March 4, 2019 – Hostile takeovers – what are they and how do they work?
Q4 GDP growth figures and their implications for interest rates.
Wilson-Raubould testimony and its potential effect on TSX returns and the Canadian economy.
Chinese tariffs and where the trade war is heading.
Salient points from Warren Buffett’s annual letter to shareholders.
Barrick’s hostile bid for Newmont and why it’s unusual.
LYFT’s upcoming IPO and its financial performance.
How multi-billion-dollar endowments are investing their money.
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Transcript
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by Accelerate Financial Technologies.
Accelerate, because performance matters. Find out more at www.AccelerateShares.com.
Julian: US Q4 economic growth numbers coming in at 2.6% annualized figure in the fourth quarter. Which is really a goldilocks number. So, we want to compare and contrast that to the Canadian GDP numbers which clocked in at 0.4% annualized. Which is significantly below expectation of a 1% increase and substantially below the U.S. growth numbers about 2.6 percent annualized. Which was a lot greater than economists expected at 2.2 percent and so these have pretty tremendous implications. I mean on the upside Trump had the goal of a 3% GDP growth. That was his repeated mantra and it looks like they’re really nailing it. Year 2018 was what, 3.1 percent?
Michael: Yeah and so credit where it’s due I guess, and it just goes to show the diverging directions of the Canadian and U.S. economies.
Julian: Yeah one major thing to point towards is the republican backed tax cuts that really put the U.S. into a super growth mode here where they’re really registering great economic numbers. Meanwhile in Canada suffering from higher taxes, much poorer business environment and the numbers that we’re seeing out of Canada, economists did expect to slow down in the fourth quarter due to energy prices really declining late last year. But there were four additional reasons that were displayed in the numbers. Number one, consumption spending grew at the slowest pace in almost four years. Number two, housing fell by the most in a decade. Number three, business investment dropped sharply for a second straight quarter and lastly domestic demand posted its largest decline since 2015. So, the Canadian economy just struggling here. I mean I’m hearing talks about the r-word, recession, declining / negative growth. Potentially, I mean we’ll see, but the major implications are that the Bank of Canada they’re really not going to be raising interest rates this year and compare that to the U.S., even with great numbers that are there I don’t see them raising rates this year either.
Michael: Absolutely and just on your second point there with regards to the housing sector is that the Canadian struggles in the housing sector really reinforced by the weakness in the q4 earnings by the Canadian banks. Those have come out over the last little bit and are really just highlighting those struggles.
Julian: Yes, certainly rising interest rates over the past year have had a much bigger impact on the economy than expected.
Political scandal worsens for the Canadian Prime Minister Justin Trudeau. So, we had Jodie Wilson Raybould testifying in the house of commons this week with some pretty explosive allegations and to quote her she stated that she experienced a consistent and sustained effort by many people within the government to seek to politically interfere in the exercise of prosecutorial discretion. What she referring to here is the government, Prime Minister and others in the Prime Minister’s office, they’re attempting or pressuring her to cut a plea deal with Quebec-based SNC Lavalin. Specifically, SNC Lavalin is being prosecuted for fraud and bribery charges from a number of years ago and the Prime Minister’s office was pressuring Wilson Raybould to have them enter a deferred prosecution agreement. So, the implications of this – I mean it does not look good for the Prime Minister’s office. This just reeks of crony capitalism. The public doesn’t like it, they don’t like favoritism, and this is a company in SNC that really doesn’t need you know the substantial favors and bailouts by the government. Mike what are your thoughts?
Michael: Yeah in terms of the public sentiment is as Canadians we typically look at the scandals going on south of the border with the current U.S. administration and look at look as if we have you know a sort of moral high-ground. I think that’s been kind of washed away with this scandal and then in terms of SNC Lavalin do you see any existential risk there?
