SOPHISTICATED FINANCE

Facebook Stock Price Slides

Facebook is now trading at 24% below the IPO price. This is a significant price adjustment for a new stock (or any stock) and suggests that the bankers overpriced the stock at the IPO. Aswath Damodaran, the legendary NYU finance professor, explains where the bankers went wrong in this excerpt from Business Insider:

"I think the investment bankers priced the offering based on how shares of Facebook were trading in the private market and their assessments of institutional demand. I don't think that revenue growth, margins, risk or any other fundamentals played much of a role in the pricing. I don't fault them for playing the momentum game, but they played it badly."

Most stocks do not have a large active private market prior to their IPO. Facebook established their private market partly as a means to provide liquidity to the founders and perhaps to provide some support for an aggressive valuation at the IPO. 

As crowd funding grows as a means to fund startups and other private markets in pre-IPO stock emerge, perhaps one should be cautious about these markets as a basis to price IPOs. 

 

Financial Modeling Workshop Miami May 11

I will be doing a workshop for the FIU Pino Entrepreneurship Center on May 11. The workshop focuses on how to build financial models, including an introduction to some advanced Excel commands that make building models easier. This workshop begins where my workshop on business concept development and growth drivers ends. There is an exercise that develops the logic of model building, a digital handout of a linked income statement, balance sheet and cash flow model and a handout of the advanced excel commands.

More details on the workshop are here. Proceeds go to the Pino Center at FIU. If you would like to see a previous presentation, look here. Very practical, little theory, informal style.

Disclosure: I am a member of the Board of Directors of the Pino Entrepreneurship Center.

Related articles

• Miami-Pino Spring Entrepreneurship Workshop Series (sophisticatedfinance.typepad.com)
• Upcoming FIU Workshop--Financial Plans (sophisticatedfinance.typepad.com)

A Thought on Facebook's IPO

Image via CrunchBase

Everyone knows that Wednesday Facebook filed an S-1 with the SEC for an IPO, initial public offering. Tech Crunch covered the story and included a public letter from Mark Zuckerberg, the CEO of Facebook. In the letter Zuckerberg states:

 "Facebook aspires to build the services that give people the power to share and help them once again transform many of our core institutions and industries.”

Tech Crunch interprets this quote to mean:

 "Zuckerberg compares Facebook to transformative technologies like the printing press and the television".

First we should recognize that every big IPO has a fair share of hyperbole. Hyperbole often helps people to understand the larger but more complex part of the investment thesis. However, hyperbole works best when solidly grounded in fact. I do not agree that Facebook is a "transformative technology" comparable to the printing press, the telephone, the automobile or even Google.

All of these technologies or business concepts launched a new phase of the industrial revolution. Each of these concepts lead to multiple, large valuable derivative industries. For example, printing presses made possible magazines and newspapers, the telephone launched remote customer service and Google made possible You Tube and Wolfram Alpha. While Google may prove to be a catalyst comparable to the automobile, it is too early to tell. The automobile launched innumerable major industries, such as taxis, car leasing, parking lots, gas stations, car repair and even fast food restaurants.

My concern in comparing Facebook to these major innovations is that I do not think it will produce derivative industries. Facebook is a closed garden that companies pay to access. I think that Facebook is more like the phonebook was to the telephone. The phonebook was a great idea but few businesses were derived from the phonebook. The phonebook did not take the industrial revolution to a new more productive level.

While I do question the hyperbole in the Facebook IPO, I think Facebook will be a successful transaction. Hopefully it will launch a strong IPO market for tech companies over the following twelve months.

 

 

Related articles

• Facebook IPO Summary (ecademy.com)
• In Depth: 10 things Zuckerberg's letter teaches us about Facebook (techradar.com)

Miami-Pino Spring Entrepreneurship Workshop Series

The Pino Entrepreneurship Center at FIU has released its schedule of workshops for March through May. These workshops are open to the south Florida business community as well as students. I will be giving two workshops:

1. "Developing a Killer Business Plan" which focuses on how to develop a business concept and a business model and also provides a checklist for how to write a business plan. March 2.
2. "Financial Modeling" which deals with the logic, design and construction of an Excel model for a business or business plan. More on my philosophy of business models is here. This is the first time in about two years that I have offered this workshop so you may want to save the date May 11.

