Buying, but for the Big Boys

The topic of Mergers and Acquisitions (M&A) is probably one of my favourite subject areas in business. I think it is because it would be so exciting to spend millions of pounds on another company then have the challenge of trying to integrate them to create the synergies and culture you have promised the shareholders (that might be crazy to hear I want to face the challenges). I remember in my GCSE and A-Level studies learning about some notable M&As:

Creating wealth for shareholders through M&A activity must be really difficult, you can do all the due diligence in the world and look at all financial indicators, but areas such as culture and employee motivation (which you can not physically see) may be your downfall which would be really unfortunate. Research conducted as far back as the 80's such as by Jensen and Ruback (1983) show that the target firms gains more than the bidding firm. I would be angry if my management based on hubris, their own self-preservation and hunger to build an empire would enter into a merger and then I wasn't gaining as much as someone who probably was not bothered.


One thing I remember from my business teacher at school was, she always stressed about culture, culture, culture (dare I go on?) was the single most important factor that could lead to the failure of M&A activity. In a sense I believe that, because you can not physically see the culture, but the financials are the starting point. My last blog (Blog 5) focused on culture which you can take a look at if you get time.


What I find really exciting (well exciting in my head) in this topic is the defence tactics that target firms can put down to stop firms bidding on them (the names are strange too). These poison pills in my head feel like they would be a little petty war like we would play at school such as flicking elastic bands at each other. How fun these poison pills may be, they can cause significant damage if a bidder does not spot them. Say a target decides to make a 'scorched earth' policy; load the firm up with debt, sell key assets to disrupt efficiency; if the bidder still goes for them they will ruin their shareholders value. I have learnt many poison pills; Pac Man Defence (who even makes up these names?), Greenmail, White Knight.


It is quite pertinent that today's blog is on M&A activity when there are two big ones in the news; Deutsche Boerse - London Stock Exchange and Three - O2 . From learning the material in this module and reading publications such as the FT, BBC to try and get all sides of the argument, I have seen that there are good and bad points for myself as a consumer and a member of the EU economy.


Firstly, the good. The Deutsche Boerse and LSE 'merger of equals' I believe will help the economy by providing better opportunities for European Companies to gain capital as well as companies from the US and Asia as London, Germany and Spain merged could help compete. However, how will the UK's EU referendum affect the benefits of this merger? I am undecided, but will continue to look.


Secondly, the bad. Three (CK Hutchinson) are looking to merge with O2, basically making the UK market for Telecom shrink to Three, EE and Vodafone (creating an oligopoly situation). Three want to pay £10.5bn for the merger (that is an exciting amount as I said before). How will it affect myself and you the consumer? Well, I think it really could, shrinking the market may lead to increased prices for the same service. When I go to look for new contracts, I currently think that there a lack of differentiation, so this will surely decrease more? Surely if they are creating better cost synergies they will reduce the prices (well this is what should happen), but I really do not think they will.


I never understood how a company would pay for the acquisition either (transfer through the banks Iphone app? Set up monthly instalments? Pay in 10p's?). But let me get serious, so the company will either pay using cash or shares. If I was a shareholder, I think I would the company to pay through cash as I would have to same amount of control and my shares won't be diluted. But if I was the target firms shareholder, cash may mean I pay a hefty sum of tax if I own a lot. Tough choice right?


As there will always be hungry managers, there will always be M&A activity in the market. Whether these are successes or failures will depend on how much research the company has done and whether they can integrate cultures. As consumers we will always be put as risk through M&As that we could be forced to pay more for the same service through lack of choice, however, we can only hope such mechanisms such as the Takeover Panel and Competition and Market Authority (CMA) regulators will help protect us.


How will the New Dividend Tax in the UK Affect Dividend Policies and Investors?

Whilst many of us 'average Joe's' will not have had to worry about paying tax on dividends before, come April 2016, taxpayers will have to declare any dividend earnings over our tax free personal allowance (£11,000 16/17) and the £5,000 tax free dividend allowance (another tax I hear you cry out, the government always finds another way to dip into our pockets). The table below shows the changes that will be made from current dividend tax-rates to the new tax-rates. 

So how will/will this affect the common investor and company dividends policies in the future under the new laws? This is what I will be trying to evaluate in this blog.

