SEC: What are you thinking?

The Securities and Exchange Commission approved in a 3-2 vote a measure to limit the ability of investors to short sell. The rule will not allow the short selling of a stock that has fallen 10% in one trading session, and shorting of the stock will not be allowed for two business days – the day of the decline and the following trading session. The argument is that short selling puts extra, unnecessary, speculative downward pressure on a stock price, and the SEC expects this new curb to put a halt on this downward pressure for stocks whose prices have fallen drastically. However, despite the expertise the SEC is supposed to possess, a lack of understanding of the fundamentals of short selling and failing to recognize the true underlying reasons for the stock price declines have led the SEC to enact a rule that will do no good.

Short selling, in simple form, is performed by an investor who borrows a share of a stock, then resells it to someone else, hoping to buy back that share of stock at a lower price and return it to the lender, making a profit on the difference. For example, an investor could borrow a share of GE at $10 a share from a broker, and sell it to someone else for that same price of $10 a share. The investor then owes the broker one share of GE. If the price of GE stock falls to $8 per share, the investor can buy back that share of GE in the market, then return the purchased share to the broker, fulfilling his or her debt obligation. The investor sold the share for $10 and bought it for $8, netting a $2 profit. In brief, a short seller profits from a decline in stock price.

The SEC has been under pressure to make changes in light of the recent financial crisis and downward pressure on financial stocks in particular. The bearish and speculative nature of short selling has caused critics to concentrate their energy, and thus the focus of the SEC, on implementing new regulations to curb its use. Despite popular belief and understanding, an actual short sale will not cause a stock price to fall. The share of stock is borrowed, sold to another person, and the investor has completed the short sale. The net result is that a share of stock has been purchased, no shares of stock sold…no actual selling took place! This not only does not cause downward pressure, it is actually bullish. A share of stock has been purchased, which will help lift the stock price.

The SEC takes issue with short selling, because it communicates a bearish sentiment on a stock. If a large number of investors are short a stock, the investment community reads this as a negative outlook on a stock. Investors seeing negative outlooks will tend to reevaluate their position, and more investors will hop on the bearish bandwagon. The problem with the SEC trying to fix this is that it is not the short selling that needs to be looked at, it is the actually company that is the problem. As Peter Boockvar writes, perhaps there were more reasons to explain the rapidly falling stock prices of the world’s largest financial institutions than the fact their stocks were shorted. Investors short a stock when they expect it to fall.Although it may make more investors believe the stock is a sell, there must have been something about the company to generate the initial increase in shorts on the stock. Maybe it was the subprime lending, exorbitant leverage, and investments in high-risk securities by the financial institutions that caused massive losses and crashing stock prices? SEC, take another look.

Saab to Spyker – A Viable Deal for Spyker?

Roughly one month ago, General Motors agreed to sell Saab to Spyker cars for approximately $400 million in cash and preferred stock. Whether or not this deal was a good value for GM was discussed in a previous post, but as a follow-up, the viability of this deal to Spyker will be discussed here. Spyker, though a car manufacturer, is a completely different type of automotive maker in terms of sales, employees, financials, and business model. Saab is also facing declining sales and a suffering brand image – two trends Spyker hopes and plans to reverse. The profitability of this deal is very difficult to predict and is dependent on many variables, but in all likelihood, this project is going to fail.

Spyker Cars is a very small, Dutch luxury maker of high-end sports cars, and despite being an automotive maker, Saab is a completely different kind of business. Spyker typically makes around 50 cars per year for a selling price in the ballpark of a quarter of a million dollars apiece, whereas Saab sold 40,000 cars in 2009 and 100,000 cars in 2008, each in the ballpark of $40,000 apiece. Compared to Saab’s 3,400 employees, Spyker has about 130. Spyker’s models are largely made-to-order and sold at just 36 dealerships worldwide, while Saab’s models are mass-produced and sold at about 150 dealerships worldwide. While these figures alone cannot predict whether this will be a successful deal for Spyker, they certainly are not figures showing support for the deal and compatibility between the two companies. The success of the deal is going to come down largely to how well Spyker and its management team can make the move from a small, niche market carmaker to a mass-producer with worldwide recognition.

Saab is being purchased at one of the lowest points in the company’s history. As mentioned previously, Saab sales have experienced a massive decline. In 2007, Saab sales were over 130,000 cars, and since then sales have fallen to 40,000 in 2009 – less than a third of 2007 sales. While the current economic downturn can be blamed in part, most of this was the doing of GM. In a response to Courtney Stuart’s article regarding the future of Saab, a current Saab owner writes:

“What GM did to Saab was short of criminal, they de-contented these cars to a HUGE degree and turned Saab into a marketing name with no substance.”