John Fleming (LinkedIn profile) will present a workshop, "Marketing Strategy and Social Media for Entrepreneurs" on April 13. John does a great job on some complex but important subjects for every entrepreneur.

Registration, location and pricing for my workshop March 2 is here. Proceeds go to the Pino Center.

Related articles

• Teaching at MIT Sloan School (sophisticatedfinance.typepad.com)
• Billion Dollar Company (my book)

Two Good Finance Articles on Returns and Valuation

A little finance never hurts and two articles on equities caught my attention. The first article comes from Bloomberg, where they cite some research by Wharton Professor Jeremy Siegel. The professor's research shows that for the first time since 1861, the thirty year return on bonds exceeds that of equity. You will remember from introductory finance class that equity returns should exceed bond returns given the higher risk in being an equityholder. A few possible explanations for this rare phenomena:

1. Equities are undervalued
2. We are in some sort of "war" market akin to the U.S. Civil War
3. Demand for bonds is disproportionately high, driving up prices and returns, in response to various global uncertainties (the other side of point 1.)

The other article cites some high level mathematical analysis from Cornell Professor Robert Jarrow  and Columbia Professor Phillip Protter to identify bubbles, or overvaluation, in different asset classes including equities. For example, the methodology correctly identified the dot.com era and the price runup after the LinkedIn IPO as bubbles. Also interesting, the methodology shows that current gold prices are not a bubble. Of course trading on such math should correct for the bubble in a given stock. Question I have is whether the professors have applied their methodology to whole asset classes such as bonds or equities to see if they give us any insight into the current existence of bubbles. If bonds showed "bubble" behavior, that might explain Siegel's findings.

I found at least one of these articles on FinanceProfessor.com.

 

Related articles

• Mathematically detecting bubbles before they burst (eurekalert.org)

UBS CEO Resigns

The New York Times is reporting that the CEO of UBS, Oswald Grubel, is resigning due to losses of $2.3 billion from a fraudulent trading scheme. Mr. Grubel had assumed the position in 2009 after the bank replaced the former CEO for losses in trading sub-prime mortgages. 

UBS appears to have a record of holding the CEO accountable for poor performance, particularly when it is attributable to control weaknesses. I think that this approach is fair, although I would expect that every manager between the rogue trader and Mr. Grubel should be relieved of their position.

Related articles

• UBS's biggest investor attacks bank's lapses (independent.co.uk)
• UBS CEO silent under fire over $2.3 B trading loss (ctv.ca)

HP Spins Off Computer Division

Image via CrunchBase

It’s always nice to have your predictions confirmed and the sooner the better. Yesterday’s post said that in five years the only surviving brands in consumer IT would be Apple and Amazon. Today’s announcement that HP is spinning off its computer division seems to support my prediction. Sale of the division would be the next logical step.

The new HP focus on business services also looks like a good decision. However, I would point out that this market is becoming more complicated by executive personal device selections, which now have a much greater effect on corporate decisions.

HP also announced that they are dropping further development of webOS. Based on this week's Google Motorola transaction, maybe someone in Asia like Samsung will buy it. In fact, maybe Samsung should buy HP's computer division. That would be an interesting development.

 

Related articles

• H-P Earnings Clouded By PC Spin-Off and Possible M&A Rumors (HPQ, SAP, DELL, AAPL, IBM, MSFT, INTC, RIMM, GOOG) (247wallst.com)
• HP to spin off PC business, discontinues TouchPad (tuaw.com)
• Why The World's Largest Computer Maker Is Ditching Hardware (huffingtonpost.com)

Accounting and Finance Workshop

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I just presented a two day workshop called "Accounting and Finance for Non-financial Managers" for a large international company. The workshop focuses on theoretical concepts in micro-economics, finance and accounting and the practical application of the concepts to business management and decision making.

