Blog 8 Ponzi Scheme

Time passes with lightning speed, the module has come to an end by the time I am writing this last blog. In this blog, I am going to discuss about Ponzi scheme which is related to the ethic issue in business. Ponzi scheme has happened over and over again around us and every time it packaged the idea very well and perfect, but it seems too good to be true for me. I recall that one of the famous Ponzi scheme that happened back in my country, Malaysia about few years ago and it has been collapsed last year. The name of the scheme is called “JJPTR” and the meaning behind of it is simply means “saviour of ordinary people”. They were so many people invested their money in it and it was so famous by the time. However, the result was pretty clear that many of those investors lost their money when the organisation faced collapse.

So why is there many people still fall for the trap even so many cases had happened? I personally think that it I because the Ponzi scheme is so attractive and the best selling point is to “get rich quick”, with an irrational rate of return up to 30% or even up to 50% with an extremely low risk. Thence, the so called “investor” would invest their money in it and hoping for a crazy return in a short period of time. However, it is not appropriate to fully blame on the investors because the directors behind the scheme were too brilliant and competent to cover up the scheme and making it looks flawless.

Speaking of Ponzi scheme, I had to mention the largest scheme ever which found by Bernie Madoff, the Madoff investment scandal. He defrauds the investors by misleading a message saying that the money is invested in shares and securities. However, the truth behind it is that the money was not invested in the market, instead Madoff used the capital from new shareholders to pay returns for the previous shareholders yet keeping the rest of money as profits for the company and himself. Similar to other Ponzi scheme, the game will just keep repeating and repeating to the point that when the new shareholders’ capital is unable to repay for the returns of the previous shareholders, hence the party will stop and leading the organisation to collapse and game over. In this case, Madoff revealed the truth behind his investment company was actually a Ponzi scheme when he was unable to repay the returns for new shareholders in year 2008. The total amount of the fraud was estimated at $65bn and he later sentenced to jail for 150 years. Well, this is so long and he could probably pass away in the first few.

After a few paragraph of a short intro Ponzi paragraph, you might wonder what is it to do with the business ethic? Here come a few important points how Madoff investment scandal erodes the business ethic and the first one is definitely fraud conducted by Madoff. Madoff and his fellow employees from the investment company had conducted fraud by misleading the investors and results in breaking the business ethical responsibility which is not desirable. The unfavor act causes the investors to losses their hard earned money which is not in line with the business ethic.

Furthermore, the second business ethic issues concern with Madoff investment scandal is the misrepresentation of its business where Madoff was deceiving the investors by telling them that his company was actually making profits by investing in shares and other securities. A business with ethic is supposed reveal its real affairs instead of misrepresenting to attract investors. In addition, Madoff had also committed money laundering which would erode business ethics and consider as crime at the same time. He was covering up the illegal revenue generates from the Ponzi scheme under his investment company to hide from Government.

Last but not least, organisations must follow and apply the business ethic to maximize stakeholder’s value and avoid themselves from any unwanted unimpressive events because in the end, the harm that they bring will come to themselves as well.

Blog 7 - The Great Crash 1929

The reason why I picked this particular finance documentary is because I believe that not much people would be taking it because history is boring, isn’t it? Especially something that happened about a century ago. However, if we look at this with a different angle, something that happened in the past is actually beneficial for us as a guidance.

As mentioned in the documentary, the so called “investors” were speculating on the stocks market, even the celebrities. In fact, they were making decent profits for their speculation. This can be explained by when the stock market is on a bull trend, the confidence of all investors is very high and results in pushing the share prices to go up. However, the speculators on stocks would be wiped out immediately during a bear market as the confidence is relatively low hence there is no buying power and causes the shares to decline drastically. This can be link to the current situation of stocks market where there are so many uncertainties over the economics and political issues such as the Brexit, US and China trade war, fluctuations in oil price and etc. When there are uncertainties over the financial world, the confidence of investors is rather low thus they would move their capital to the “safe zone” such as the gold commodity. Therefore, it would lead to a fall in equity market and it can be seen in the Dow Jones index, which has dropped for almost 20% from its highest point recently.

One thing that I have to mention from the documentary is that investing with margin is a double-edged knife. It could benefit you by leveraging your capital and profits but it could also be a very dangerous tool as your losses would be “leveraged” as well. In the 1920’s, investors can just leverage their investment with margin for a ten-fold where $6,000 of capital can purchase shares up to $60,000. This is very crazy and dangerous especially for speculators who doesn’t even concern what were they buying, they have no idea what are the industry that the company is in, the business and whatsoever. They would just invest their money in whatever seems right and ignore any other matters. Without a question, they could still generate decent profit during the bull market, but let’s imagine that when the bear market is in control, the outcome is obvious that the bankruptcies were just occurs everywhere which has happened in the great crash of year 1929.