Many consumers share this same sentiment, as evidenced by the falling sales and declining brand image in the automotive community. Now that Saab has been sold and the opportunity to begin anew has presented itself, Saab stands a chance to be rescued. However, as the above figures, dissimilarities between the two companies, and consumer sentiments suggest, Spyker faces an uphill battle with this deal.

The Man for the Job

CIT Group hired ex-Merrill Lynch CEO John Thain earlier this week, marking Thain’s first return to work after resigning from Merrill in January of 2009. CIT, a commercial lender to small and midsize businesses, filed for Chapter 11 bankruptcy in November of last year and anticipates Thain will restore investor confidence about future expectations for the firm as it emerges from bankruptcy. Thain, on the other hand, is marred by his controversial exit from Merrill involving questionably high bonuses and mounting investment banking losses. Critics cite these controversies in arguing Thain was a poor choice to head CIT; however, Thain’s education, work experience, and desire to restore his legacy make him the ideal CEO.

In selecting a company head, the most important factor in the decision-making process is arguably education and work experience. Firms ideally want a leader from an excellent educational institution – preferably the Ivy League – and that leader should also have vast, relevant work experience. Strong performance at an elite school indicates the candidate is intelligent and possesses a strong capability to learn. Work experience shows that the candidate has gained a wealth of industry and product expertise, and he or she has been exposed to a wide variety of company situations and market scenarios. Additionally, the candidate will be able to fix and prevent problems, as well as recognize and expand upon opportunities. Thain has a bachelor’s degree from MIT and a Harvard MBA, and in terms of work experience, Thain was president and COO of Goldman Sachs, CEO of the New York Stock Exchange, and CEO of Merrill Lynch. That kind of a resume speaks for itself – Thain’s work experience coupled with his strong academic credentials prepares him well for the job.

CEOs tend to have big egos, which is unfortunate in most cases as CEOs have made extremely risky business decisions and made high or illegal demands for compensation. However, Thain’s ego is actually a good thing in this situation, because he needs to restore his legacy after it was tarnished during his final days at Merrill Lynch. Thain rose to the top of Goldman Sachs, one of the most elite and prestigious financial firms on The Street, later leaving fortune for fame as he took the helm of the New York Stock Exchange. Following the money, Thain left to be the CEO of Merrill Lynch, and after earning $84 million in 2007, he was at the peak of his career. Merrill suddenly began accumulating massive losses due to investments in mortgage-backed securities and other risky assets. In preventing an almost certain bankruptcy, Thain negotiated the sale of Merrill to Bank of America, and because he believe he “saved” the company, he requested a $40 million dollar bonus. Public and governmental scrutiny obviously fell upon this request, which he lowered to $10 million, then to $0, and now he has been quoted in interviews as saying he never requested a bonus at all. He resigned from Merrill, and his legacy as it stands is the greedy CEO who took down Merrill. He, nor any other CEO wants to be remembered that way. With this in mind, Thain will take over at CIT, wanting to be remembered as the man who saved CIT.

At the surface, it may not appear to be a wise decision to hire a greedy CEO who has run the largest multibillion dollar financial corporations to now lead a somewhat smaller CIT, but as mentioned above, his past experience and need to repair his image make him a perfect candidate. The market shares this sentiment – CIT shares rose 3.5% after the announcement was made.

Investment Banking Analyst – Part 1: Sleep Deprivation

This will serve as the first post in a two part series examining the health and aging effects of the lifestyle of an investment banking analyst.

An investment banker has two primary job functions: to advise on major transactions and to raise capital for businesses. These business transactions include mergers and acquisitions activity – essentially buying or selling other firms – and the capital raising activities include raising money through stock and debt offerings. An analyst in investment banking is the most entry-level position, whose job responsibilities include industry research and extensive use of Excel in creating financial models. Investment banks are often as thinly staffed as possible to cut costs and increase returns, so analysts often work an exorbitant amount of hours per week. A typical analyst week might include an all-nighter or two, and not uncommonly totals 120 or more hours of work per week.