The client wanted the workshop to focus on the analysis of new projects using the discounted cash flow methodology. What was particularly interesting is that the company shared their own discounted cash flow template for project analysis. Every CFO makes adjustments to such a template to achieve certain strategic or risk management objectives. When I was CFO of the Indonesian company I added seven percent to the actual weighted average cost of capital discount factor to reflect the uncertainty of the operating environment. The differences between the client template and the theoretical model for discounted cash flow gave me quite a lot of insight into the strategy of the company. I would like to illustrate this point more fully but I would be violating my non-disclosure agreement with the client. One point worth noting is that the next time you do due diligence on a large acquisition ask to see their capital expenditure evaluation template. May give you some real insights into how they think about the business.

If you are interested in refreshing your knowledge of theoretical finance and valuation, Aswath Damodaran, a professor at the Stern School at NYU, has a terrific website here. What could be more fun on this 4th of July weekend than reading about beta and weighted average cost of capital. Enjoy the weekend even if you don't do any finance.

 

Peru, Colombia and Chile Merge Stock Markets

As reported in Big Think, South America's most centrist governments are merging their stock markets. Peru, Colombia and Chile have announced the merger of their stock markets to improve market liquidity and access to capital for local companies. In the run up to the Peruvian presidential elections, this announcement and its timing raises interesting issues for front runner Ollanta Humala. Humala is backed by former President Lugo of Brazil and President Chavez of Venezuela and would be expected to be against such a pro-business merger. Comments against the merger would increase concerns in the business community and abroad about a future Humala government. My guess is that Humala will remain silent on the issue until after the elections.

Related articles

• You: Peruvian presidential race virtually tied: report (menafn.com)
• Emerging Markets Report: Peruvian presidential race virtually tied: report (marketwatch.com)

Finance Term--Civets

For years I have been trying to introduce into common English usage the word "bozette". A bozette is a female "bozo". I have had little success but never the less I carry on. Now to "Civets".

Civets are the group of six emerging market countries just below the BRIC countries in terms of economic attractiveness. The countries include Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. According to this story in the FT, the term "Civets" was coined by Michael Geoghegan, former chief executive of HSBC, to define an investment product for this country grouping.

 

Related articles

• Standard & Poor launches S&P CIVETS 60 Index (lookatvietnam.com)

Bond Rating Agencies--China vs the U.S.

Traditionally bonds for corporates, banks and sovereigns have been rated by Moody's, Standard & Poor and Fitch. All three of these rating agencies are based in the U.S. It is not surprising given the size of the U.S. bond market and the large institutional investor base here. Of course the size of U.S. debt markets may call in to question the objectivity of U.S.-based rating agencies. These were the same rating agencies who missed the problems in real estate loans and derivatives in 2008.

As reported in this post, capital markets are increasingly becoming influenced by Asia and the capital being accumulated there. So it comes perhaps as no surprise that China has developed their own rating agencies. The leading rating agency is Degong Global. Degong downgraded the U.S. credit rating from AAA to AA+ in 2010. Some might speculate that the downgrade was politically motivated. Hard to believe that Degong, based in the most politicized capital market in the world--China, has much likelihood of being taken seriously.

Might be a good new business idea to start a rating agency based in Singapore or Switzerland where political interference would be minimal, no allegations of vested interest are likely and home country debt is not significant enough to affect ratings.

I found this story on Big Think, who found it on Mail.

 

Africa Looks Promising

Everyone is watching China and those of us in Miami are always focused on Latin America. With my work for OLPC I have been following Africa for the first time in my career. In the next 10-20 years I think that Africa could emerge as the new darling in emerging markets. My logic is in part based on these facts:

• Angola is the fastest growing economy in the world at over 10 percent per annum
• Demand for natural resources will increase dramatically over the next 10-20 years, which will benefit the resource rich continent of Africa
• China is investing large amounts of foreign aid in infrastructure in Africa
• Sources of capital are starting to focus on Africa, as evidenced by the FT report that Carlyle is setting up a private equity fund for the continent

Keys to the success of Africa will be whether it can develop its human resources and a middle class. Education and health services will be the important requirements to achieve these two objectives.

