Week 8 Blog – Investment Appraisal Tools, useful or inaccurate?

The term investment has many definitions, a common theme involves; the commitment of money, time, effort and/or other resources with the expectation of a worthwhile result(s).  However, how can an individual and/or a large organisation truly determine if such an investment will result in gaining something deemed ‘worthwhile’?

One way recommended by academics is to consider to time value of money, the use of this can aid in creating shareholder wealth since the cash flows of a project are monitored over a time period.  Doing so can help monitor the risk of the project – business, financial and bankruptcy risks, and help in analysing the value of the project against the rate of inflation, without returns being higher than inflation the shareholder will not receive any wealth.  This topic can be linked back to my first blog regarding the acquisition made by Sanofi-aventis (SA) on Genzyme.  This case involves SA undervaluing Genzyme’s shares; they offered $69 per share when they were operating at $72 per share (BBC News, 2011).  A main issue in this deal, which is still continuing, is the drug Lemtrada.  The problem involves SA not believing this drug will have the returns that Genzyme believe it will.  Trying to resolve this, SA offered a Contingent Rights Value on the drug (The Financial Times), meaning they agreed to future payments if Lemtrada is more successful than originally thought, an attempt by SA to ‘bridge the gap’ between the views of the companies. 

Not knowing whether SA contemplated other options, but using Internal Rate of Return (IRR) on Lemtrada to truly see if it is likely to bring about the returns expected by either company.  Secondly, Net Present Value (NPV) could be calculated on the acquisition of Genzyme could maybe see if the deal would bring about a positive return.  The use of IRR can be easier communicated with it showing an actually percentage, making it easier for those who don’t understand appraisal techniques. The calculation of NPV is a strong tool with it having goal congruence with the organisations aim of shareholder wealth, by highlighting the project that will create the most wealth.  The calculation results in it either being positive, negative or equal to zero.  Generally speaking if the NPV was to be positive it suggests that the project is worth investing in as it will create wealth.  A common problem when considering NPV is that it is complex and difficult to understand, but how hard is it when it has been taught and used in the business world for many years.  Secondly, it is criticised due to the fact that it is difficult in determining the cash flow and due to them being an estimate can you trust them? – When you think about, is this not the case for all tools similar to NPV?  Other issues involve the fact that any project with a positive NPV the company should invest into, obviously only if there is sufficient cash available. Should the company really do this, they need to ensure that there is a synergy between the original company and the project/company they may be working with, merging or acquiring. In the case of SA and Genzyme there is synergies between the two, but it is giving SA the opportunity to diversify into more rare diseases.  However, with this not being the case in all ventures, NPV does not take all strategic issues into account, therefore I would suggest to not use NPV blindly.

Realised by academics and other business experts was that you often don’t know what the returns or even the costs would be when calculating things like NPV and IRR.  What was suggested was to calculate the probability of the different values occurring, therefore translating uncertainties into hard figures.  Again the critics highlight the fact of where did the probabilities come from and argue are we not just substituting one estimate for another? - And making an organisation exposed to possibly losing millions by injecting further subjectivity into their activities and decisions?

Week 7 Blog – The Credit Crunch

The term ‘credit crunch’ has been thrown around for many years now, a simple definition of it is “a severe shortage of money or credit”.  Since 2007, when the credit crunch went full steam ahead, whether a company was deemed successful or not they were not able to function without being able to borrow, they were either refused point blank or were tied into repayments with a high interest rate tied on to the agreement. 

One cause of the credit crunch was linked to the US sub-prime mortgage market, when many America consumers usually the lower class, were sold the dream of owning their own property.  The U.S FDIC office could interpret this action as “lending without regard to ability to repay”, since the sellers of the mortgages had incentives for the higher amount of people they could successfully sell a mortgage too.  This was do-able since banks were lending at a cheap rate, an historic low (BBC News), which caused issues since the people taking out the mortgage generally did not understand how a mortgage works.  With the lending amounts increasing, the banks leveraged the debt they had, taking the form of a CDO (Collateralised Debt Obligation), this was used as security for the high amounts the banks were lending. 

The use of a CDO involves securitisation, which is the process of taking an unsalable assetsand moving it to a state that is more saleable. This is what happened with peoples mortgages, if the mortgages were pooled together it was a risky investment, however if it was the repayments pooled together it was less risky.  This is effectively what happened with the lenders; they pooled these together and attached security ratings to them allowing people to invest in this market.  The ‘tranches’ included; AAA, AA, A, B etc, with AAA being less risky.  However, what was found is that fewer were investing in the lower tranches.  Credit enhancements then appeared, which involved taking parts out of the lower levels and putting them together and starting again from using AAA to try make them seem less risky, known as a re-mixer. The same problem occurred and less were investing in these lower levels, so funnily enough they repeated it, introducing the term re-remixer. There was a big incentive to do this since the big investors like the banks and pension funds were restricted from investing in the lower grades due to the lower security of it, rather deceitful of this market don’t you think? 

The problem arose when the stream of payments into the pools fell when people were struggling to pay their mortgage.  If these lenders used the re-mixers (which they were unaware of) up as security against their assets, other banks/lenders would not do business with them since they were unsure whether the original or re-mixed was used, due to the lack of transparency of the market the banks were unable to know.  This caused historically low levels of interbank lending, due to insecurity of it all.

People invested in the CDO market since they thought they were protected, however this was only to a certain point.  Santander was one company who wanted to invest into this market, however due to Spanish law they were restricted to do so. I bet now they are thankful of this,  since this allowed them to have the money available to buy out Abbey National.  This is even more true when considering the mess that a similar bank, Northern Rock, got itself in to.  Northern Rock’s whole business design was around the London Interbank market, which was ideally designed as ‘overnight’ lending.   They borrowed cheaply from and then resold in the form of a 25 year mortgage, smart move?  When interbank lending levels severally lowered, it had major issues, ones that resulted in the Bank of England bailing it out at a value of £119bn (BBC News).