Consequently, the overly speculations had caused a gigantic bubble on the stocks market but the investors were just ignored the fact and chose to continue the party. For my understandings, the share prices were far beyond its intrinsic value and it could be corrected at any time, before the investors could even realize. The profits that they enjoyed during the bull market was so high, it reaches the point that they would just simply neglect the risk behind it and causing a tragedy to happen. This is very similar to the financial crisis took place in year 2008, everyone is just celebrating for the large profits and blindfolded for the bubble caused by over leveraging.

In short, we must learn from the past and avoid the mistakes that made by ancestors. I am certain that there will be another, and another financial crisis happens in the future, just like the one in year 2008 because the tragedy in history is easily forget by humans, especially when there is another bubble rising up. The only thing that we can do is to take precaution step to minimize our losses and always perceive risk at the first place.

Blog 6 M&A

In this day and age, technology advancement had greatly changes the lifestyle of people. Back in the 80-90’s, gadgets like tablets and smartphones were not even exist. In contrast, we can see that most of the people, including us are holding a smartphone in every corner of the world. Besides, technology advancement had also changes the way of communication as in online chatting which is driven by social media. Facebook is ranked top 1 for having more than 2billions monthly active users and Instagram is ranked top 3 for a billion users. Well, I am not surprised by the unbelievable figures as almost every friends and relatives of mine are the loyal customers of these two social medias. Nevertheless, these two giant social media companies are controlled by the same boss, which is CEO of Facebook, Mark Zuckerberg. Specifically, Facebook had acquired Instagram on year 2012 for nearly $1billion USD yet Instagram was only launched for 2 years with 13 employees at the time. The acquisition of Instagram was the 40^th M&A transactions of Facebook and it was the third largest acquisition among its history.

In the process of acquisition, the fund was allocated by $300million in cash and $700millions worth of shares. In my opinion, the allocation was effective and well balanced as there are advantages and disadvantages for both approach. The advantage for the shareholders of Instagram receiving 23million shares that worth $700million throughout the acquisition is that they are able to maintain an interest in the combined entity. For example, they will be involved in decision making process and also entitled to receive dividends from profits. However, the positions of Facebook’s shareholders was diluted because there are more shares issued hence decreasing the weight for existing shareholders in the company. Issuing new shares to fund the acquisition could also benefit Facebook because the outflow of cash can be mitigated thus increasing the liquidity for company. In contrast, the drawback of Facebook paying $300million in cash for the shareholders of Instagram is that they might be responsible for capital gains tax throughout the acquisition. This is very undesirable for the shareholders because a good number of tax paid would cut down their profits. In addition, the disadvantage for Facebook can be easily found because they might face cash flow strain in short term. For instance, if there are financial crisis or any terrible events occur right after the acquisition, it would put Facebook in a bad situation as they are lack of cash to deal with the problems.

As of today, we can conclude that the acquisition is successful as Instagram is now making around $1billion in every quarter, which is close to $4 billion of Facebook’s $20 billion annual ad revenue. At the time when the acquisition was just finished, Instagram has only 35million users and it has increased in five-fold in just 2 and a half years. At the year of 2016, the monthly active users of Instagram had already reached to 600million which shows an astonishing growth rate. However, Facebook was criticized by many others few years back then for the acquisition on a new start-up tech company. In an episode of “The Daily Show”, Jon Stewart was sarcastically saying ““A billion dollars of money?! For a thing that kind of ruins your pictures? The only Instagram worth a billion dollars would be an app that instantly gets you a gram.” Apparently, not much people were really understood the vision that Mark Zuckerberg had on the acquisition. He knew that Instagram had a promising future and might be a difficult competitor in the near future. Therefore, he chose to be friends instead of fighting it as an enemy.

