Weekly Updates (3-25-2015)
- joshnosal
- Mar 25, 2015
- 4 min read
————— Summary —————
Dow Chemical's Reverse Morris Trust
Warren Buffet and 3G Capital Team Up
Boutique Banks Gain Market Share
The Airline Oligopoly
Financial Lessons from the Game of Thrones
Oil is Turning to Big Data
————— News —————
Dow Chemical seeks to use a reverse Morris Trust to offload $5 billion of its low-margin bleach and vinyl-related operations to Olin Corporation. This will allow Dow to avoid paying capital gains on the $5 billion windfall, which translates into eight times Ebitda for the chlorine spinoff. A straightforward sale earning the same amount for Dow shareholders would require the spinoff’s sale at $8 billion. The Dow shareholders will also benefit from the expected costs savings by year 3 of close to $1 billion dollars. This amounts to $500 million for the Dow shareholders, who will own just over 50% of the enlarged Olin. Yet, investors must be wary of this deal based on the rough history of Morris Trust transactions.
Warren Buffett and 3G have created an intimidating merger and acquisition machine, which made its biggest collaboration this Wednesday on the merger of Kraft and H.J. Heinz, worth roughly $80 billion. Right now “the only barrier to even bigger deals may be 3G’s capacity for new projects.” Berkshire Hathaway has come up with $17 billion to take Heinz private in 2013 and another $10 billion in equity to merge Heinz with Kraft. Although these investments will take years to generate a decent return, Berkshire Hathaway and 3G are both uncommonly patient investors. “Mr. Bufett is known for taking a hands-off approach with Berkshire’s portfolio companies,” while “[t]he original three men behind 3G … relish getting their hands dirty … and have been steeped in the consumer businesses since 1989.” Once the two investor groups are ready, “PepsiCo … or Coca-Cola … whose biggest shareholder is Berkshire — would do well to take note.”
“In each of the last six years, boutique [banks] have continued to gain market share in advising on American deals.” In 2014, boutique banks took up 18% of the advisory business, up from 8% in 2008. This year, the merger of Kraft and Heinz boxed out the major banks as Centerview Partners, a small advisory firm, and Lazard, were the exclusive advisors to the deal. However, it was easy for the two smaller banks to take lead roles in the deal because no debt financing was needed. If debt had been needed, one of the larger banks would have likely stepped in. Yet, companies and executives are valuing boutique services more and more. Boutiques have poached a number of top dealmakers from bigger banks by offering better compensation with less risk of deal leaks before announcement.
It is unclear why airfare prices have not dropped at the same rate as oil prices, since fuel is the largest cost for airlines. Some suggest that an oligopoly has been created that has hindered competition in the industry. Presently, there are only four major competitors in the U.S. — Delta, United, Southwest, and American-US Airways. Democratic Senator, Charles E. Schumer, from New York, has urged the Justice Department and the Transportation Department to investigate airline profits, but with little response. Although we want to avoid a profitless airline industry, that was a result of a “free market run amok. Now we might have an oligopoly run amok.” As a result, any regulatory changes in the industry may have drastic implications on the big players, but for now airfare will continue to shoot up like a rocket but fall like a feather.
Not only are comic-book geeks being drawn into the “Game of Thrones” franchise, but also powerful money managers like Gavin Baker, head of Fidelity’s $13 billion OTC Portfolio fund. As a result, it may be prudent to understand some of the financial lessons this TV series imparts. They include:
1) Listen for weak signals and be open to the possibility that your view of the world is incorrect.
2) Make dispassionate decisions without mixing emotion and investing in your practice.
3) Leverage what you have. Even without cash, quality assets can be leveraged into powerful business tools.
4) Too much debt is a killer. When debt is involved, it is always the bank, with its impartial decision-making that wields the true power.
5) Hard assets matter. Land can often prop up powerful players and fund strategic business maneuvers.
Oil companies continue to search for innovative and efficient means for drilling to combat sunken oil prices. One resource is big data. “GroundMetrics estimates that its cheaper and more efficient alternative to microseismic technology used now in energy exploration will allow oil firms to drill 10 percent fewer wells. That, executives say, could translate into over $20 billion in annual savings for the whole industry if widely applied. Core laboratories, Baker Hughes, and Welldog have also adapted existing technology to help make existing wells more profitable.
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