It could be argued that this credit crunch was inevitable, as it was not possible that lenders could continue to provide credit at such a cheap rate and repackaging the repayments and interests in the form of CDO’s without serious repercussions, don’t you agree?

Week 6 - News Corp to buy BskyB: Is it a good decision?

During the time of mergers and acquisitions the overall aim is to create shareholder wealth. However, one must keep in mind the other stakeholders affected by the activity.  For example, generally during a time like this cost synergies are created and so the leading organisation focuses on saving money.  One example of this would be lowering its employment levels. Despite saving money it can have damaging repercussions such as Trade Unions getting involved and the lay offs negatively affecting the brand image.  Other stakeholders becoming affected are the Management/Directors involved in making the decisions.  The management of the smaller entity usually is asked to step down, however the idea of a ‘golden parachute’ would cushion the blow some would say.

Currently having a high presence in the news is the deal proposed by News Corps, Rupert Murdoch to purchase the remaining 61% it doesn’t already own of BskyB (BBC News, 2011). Key stakeholders directly affected by this deal are; shareholders, customers, society and the Government.  The question could arise as to whether News Corp is undervaluing the shareholders of BskyB by only offering 700p per share, whereas earlier last week BskyB closed at 825p per share (The Guardian, 2011).  However, reported by The Guardian (2011), this price can be understood, with News Corp reporting $4.7bn net debt, it if was to raise its offer to say 900p per share, it would be forced to take out borrowings of $20bn.  Despite this, it could be argued whether News Corp should enter into this deal if it cannot afford to propose an offer deserved by BskyB shareholders?

Secondly, the Government are playing a major part in this deal.  This deal has recently been defended by the U.K. Government with the deal ensuring greater independence for Sky News for at least 10 years, (Jeremy Hunt, Culture Secretary The Telegraph, 2011).  This is due to the board members of Sky News to be mostly independent, meaning James Murdoch (Rupert Murdoch’s son) to step down.  This deal it severally objected by other members of the media community.  This is evident with Guardian, Associated Newspapers, Trinity Mirror and the Telegraph all coming together to exhaust every legal option open to them, (BBC News, 2011).  It has been found by the BBC News that the public and as previously mentioned, other media companies, are highly concerned with the politician’s motives for this deal, which instigated Hunts talks with Ofcom and OFT for their help.  This suspicion of the public is warranted with the history that Murdoch has within politics and the relationships he has built with past and current Governments.

Finally, this deal will also have an impact upon the customers and the society.  Since BBC News (2011) sees that having one man/company controlling the nation’s newspaper and broadcasting interests is an issue for public concern.  Rupert Murdoch already owns; The Sun, The Times, The Sunday Times, News of the World, the 39% it currently owns of BskyB and Americas Fox Networks.  It may be argued that freedom of speech could be lacking if the views and beliefs of one man/company are portrayed through the use of the media organisations it owns.  With this in mind, the deal has been delayed to be investigated by the Competition Commission, talks with Ofcom and the Office of fair trading, leading to a 15 day public consultation, but ultimately if Hunt gives this deal the go ahead, the final decision will be made by BskyB and its shareholders.

There are several reasons for mergers and acquisitions, some include; survival, status, inefficient management, undervalued shares on the stock market and to gain market power.  Keeping in mind that market power is one main reason, with the power currently held by News Corp and the influence and relationships Rupert Murdoch has within the political crowd, should this deal go through? 

Why Foreign Direct Investment?

There are many theories to why large companies choose Foreign Direct Investment (FDI) over other options like; Exporting, Franchising or Licensing.  These theories include; transportation costs, market imperfections or the leading company could potentially loose its competitive advantage if it was to share it’s know how through licensing.  Dunning (1988) saw that not one reason will suit each company and so designed the ‘Eclectic Paradigm’.  This framework brings all theories in together to try explain why FDI is a good thing.  His ideas involved;

• Location advantage - An example of this is BP locating to Libya for the oil

• Ownership advantage – Retaining control is important.  A bad case of this involves Schwinn, a creator of bikes who released freely its own expert knowledge in two separate occasions, causing the finale of bankruptcy.

• Internalisation advantage – This involves a company believing the outcome with be better if it is kept inside the company.

Despite the advantages of using FDI, Thailand is one country who in the past is evident of focusing on exporting as a way of boosting its country’s economy during the recession.  The final quarter of 2010 saw an increase of 6.7% in export of goods and services, and growing by 28% for the whole year, (BBC News 2010).  This growth is continued to be expected during the course of 2011, strengthened by the fact that analysts have predicted more stable economies in other countries, which should only benefit Thailand’s exporting fetish further.

One Thai company not following this pattern is SSI.  SSI, a steel manufacturing company  recently purchased the steel giant ‘Corus’, who are therefore investing into a company outside their home country, where the majority of its other plants are placed, (The Independent, 2011).  There are some parts of this deal I do not understand. I know it is creating around 700 jobs in the somewhat destitute area of Redcar and I know the plant has the well above average infrastructure to produce the steel, (BBC News, 2011) but why invest in this plant in England, but then open SSI to more risk like; exchange rates changing or transportation costs, through exporting the steel back over the Thailand?

With the above being a prime example of the question that – is FDI a good strategy for the long term? Or is it, like the oil industry locating in Africa for obvious location purposes, an inevitable trap? Since the oil is eventually bound to run out.