The first thing I do when I turn on my laptop or smartphone is to scroll through Facebook and Instagram. Besides that, I would also use the social medias to pass my free time and I believe many others does the same thing as well. Imagine that these social medias just gone and disappear out of a sudden, I think that it would be a terrible disaster for mankind. Too much on the exaggerating, however, Facebook and Instagram are deeply integrated to our lives and that is the reason why it is so profitable

Margin Call

Life is a matter of choices as you have to choose what you want but you can’t have both at once. The board of directors from the movie of “Margin Call” were in a hardship of whether to sell the valueless financial products to their customer or to keep their reputations. In the meantime, it is worthwhile to argue that should the company keep their reputation while they are on the verge of bankruptcy? Yet, should the employees keep their professional ethics towards the customers in the situation where they might lose their decent and high paying jobs? In the virtue of moral responsibility and obligations, the answer is yes because the reputation of company would be destroyed if they sell it all to their customers. In contrast, the answer is undoubtedly no because they would have to protect their self-interest in order to prevent the company from bankruptcy. From my point of view, the movie had formed a polarized situation and it is very difficult for the board of directors to make a choice. However, it is understandable that they eventually encourage their employees by providing high bonuses to sell the valueless investment products to the unsuspecting customers. After all, the so called “investors” or buyers of the products were buying it with the assumption of they can purchase it at a cheaper price and make profits out of it without considering the risks nor morality.

Furthermore, I am concerned with the level of job security that reflected on “Margin Call”. In the beginning of the movie, a number of employees including an employee who were with the company for 19years were sacked for the welfare of company. This shows that loyalty of employees towards a company is no longer able to for them secure their jobs. In fact, these miserable events happened not only in the movies, it can be seen often in the real-world situation as well where employees are lay off in the process of company downsizing and bankruptcy. The outcome is that many people are jobless and their living are dramatically impacted.  I personally think that this is quite ironic because it is inverse with the concept instilled by our parents and society since we were born. Most people are told that getting a flying colors results for academic, graduated from university with high prestige would secure a decent job and life would be much more easy. The fact is that unemployment rates of graduates are increasing at an alarming rates and not to mention the unemployment rates worldwide. On the other hand, the 99% of wealth are controlled by the 1% richest people thus the wealth distribution is imbalance severely and it had created a scenario of the rich are getting richer and the poor are getting poorer. Many people are trapped as they worked their ass off just to pay their taxes and debts such as car and housing loans.

Consequently, it is believed that securing a decent job is no longer the priority to pursue for us. A recommended solution from a famous book “Rich Dad, Poor Dad” by Richard Kiyosaki is that employees should start “paying themselves first” as soon as possible. This simply means that employees should retained around 10% of their pay once they receive their salary monthly and when the savings had increased to a certain amount, they then able to generate more passive income using their capital. For instance, they can use their free time to start a business such as an online store or investment like stocks and bonds market. However, starting a new business consists of a high risk thus they must develop a business strategy and risk management in order to sustain and grow their business. In contrast, stocks market also posted a certain level of risks hence they must understand the business and company in order to avoid losses. For example, they can gather and analyze tons of useful information from company’s annual and quarter report, such as the balance sheets, cash flow, profit and loss table as well as company’s future prospects. “Don’t put all your eggs in a single basket”, therefore it is advisable to distribute capital into other financial instruments as well. A great example is to invest 60% of their capital in stocks market and 40% in bonds market.

In short, when the passive income generated monthly from their business or investment is greater than the expenses, employees are no longer depending on their job to survive, they are able to make a living even if they had lost their jobs. After all, it is much more easy to say than doing it realistically, thus we must start carrying out the strategy as soon as possible in order to get out of the trap.

Should Companies Set a Dividend Policy?

Along my path of investing in stocks, I’ve heard that Berkshire Hathaway had never pay out dividend to their shareholders. This is because of the current chairman and also CEO of Berkshire Hathaway, Warren Buffet believes that the cash can be well utilized in investing back into his business instead of paying out to shareholders as dividends. However, the company has a decent shares buyback policy which is an another pipeline to reward its shareholders with cash. Tax implication is one of the difference between shares buyback and dividend as companies are taxed twice when giving out dividends. In fact, the company had only paid dividend once to its shareholders back in year 1967 and Sir Warren Buffet joked that the decision was made when he was showering in the bathroom. The company is now worth nearly $540billions and its share price is current trading at $330,350 which is similar to the price of a house thus it proves that reinvesting cash to the business instead of giving out dividend is indeed an effective strategy to grow the business. Nevertheless, should companies carry out an ideal dividend policy to rewards its loyal shareholders? Or let’s put ourselves in shareholders’ shoes, do they desire dividend payment from the company they invested or prefer the company to reinvest the retained earnings back into business?