Julian: No not necessarily. I think they’ll be fine, the threats that they’re indicating they’re saying that they need a deferred prosecution agreement, they might be subject to a hostile takeover. They’re threatening to leave move to potentially Europe for their head office. But under special loans from the government they’re stuck in Canada until 2024 and in my opinion, no one’s going to bid for SNC Lavalin. I mean with all the problems they have, all the issues, I just don’t see them catching a takeover from anyone. Not to mention that they have strong long-term shareholders in the government pension plan. So, I don’t think that’s an issue. But the main implications of this story are that it’s potentially toxic for Trudeau’s government. There’s a Canadian election coming up in October and the polls say that the rival conservatives are now leading in the polls. I want to talk about implications I mean in terms of economic performance under Trudeau’s liberals, it’s been quite negative. They’ve introduced a carbon tax, they boosted personal income tax and they boosted corporate tax as well and the market has not done well under Trudeau’s governance. So, what we can look forward to as investors if the polls do indicate some truth to this, that the conservatives win in the election which I think is a relatively high probability. We can look forward to lower income tax, perhaps no carbon tax and quite certainly lower corporate tax to better compete with the U.S. economy and so from that we can ultimately expect higher stock prices in my opinion.
President Trump delays tariffs on Chinese goods set to be implemented March 1st. So, what was going to happen here was the U.S. government had previously indicated that they were going to increase tariffs on a myriad of Chinese goods starting March 1st, 2019 from 10% to 25%. Which would have been absolutely devastating for the Chinese economy.
Michael: Yeah at its base why is the U.S. pursuing these tariffs?
Julian: So ultimately the U.S. has had a very large and growing each year trade deficit with the Chinese and now it’s nearly 400 billion dollars and so the U.S. imports 500 billion in goods from China and they only export 130 billion to China. And so the U.S. is really demanding a wholesale trade and economic reform coming out of China and they view tariffs as the best way to utilize that in and talking about the trade war and it is quite the war that they’re having here, I think that the U.S. is winning. You can judge by the Chinese stock market versus the U.S. market. You can look at the Chinese economic growth numbers, which are really struggling versus the U.S. which is doing quite fine. And so Trump tweeted last Sunday that they have made substantial progress on trade talks and he is meeting with the Chinese president Xi sometime in March at his estate in Mar-a-Lago. So, I think market participants can look forward to this trade war getting resolved and I mean that’s only going to be good for stocks here.
Michael: And I think the other positive is that initially the trump administration indicated that they would be very hard line in their negotiations. This is indicating some flexibility, showing that there could be room for you know a less extreme deal.
Julian: Certainly, and thus far China is committed to buying up to 1.2 trillion in U.S. goods. The only thing that the U.S. really needs to seal up is some sort of guarantee that they’re going to follow through with that.
Last Saturday super investor Warren Buffett, chairman and CEO of Berkshire Hathaway released his annual letter to shareholders. So, like all investors I woke up early Saturday morning to give it a read. To summarize it for you Buffett was pretty frustrated because it’s another year without so-called elephant-sized acquisition that he’s been looking to make for a while now. Their cash balance continues to just pile up. I mean they have a hundred and twelve billion in cash. Buffet’s looking to do a deal, but he really can’t find a large acquisition that really fits his mandate of being attractively priced. Some other salient points from the letter. Number one, Berkshire is now moving from a book value to market value in terms of measuring success of the company. Number two, they had to implement a new accounting change what considers the quarterly changes and that value of their equity portfolio flowing to the bottom line of their net income. So, you’re going to start to see highly volatile profit and loss figures out of Berkshire on a go-forward basis and lastly a continued commitment to share a purchase which Berkshire really just started doing recently.
Michael: Yeah and in terms of those points what I found interesting and a little bit ironic actually is his discussion of acquisitions and the saying that the thinking of it causes his pulse rate to soar and in terms of value investment managers, they typically are quite critical of CEOs that our acquisition hungry. So, I think this kind of highlights a behavioral bias that even the oracle of Omaha isn’t immune to.
Julian: Yeah, he certainly loves to do deals and a quote from Buffett here he claims that “prices are sky high for businesses possessing decent long-term prospects” and to quote what he said, he said “just writing about the possibility of a huge purchase has caused my pulse rate to soar”. So, Buffett certainly looking for a good deal. They have a lot cash. But for right now he believes stocks offer far better value for their money than purchasing large businesses outright.