Interesting fact: Africa is a larger land area than China, the U.S. and Europe combined.

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Pitching a Deal

The Gong Show has an interesting article on a different style of presenting an investment to an investor. After the introductions and small talk, start the presentation by highlighting the reasons not to do the deal. In other words, present the key assumptions or risks in the deal. By getting these issues out of the way, the presentation can focus on the reasons to do the deal.

This is perhaps an extreme approach to pitching but it has several advantages that should be in every first pitch:

1. It conveys honesty
2. It shows a more profound understanding of the business concept
3. It focuses the pitch on the key issues for the investor
4. It weeds out the uninterested investor more quickly, saving you time

Suffice it to say, you are supposed to have mitigants for the risks identified and these are further developed in the presentation.

If you are going to use this up front style I would make one exception. At the end of the presentation I would briefly mention felony convictions, tax liens, personal bankruptcies or Attorney General or SEC investigations. Up front these issues might consume all the alloted time or turn off the people before you get to describe the business concept, but you mention such items in the first meeting.

Sophisticated investors are very methodical in risk analysis and they are going to discover the issues eventually. The key is to have the honesty and experience to correctly identify the major risks. I have used this type of approach for thirty years and it works effectively worldwide regardless of culture with sophisticated investors. 

Note: This approach is for pitching sophisticated people, which would be my preferred source of capital every time. I have never pitched friends and family but honesty is still the best policy if you want a chance to be invited back to Thanksgiving dinner after the company fails.

 

Muhammad Yunus Terminated--Changing the Status Quo

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When you think about the number of people who have affected positive social change in the lives of millions or billions of people with little or no financial gain for themselves, the list in all of history is quite short. One candidate for the list is Muhammad Yunus, the Nobel Laureate who launched the worldwide initiative for micro-finance as a means to economic development for the world's poor. He also probably deserves the credit for bringing social entrepreneurship to the world's attention and in the long run that may be a greater contribution than popularizing micro-finance.

Today the BBC announced that the Central Bank of Bangladesh is trying to terminate Mr. Yunus as the head of Grameen Bank, the vehicle for micro-finance which has been copied in so many countries. The Central Bank is a significant shareholder in Grameen and are taking action because Mr. Yunus is ten years past retirment age and twenty two years ago was alledgedly not installed properly as the head of Grameen. One might wonder why it took the Central bank ten to twenty years to identify these issues. The answer lies in understanding how the status quo is changed.

Significant change in the status quo, especially in social issues, is very much a matter of substance over form. One must disrupt the current governmental and commercial interests who invariably feel threatened by new methods that perhaps do not involve them. As the social project makes progress and gains traction the world press begins to document the success, the jealousy begins and the fear of disruption increases in the government and commercial sectors. In response, those threatened unleash a wave of criticism. (Mr. Yunus is frrequently held responsible by his critics for every failing of micro-finance anywhere in the world.) Much of the criticism is unfair or unfounded but it does have the desired result to slow down the social change. When criticism is ineffective, the commercial and government interests resort to legal remedies, such as removing Mr. Yunus for legal technicalities. Whether the Central Bank Governors are acting from jealousy or fear of being disrupted is unclear, but somewhere in that maze of personal motivations lies the explanation for the Central Bank removal efforts of Yunus.

Of course Mr. Unus' efforts in micro-finance are not the only large social project serving millions of the most needy that face similar challenges from those disrupted, but the behavior of the "critics" appears to always be the same. Maybe there is something about social entrepreneurship that attracts such ire. Maybe combining the best commercial practices with a social mission is particularly threatening to the vested interests. 

The views here are my personal opinions and do not reflect the views of any organization with whom I am affiliated.

Related articles

• Nobel laureate ousted from microfinance bank (msnbc.msn.com)
• Laureate Yunus faces removal from Grameen Bank (seattletimes.nwsource.com)

Interesting Posts Today

The blogging muse went on vacation and did not tell me. So today's post is a summary of some very interesting articles from this morning's reading.