I would first like to start with the individual common investor (as it could affect me in future, so where better to begin?). Under the new law, as a basic-rate investor, I would have a £5,000 dividend allowance before the taxman would then take 7.5% off me. So therefore I believe it will affect a common investor to an extent as before the tax-rate on dividends for basic-rate was 0% (any tax at 0% is absolutely fine with me, not 7.5% though).
Before I use an example, it must be noted that to get dividends of over £5,000 you would need a considerably high amount of investments in high dividend paying companies (£63,000 portfolio according to Clare Walsh, a financial planner from Aspect 8 (Telegraph, 2015)). Take myself for example; when I finish university I will be in a graduate job which pays above the personal tax-free allowance (a lot of other investors will be on more). Therefore I would be within the dividend allowance (as I do not have enough investments). But if I did, I would pay Income Tax of 20% and Capital Gains Tax of 18% (if I had investments large enough) on top. I really believe that for the risk I would be taking, some form of investment 'gain' should be tax free.

Of course, I believe it will affect the higher-rate taxpayer or basic-rate with a large portfolio more. I found an interesting article on Accountancy Age (I started using this when doing a placement in a Top 10 accountancy firm) which was talking about how SME owners (the individuals in the business) are "in a race against time to benefit from a special dividend pay-out" (Accountancy Age, 2016). This is understandable as the higher tax rate will really damage the value they have created if they want to take dividends out after April 2016. Of course, from what I have learnt in the module, the 'realised profits' have to be there before they can pay-out the dividends. If the owner of the SME took out £100,000 (for arguments sake, an easy number), with them being a high-rate taxpayer, they would pay £25,000, under the new system they would pay £30,875 (quite a lot more really if you scale it up).

Second on the agenda is how the new Dividend Tax will affect company's policies. In my opinion I do not believe it will affect their dividend policies and they will not switch to share repurchase schemes to help investors. This is due to many large companies' main investors being institutional investors such as pension schemes or insurance companies who would not be affected. As this is the case, I have learned that managers will use 'catering theory' to cater to the wishes of investors (such as those institutions) who want both higher share prices AND dividend payments to grow their funds.

Also, a company that says 'we are not going to give anymore dividends' will have a dramatic drop in their share prices due to their investors having certain tax preferences; known by researchers as Clientele Theory. If I have learnt something from this module it is that investors do not think rationally. See British Airways as an example, in 2010, they did not pay a dividend due to a pension obligation, this resulted in people selling of their shares and the price being reduced (I think that if a company does not have to reduce dividend payments, then they won't do it).

To conclude, in my opinion, the new dividend tax will affect the common investor and high paid investor who has a job which pays above the personal tax-free allowance, however this will not affect companies at all. I find this really unfortunate as it is always the public who suffer rather than the large companies that can afford it and will just try to avoid the taxes anyways.

References

Accountancy Age. (2016). SMEs set to take Advantage of Dividend Pay-outs. Retrieved 29th February 2016, from http://www.accountancyage.com/aa/news/2448321/smes-set-to-take-advantage-of-dividend-pay-outs/

Telegraph. (2015). New Dividend Tax: How it Works - and How to Avoid it. Retrieved 29th February 2016, from http://www.telegraph.co.uk/investing/shares/new-dividend-tax-how-it-works--and-how-to-avoid-it/ 

Empty Vaults - The RBS Collapse

The Royal Bank of Scotland (RBS) which found notoriety in 2008 when it was apparently '2 hours away from running out of money' and losses of £24.1bn (I can't even comprehend this figure). It was clear from my own viewing that I could conclude RBS had serious problems which included to rate of acquisitions, due diligence of these acquisitions and Fred Goodwin's leadership. As you can see below, this is the result of RBS management decisions.

RBS Share Price (Yahoo! Finance)

Acquisitions
RBS I feel really fell down on their rate of acquisitions, I think they over expanded too quickly and this can't be good as they ultimately had 'a finger in too many pies'. They were involved in Insurance, Hospitals, Airports, second-hand cars and asset finance (I can't see where some fit into banking). I thought that these acquisitions were a waste of money and there was no need to diversify from their core business of banking. The acquisition of ABN-Amro was obviously their biggest downfall. They had no idea about the level of sub-prime mortgages ABN held and therefore I do feel I can reach a conclusion that this was why they failed.

Fred Goodwin said "we don't do acquisitions for fun", but I thought that them buying a second-hand car company, this did not seem like it was done to 'better the core business'. RBS was not the only company undertaking failing acquisitions; HSBC's acquisition of Household (2003) fell victim to the sub-prime collapse and AOL's acquisition of Time Warner took less than 2yrs to fail.

Due Diligence
Watching the part where Fred Goodwin said that there was no real scrutiny of ABN-Amro's books really made me annoyed. I would have thought someone with all that business knowledge wouldn't have gone with the 'we did Natwest well, so this will be fine' mentality. Even myself, a final year business student looks into everything I buy; if I purchase a TV, I will be looking into it for a week at least to see if it is worth it (and that only costs £300 not £49bn).