Michael: And also, I think there’s just a disconnect in terms of how the market views Berkshire and how Buffett does. Buffett views Berkshire is more the operating businesses with a stock portfolio on top of that. Whereas I think the market really focuses on his stock picking and that’s really where the disconnect is on his view of the accounting changes and how they’re affecting Berkshire is I think it is fair to look at how his investments are faring in terms of the overall gap earnings. But obviously he disagrees.
Julian: Barrick gold launches an 18 billion-dollar hostile bid for Newmont Mining. This deal is somewhat unprecedented in my opinion and the number one it’s an all share hostile deal and those are pretty rare and number two, it is a no premium hostile deal and by the premium I’m discussing, I’m referring to a takeover price that is in excess of the current market price or what you could currently sell your Newmont shares and what Barrek is offering on an unsolicited basis that means not supported by Newmont management. What they just went out and offered Newmont shareholders is an exchange ratio of two point five six nine four Barrick shares for each Newmont share. I checked out the prices today where Barrick is trading implies shared consideration for Newmont of $31.58 versus you compare that versus Newmont’s current price, it’s $33.82. So currently Barrick consideration is seven percent below the Newmont share price. So, in my opinion this hostile bid really faces a little chance of success and to make things worse, the financial times today had a Barrick CEO indicating that they do not plan on increasing the hostile offer. So, in my opinion this bid is just dead in the water and stands very very little chance of success.
Michael: Yeah and in terms of the party line in terms of the take under price of the actual discount is that the premium is in the synergies and so what do you think Barrick’s play is here? Do you think it’s to bump the share price after and try to get shareholders to approve it?
Julian: That is the typical game plan. But with the Barrick’ CEO coming out and announcing that they absolutely do not plan on increasing the consideration, I don’t really understand what their strategy is here. It seems like a bitter clash of egos in a pretty epic battle to create the world’s largest gold producer and referring to those synergies, Newmont agrees that there are some synergies available. But these could be just as easily if perhaps even more easily attained through a simple joint venture of their assets in Nevada. You don’t need to create this massive gold-mining conglomerate. You can just do a simple deal with just the Nevada assets. So, I think there’s a lot of ego coming into play here and I just don’t think it’s going to be successful.
Michael: And in terms of the ego in rhetoric, Mark Bristow the CEO of Barrick, he actually described Newmont’s bid for Goldcorp as desperate and bizarre. You could arguably say that that thier move on Newmont is also desperate and bizarre.
Julian: Yeah well quote Newmont saying that Barrick has a quote “poor track record on delivering shareholder returns”. So, there it is, a bitter battle of words in this hostile takeover.
Ride-sharing company Lyft filing for an IPO valuing the company at twenty to twenty-five billion dollars. As you can recall, last June Lyft raised around six hundred million dollars at a fifteen-billion-dollar valuation. So, they plan on going public on the Nasdaq. Unsurprisingly under the ticker Lyft. Mike what are your thoughts on this deal?
Michael: So, this is really just them trying to get their IPO ahead if their main competitor Uber, who is valued at 76 billion. The IPO is being led by JP Morgan and Jefferies. If you look at their financials they’re pretty ugly. They’ve had a net loss of 900 million dollars in 2018 on revenue of 2.2 billion dollars. You know massive losses and really just being subsidized by venture capitalists and if you look at it in terms of IPO investing in general, Bloomberg quotes that U.S. firms that have IPO’d in the last 12 months have returned about 22%. That’s versus the total return of 6% for the S&P500. So, it does lend some credence into investing into IPOs. I just don’t know whether I would be investing in this one.
Julian: Exactly I typically stay away from IPOs. So, ladies and gents just remember IPO sometimes stands for It’s Probably Overpriced.