Fred Wilson, legendary NYC VC, started a huge debate on the internet here on the role of marketing in early stage companies. Basically all the VCs lined up with Fred  and the marketing mavens all took the opposite view. Fred basically argued for a focus on sales with support from internally generated PR and social media. What the marketing mavens said was largely wrong or confusing. Bottom line do not think about "marketing" in the classic sense and focus on very capital efficient approaches to get customers. One of the more interesting articles in the debate came from the Equity Kicker.

Another interesting article came from an old Tech Crunch post on the pitch deck for a VC or angel. Tim Young reveals the secrets that he used successfully to raise $10 million for two startups in the same year. He uses a 5 slide deck. I love the simplicity, clarity and elegance of his sample deck. I think I found this article through an answer on Quora.

I cannot believe I am going to mention a story about Microsoft technology. Please do not tell anybody. This story describes how Microsoft is developing technology where the human body is the interface to the computer. No mouse, no keyboard. Just hit your arm with your hand in different places and the computer correctly does what you want. And you thought the iPad was cool. Interface to the computer is a big new frontier. 

Suggested ideas for future blog posts welcome.

Related articles

• Kill All The Marketers? (myventurepad.com)
• Fred Wilson: "Marketing Is For Companies Who Have Sucky Products" (techcrunch.com)
• Why A New Startup Shouldn't Have a Marketing Budget (feld.com)

LinkedIn: Is it a Short?

Years ago I received a call from the lead manager of an IPO for a convenience store chain. They asked me if I wanted to buy shares at the IPO price. At the time I was heavily involved in the convenience store industry. I did an analysis of the company and told them I wanted to short the stock, implying that this world renown investment bank had mispriced the stock. On the first day of trading the stock traded down and stayed down for at least the first two weeks of trading.

I do not make a habit of trading in IPO stocks and I rarely go short, but for the recently announced LinkedIn IPO one might want to consider it. Now the pricing has not been set so it is premature to advocate for shorting the stock, but I have followed this company closely for years. The most popular post on SF in 2010 was this story "LinkedIn: Is It a Strategic Error". The post made the first page of Hacker News, which suggests to me that the geek world found merit in the story.

Business Insider reported yesterday on the LinkedIn 2010 revenue growth, which in absolute and relative terms looks strong. What concerned me is that for the year-to-date 45 percent of revenue comes from recruiting, up from 30 percent in 2009. While it appears that LinkedIn has focused on a growing segment in their business, how attractive is another job site. With all of its potential, is LinkedIn settling to be just another player in the crowded job market?

This weekend I plan to read the S-1 in detail. The LinkedIn S-1 is here.

Remember to consult your investment advisor before making any investment decisions, that shorting stocks is a high risk trading strategy and that I rarely go short so my analysis is suspect.

New Business Ideas 2011--II

Recently I have been getting requests to reblog my SF posts on other sites. Most recently I got a request from @gtea at Toolbox for Finance, which also includes toolboxes in accounting, strategy and operations.

Here's the problem. I do not have the time to go to every site and manually re-blog my posts. What I need is for someone to develop an app that allows all these re-blogging sites to automatically capture my blog feed. Perhaps it should be built with the option to omit a site if the post is off topic. TypePad allows for easy reblogging to FaceBook, Twitter and LinkedIn, but I need a product for the next tier of sites such as Toolbox and Proformative. A special thank you to Finance 3.0 who featured my blog posts without my having to do anything :)

There's one other problem. I do not post on finance topics that often. Send me your ideas in the comments on topics in finance that you would like me to discuss here.

• Toolbox would have been a good site to add to this post on Sources of Financial Education.
• The first new business idea of 2011 is here.

President Hu's Thoughts on the Currency System

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Chinese President Hu Jintao will be visiting Washington this week for high level talks on a wide range of issues. In anticipation of the visit the Wall Street Journal and other leading newspapers prepared questions for the President and received written answers. In the WSJ article two quotes attributed to President Hu caught my attention:

1. "U.S. monetary policy "has a major impact on global liquidity and capital flows and therefore, the liquidity of the U.S. dollar should be kept at a reasonable and stable level.""
   