This job includes a number of negative health consequences; chief among them is sleep deprivation. When the work load calls for being at the office for two complete days straight without sleep, the effects of sleep deprivation begin to take effect. Of the effects, headaches, irritability, and memory losses will cause a decrease in work quality, productivity, and ability to work in a team. A recent Gallup poll suggested sleep deprivation can cause as much of a detrimental effect on job performance as the consumption of alcohol. Although investment banks surely realize this, I believe banks want to squeeze every ounce of work out of an analyst as possible. Despite the analyst’s productivity decreasing as they go without sleep, they are still producing some work, and the investment bank wants to squeeze every bit of work out of the analyst in the shortest amount of time they possibly can.

As it relates to aging, one would struggle to find an analyst who would disagree in saying that they have physically aged more quickly as an analyst than they would have otherwise aged at a 40-hour-per-week job. Investment banking analysts commonly work in banking for two years before jumping to another career opportunity. The benefit of working so many hours is that analysts get four years of work experience in two years’ time. However, analysts frequently feel as though they have aged four years in two years’ time. A Gallup poll suggests that about 30% of Americans say they do not feel well-rested, but virtually all investment banking analysts feel this way. This appearance and demeanor with which analysts carry themselves could have negative consequences further along in the aging process.

Another downside of working those extreme numbers of hours in a week is the inability to provide caregiving services. Although analysts are frequently in their early twenties and do not have relatively high caregiving demands, 120 hours of work in a week almost completely preclude any opportunity at all. Many religions and cultures ask for young adults to take care of aging parents or grandparents, which is almost impossible to do as an investment banking analyst. With very little sleep and virtually no free time, an analyst cannot even find the time to take care of a pet.

While sleep deprivation is a very serious downside of working in investment banking as an analyst, perhaps the most taxing con is yet to be discussed – stress. Stress will be discussed in part 2, which will be up shortly.

Saab to Spyker - Good Value to GM?

The economic downturn of the past two years has taken a toll on automakers around the world. Programs like Cash for Clunkers and bailouts of the U.S. Big Three by the U.S. government have been enacted to help weather the downturn and keep the U.S. automotive industry’s head above water. In addition to help from the outside, automakers have made internal changes to adapt to the economic climate and better position themselves for the future. General Motors in particular filed for Chapter 11 Bankruptcy, is selling its Hummer line to the Chinese, and is winding down its Pontiac and Saturn brands. Swedish automaker Saab, owned by GM, was also under the microscope as GM considered its sale, and after many negotiations failed, discussion switched to shutting down the line. However, on January 26th, GM suddenly announced it had struck a deal to sell Saab to Spyker Cars, a small Dutch luxury sports car company. As the deal is set to be finalized in the next couple of weeks, investors are asking, did GM get a good value for Saab? To answer the question, GM acted in its best interest and got the best deal it could.

Saab was sold to Spyker for $74 million in cash and $326 million in preferred stock in the new Saab-Spyker business, for a total purchase price of $400 million. To put this deal into perspective, recall that GM originally purchased a 50% ownership in Saab for $600 million in 1990 and purchased the remaining half for $125 million in 2000. Had that deal taken place today, the combined inflation-adjusted acquisition prices for the two halves of Saab would amount to a total purchase price of $1.14 billion. In other words, GM sold Saab for about 35% of what it paid – not an incredibly good return on investment.

However, despite selling the business for a third of the inflation-adjusted price it paid in 1990 and 2000, GM received a good value for Saab. The number of Saab cars sold in 2009 was half of what it was in 2008, and the brand image of Saab is on the decline. Now that GM has announced plans to focus on its four core brands, the revival of Saab is best left to another company. Given the economic climate and shrinking Saab market share, a sale of the company for less than originally paid is to be expected.

As for the specific $400 million selling price itself, any price GM could find above Saab’s liquidation value would be sufficient justification to sell the brand. The liquidation value of Saab refers to the total value GM could get by shutting down production and selling all of the company’s assets – factories, parts, cars, production equipment, etc. GM most certainly had calculated a figure for what it thought it could obtain by liquidating Saab’s assets, and the sales negotiations that failed prior to those with Spyker likely failed because offers were made for Saab below that liquidation value. If GM were to receive a bid for Saab at a price at or above liquidation value, the sale of Saab would then provide more financial gain than the closing of Saab, and GM should take it. Such is the case that likely occurred with Spyker’s bid.

Although GM and Spyker speak of how excited they are to save the “iconic” 60-year brand of Saab automotives, at the end of the day it all comes down to the financials. GM was ready to rid of Saab and received the best value it could, while Spyker saw Saab as an opportunity for growth and profits. Despite the arguably low sale price, GM did what was best for its shareholders and growth strategy for the future, and in turn, got a great deal.

For a more specific timeline and deal history, click here