Due Diligence is key when acquiring a business. It makes sure you're not buying 'junk' and will reassure you that you are not paying over the odds. I am currently looking to buy a car for work, I wouldn't want to pay £10,000 for something that is actually worth £6,000 or a car that has been written-off in the past. This is why you undertake due diligence. Anglo American mining is another example, they have really underestimated the challenges they would face when going to Brazil in 2009 and other projects where now their share price has dipped below 1999 listing level and have been given 'junk' bond status by credit firms such as Moody's (FT, 2016) (would they have been more successful if undertaking more due diligence?).

Leadership
One thing that was apparent when watching the documentary to me was Fred Goodwin's management style. Morning meetings were called 'morning beatings' and managers were intimidated to say if they believed something was wrong. I don't think you can run an organisation like that. Listening to others is the most important thing, especially when dealing with a public interest sector.

When I was in my placement working in the audit department, listening to what I was doing wrong and what I could do better was important to help me do a quality job and make sure every part of the audit was correct. This helped shareholders/stakeholders base decisions on true and fair information. If not, I could have been misreporting values and making wrong decisions which may have lost people money. This is exactly what Fred Goodwin did with RBS and definitely I believe another reason for their demise.

A Final Note
I think what really hit me the most when watching the documentary was that ordinary people (which I probably know a few) who have saved for years and were unfortunate enough to invest in RBS (where they thought their money would be safe) lost around 90% when RBS collapsed. These are the people who I really feel for.

References
Financial Times. (2016). Anglo American’s credit rating downgraded to junk, retrieved from http://www.ft.com/cms/s/0/1f989c28-d409-11e5-829b-8564e7528e54.html#axzz40cHUmspG 
BBC. (2011). RBS - Inside the Bank that Ran out of Money (documentary).

Can I Spread the Risk for better Returns? Portfolio Theory

The most common phrase uttered when someone wants to invest in the stock market is one of ‘how can I get high returns guaranteed with low risk?’ (I could probably find a top Google search with something similar). To be honest, I have probably searched this myself before attending sessions on Efficient Market Hypotheses (EMH), learning about such things as ‘random walks’ and that investors irrational behaviour makes stocks difficult to predict for even seasoned investors never mind the average Joe.  


Those who (apparently) have….

Some new investors think that there is a way to have guaranteed returns after they see such people as Warren Buffett get a compounded annual rate of 19.7% from 1965-2012 (luck or skill?) or Bill Miller beating the market for 15 consecutive years, which is something we as investors could only wish for.

Some ways to hopefully get a better return….

Those famous words ‘Don’t put all your eggs in one basket’ (who doesn't love a cliché) could actually be the way to mitigate losses in your investment portfolio and come out with a not so bad return (well, you hope more than the risk free return rate of 1.44% (based on UK 10yr Gilt 9/2/16)). Spreading your portfolio will help in reducing your risk of putting all your money in one industry. If you had your entire portfolio in the banking sector (e.g. Barclays) when it collapsed in 2008, you may have seen up to a 40% loss. However, if you had part of your portfolio in banking and some in say, gold, then you would have been able to mitigate you loss and come out with a ‘zero sum’ at worst (the win may cancel out the loss, but at least you didn’t lose which is good, right?). I think sensible people don't invest all of their money in shares anyways, even Markowitz (the creator of modern portfolio theory) said that he puts at least 50% in 'safer' bonds.

An interesting article appeared on the FT (link here) about China and how their reliance on Saudi Arabian oil could lead them to become vulnerable to any instability and other factors in that region. The quote that really sums up what I am trying to explain with portfolio theory above and ‘not putting all your eggs in one basket’ is “it’s all about diversifying risk. It’s less about picking winners and more about modern portfolio”.

Correlation is key when trying to spread your portfolio, you do not want to invest in an industry that can be effected by another one as it will mean your return may increase in one, then decrease in another ('zero-sum'). Let me give you an example:

• The Oil and Airline industry are quite closely correlated (planes use oil; therefore airlines are heavily reliant on the oil price). Between August 2014 and January 2015 the oil price went from $97.27 to $48.36 (a considerable drop), however, American Airlines share price in the same period went from $30.78 to $55.69 (there may be other reasons of course). What I am trying to say with this example is that if you had an oil company investment that would have gone down, but an airline investment would have gone up (probably giving you a low return as the decrease cancels out the increase).

As a final note, I believe the world is more unstable now than ever before so there is a low probability of being able to predict or beat the market, but diversification of your investment portfolio will at least help mitigate losses in my eyes.