2. "The current international currency system is the product of the past,"
   

Much as President Obama explains the undervalued Yuan as apart of the cause of U.S. economic problems, President Hu accuses the U.S. of contributing to the escalating inflation in China by the Federal Reserve's excessive growth of the money supply. Both Presidents are correct in their criticism but nothing will change as each President gives first priority to their domestic economy.

President Hu's comments on the currency system strike me as wishful thinking for several reasons:

1. An estimated 65 percent of China's currency reserves of $2.8 trillion are in U.S. Dollars, giving President Hu the largest "long" position in any currency (or commodity) in history; unwinding that position by swapping into other currencies would create enormous loses and might very well destroy the entire world economy.
2. If China were to move its reserves into alternative currencies to an even greater percentage, the economies of those countries would significantly lose their export markets and their economies would grind to a halt
3. For President Hu to remake the currency system, the Yuan would have to become a freely traded market currency; there is not a single centrally-controlled government that allows its currency to float subject to market forces (ignore any small countries in Africa) and China is not likely to do it soon.

One possible alternative for President Hu might be to encourage more foreign investment by Chinese companies in the U.S. Such a strategy might be high risk politically but it might be less disruptive economically. Maybe start with Exxon or Wal-Mart. You need to make big investments to have any real effect.

Related articles

• Hong Kong used as lab in currency experiment (FT.com)
• Hu questions future role of U.S. dollar (cnn.com)
• Reserves: All eyes turn to China’s foreign money mountain (FT.com)

Sources of Financial Education

I have practiced finance for over 35 years and my expertise is in using finance to accelerate a strategy and revenue growth. With the growth in the Web the sources of high quality information on theoretical and practical finance have increased dramatically. Three sites that I like are:

1. Finance 3.0 The oldest of the good sites I know, this site offers online training courses, blog posts and discussion topics and a wide range of tools and templates focused principally on finance. This site has been constantly evolving for the better during the last three years and is now focused on its wide range of online courses in finance and related areas. This site appears to cater to financial professionals beginning their career.
2. Proformative targets finance, accounting and treasury practioners with blog posts, discussion groups and other community features. The site also offers product information of interest to practioners and a job board. No online training courses. This site focuses more on the practical side of being a financial practioner rather than theoretical concepts and appeals to more seasoned executives and students seeking jobs with these executives.
3. Finatics looks like the newest of the three sites and the purpose is to sell online courses and consulting in finance and modeling.The Finatics blog is here. The blog has a nice free tools section and book reviews of recently published finance books. This blog is a nice balance between the theoretical and the practical.

Apologies to Finance 3.0. In the original post I called them Web 3.0 but the link was to Finance 3.0.

My new book, Billion Dollar Company: An Entrepreneur's guide to business models for high growth companies is available on Amazon. The book website is here, with book reviews, two videos, an extensive bio and much more.

Predicting Extreme Events

We all live our personal and professional lives based on forecasts. Forecasts are used for many routine things such as buying a home. investing in a college education and planning for retirement. Some rely on other people's advice and some of us like to make our own forecasts. Everyone has heard stories about the forecaster that called the stock market crash of 1929 or the economic crisis of 2008. An article in Boston.com describes a new academic study on the accuracy of forecasters by Jerker Denrell of Oxford and Christina Fang of NYU. The conclusions from the paper are:

1. "Economists who had a better record at calling extreme events had a worse record in general."
2. "The analyst with the largest number as well as the highest proportion of accurate and extreme forecasts had, by far, the worst forecasting record."
3. "Those who correctly predict extreme events tend to have a greater tendency to make extreme predictions; those who make extreme predictions tend to spend most of the time being wrong." 

The conclusions I draw:

1. A forecaster who correctly calls an extreme event is probably not reliable to call the next extreme event
2. Good forecasters tend to forecast well in normal times and are not likely to forsee extreme events
3. Do your own analysis and make your own forecasts.

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