMC tightened less this time relative to prior times, if the measure is inflation versus the Fed funds rate.
That’s all for now. The two biggest bits of news are the tariffs on Chinese goods, and the decline in my M3 proxy. Bearish items both.
My current industry models can be found here. No commentary, just a service for readers. If you use it in value mode, pick from the green zone. If in momentum mode, the red zone.
I’m still looking for a way to document my performance to readers, but let me simply say that the broad market portfolio beat the S&P by a few percent. What worked?
- Fresh Del Monte
- Grupo Casa Saba
- Valero Energy
- Helmerich & Payne
- ABN Amro (sold too soon) 😉
- Dorel Industries (wish they hadn’t delisted)
- Lyondell Chemicals
- Dow Chemicals, and
- SPX Corp
You see any commonalities there? Energy, especially refining. Chemicals. Aside from that, I don’t see anything really correlated.
What didn’t work?
- St. Joe
- Barclays plc
- Japan Smaller Capitalization Fund
- Nam Tai Electronics
- Lithia Motors
- Conoco Phillips
- Magna International
- Jones Apparel
- Deerfield Triarc, and
- Allstate (ouch)
Commonalities? Autos, maybe? Away from that, it seems eclectic to me.
In my balanced mandates, my foreign bonds and floating rate securities worked. High quality paid off as volatility rose. Really didn’t have any problems with my bonds.
Now I just have to do as well next quarter. 🙂
Full disclosure: long FDP SAB VLO HP ABN DIIB LYO DOW SPW JOE BCS NTE CX LAD COP MGA JNY DFR ALL
I had a two-part series that was published at RealMoney, and at the free site, TheStreet.com, that further explains a series of posts that I did here on my recent portfolio reshaping. Here are the links:
It’s relatively unusual for my articles to be out on the free site, so enjoy the boon from The Street.com.
A bicycle has to keep on moving to stay upright. A table does not have to move to stay upright, and only a severe event will upend a large table.
I developed this analogy back when I was a corporate bond manager, because there were some companies that would only stay afloat if they kept moving, i.e., if operating cash flow continued at its projected pace. That is bicycle stability; they have to keep pedaling. There were other companies that could survive a setback in earnings, and even lose money for a time, and the debt would still be good. That is table stability.
Need I mention that in a crisis, the equity of companies with table stability typically fall less than those with bicycle stability?
I think that it is incumbent on every portfolio manager to look over his portfolio, and ask what companies that they own would not be able to survive if they were not able to raise capital for two years.
My current main economic concern is that inflation in the developing world, particularly China and India, will lead to their central banks to overshoot on policy, and cause a drop in global aggregate demand. Inflation is accelerating, and money supply is not slowing. The excess liquidity is not finding its way into goods prices as much as into asset prices.
This portfolio review will not protect you from loss, but it will protect you in relative terms in a crisis. You won’t be hurt as much.