Put out a blog post this week called How Multi-Billion-Dollar Endowments Are Investing Their Money. So, the NACUBO released a study on endowments. Specifically, they took a poll of 802 U.S. college and university endowments and foundations. So, this represented over 600 billion in professionally managed financial assets. So, some interesting figures here. Endowments of over 1 billion in assets had 58 percent of their assets in alternative strategies and by alternative investment strategies we are talking private equity, hedge funds, venture capital, private real estate energy and lastly distressed debt. Compare and contrast that to the smallest of endowments being under 25 billion, they only had 11% of their assets in alternative strategies. While in on a dollar-weighted basis endowment in the study had more than half or 53% of their assets and alternative strategies. But why do endowments allocate so heavily to alternatives? You may hear of the standard 60/40 equity bond portfolio. But endowments are investing dramatically different than that. So, they’re looking to allocate to alternatives, because they have pretty aggressive return targets that they need to achieve in order to satisfy their spending obligations. So, they look to allocate to alternatives pretty much for three main reasons. Number one, they’re aiming for increased returns. Number two, with manage risk and then lastly higher consistency. So ultimately endowments are using alternative strategies to increase their portfolio returns on a risk-adjusted basis.
Now we’ll get to some reader questions. Mike what do we got this week?
Michael: So first what’s a hostile takeover and how does it work?
Julian: So, with all the news that have Barrick and Newmont and hostile takeovers, figured it’s worthwhile explaining what is going on. So hostile it means when the management to the target company does not support a deal with the company trying to make the acquisition and so they typically refer it on a buyer’s side as being unsolicited. But it typically is not friendly what the acquiror does is they take the offer directly to the target company’s shareholders. Since the target company’s management and board of directors are uninterested or perhaps even stonewalling the acquiror. So, they believe that if they put an attractive offer on the table and they can get the target shareholders onside, then they can seal up the deal. Now these are quite a bit easier to execute in Canada. In the U.S. they have what’s called a poison pill. Which is a legal strategy to effectively stonewall a potential acquirer and the shareholders just aren’t allowed to decide on the hostile bid or they’ll be massively diluted through this shareholder rights plan or a poison pill as it’s also known as. But in Canada the courts typically strike down this legal strategy known as a poison pill and allow the acquiror to take the offer directly to shareholders. Now typically a hostile takeover would have a pretty significant premium over the market price of the shares. Such that shareholders will be incentivized to tender their shares and not just sell them in the market and so the goal is the acquirer is looking to by a target without support of the target board and management. But typically, what happens is that the target company puts itself up for sale, also known in industry language as exploring strategic alternatives. In which they hope to solicit higher offers for the company from other competing acquires and in terms of investors who invest in these deals also known as merger arbitragers, the absolute dream scenario for them is a competitive bidding scenario. Where you have the hostile acquiror and a higher bid from what we call a white knight or a friendly acquiror that the target finds through its sale process that wants to buy them on a friendly basis. So, if you can get a bidding more with higher and higher prices for the target as a merger arbitrager or investor in the target company, that is really what you live for and where that real big returns come from. How we see these situations typically playing out either the acquirer gets stonewalled and gives up or they enter into friendly discussions with the target after increasing their bid to get the board onside and ultimately support a friendly deal on the two companies.
Michael: Now one thing that you mentioned earlier was in Barrick’s bid for Newmont is that the use of shares as opposed to cash is uncommon. Why is that?
Julian: Well it’s like that quote from that movie show me the money and so they like is saying cold hard as cash shares are not certain in value. I mean they’re moving around every second of every day as they trade in the market and who knows after the deal closes they could drop precipitously and so they like to see cold hard cash, they like to see a large premium. So, if you want to increase the chance of success on a hostile takeover, pay large premium that is a large increase over the last market price and number two just have a lot of cash within that bid and so that’s its ladies and gents, we hope you enjoyed episode 3 and we look forward to hearing from you. Give us a rating on apple iTunes or submit a question to us on twitter. We will chat later cheers.
Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf Accelerate. As to the accuracy or completeness of the information contained in this podcast, Accelerate does not accept any liability for any direct indirect or consequential damage suffered by any person as a result of relying on all or any part of this podcast and any liability is expressly disclaimed.