          

             

           From my point of view, a company with a dividend policy that giving out dividends between the range of 20%-40% from its retained earnings is desirable. This is because when the share price of the company is not performing, dividends play an important role to safeguard shareholders’ value. Even though shareholders are making loss on the declining share price, they would still receive dividend as a “compensation” for their investment and the risk that they are taking. For instance, when the bear has take over the market and the overall market sentiment is bad for a certain period of time, companies with a high dividend yield are very defensive and preferable for shareholders to invest because the share prices will generally decline at a high range hence dividends are able to guarantee shareholders’ investment as a passive income. In contrast, it is advisable that growing companies do not implement a dividend policy because they can expand their business by investing the retained earnings in projects and other investment. In this case, companies are able to growth at a high pace and the share prices would eventually increase due to the rising future earnings. Therefore, shareholders can enjoy a “yummy” capital gains out of the stocks yet companies fulfilled their obligations by maximizing its shareholders’ wealth.

             Speaking of dividend, I recall that I had a best friend back in high school who came from a wealthy background. I was admired by his wealth and one day when we were eating lunch at canteen, I asked him about what do his family do for a living out of curiosity, specifically his dad’s career. He answered: “my dad is jobless.” I was terribly shocked by his answer and asked him immediately after: “Then where are all the wealth from?!” He said he only knew that his family would receive money regularly but had no idea where was it from. I was desperate to figure out the answer then I asked my best friend to inquire his parents. On the next day, he then told me that it was stocks, stocks that his grandfather bought many years ago. At the time being, I barely know what stocks really is and it turned out that his grandfather bought a large amount of blue-chip stocks and later on transferred to his dad which stated on his will that the stocks are prohibited to sell, the family could only receive dividends for their lifetime. Therefore, his father receives these dividends regularly and lives a wealthy life. As a matter of fact, there are quite a number of shareholders are aiming at stocks with high dividend yields in order to increase their passive income and eventually achieve the so called “financially freedom”, where passive income is higher than the expenses.

            In short, it is not mandatory for companies to implement a dividend policy because every companies are different in terms of their assets, liabilities, cash flow and etc. However, companies can set their dividend policy using various Dividend Relevance Theories as a reference whichever best fit their criteria. For example, the theory of Bird-in-the-hand implies that companies should pay high dividends to their shareholders in order to maximize share price because investors prefer the certainty of dividend payments to the possibility of substantially higher future capital gains. In contrast, Firm life-cycle theory shows that company should implement dividend policy based on its life cycle thus when a company’s growth rate and profitability rate are expected to decline in the future, company should pay out dividends and vice versa.

Blog 3- Capital Structure

Coca-cola has been my favourite soft drinks since I was a kid, and it still is now. Imagine one sip of it went into your mouth, it just feels so great, sort of like an explosion in the mouth many thanks to the “secret recipe” of coca-cola. Another of my favourite drink, is of course the coffee! I can never go on a day without a cup of coffee in the morning, it sorts of like “a coffee a day, keep the sickness away” to me. So why are we talking about these two of my favourite drinks in this blog? It is because the main topic today is about one of the shocking acquisition happened in the late August this year, which is Coca-cola is buying the business of Costa from Whitbread.

Coca-cola has offered an £3.9 billion all cash for the business of Costa, the UK’s favourite coffee shop. Nevertheless, the area that we are focusing in this blog is the capital structure of Coca-cola funding the acquisition. In order to fund the acquisition solely through cash, Coca-cola would have to issue new debt, I mean, who would have carry so much cash in their pocket? Right? Debt financing has a lower cost than equity financing because it is tax deductible thus the company do not have to worry about paying large sum of taxes throughout the acquisition. By doing so, the weighted average cost of capital is actually lower if Coca-cola were to fund it through debt financing instead of issuance of new shares.

Consequently, the shareholders of the company would not face a dilution of their ownership without issuing new shares. In this case, the company can also maintain the earnings per shares which is actually beneficial to the shareholders. However, there is always a good side and a bad side in everything. The disadvantages for the company to finance through debt is that the credit rating might affected or downgraded due to the increasing debt and trigger a bad cycle such as the drop of share price or whatsoever.

In addition, the increasing debt level would also cause the interest rate to rise, and eventually pull up their cost of debt. In this case, it might offset the reduced in WACC that we discuss earlier. During the bad days, cash plays an important role for any company to settle their problem like the liquidity, hence there is a hidden risk for Coca-cola to turnover if there is any unwanted event happens. Overall, I personally think that this is a pretty good deal because Coca-cola get to involve in other business besides its core business as it could generate a decent continually revenue and contributes to its bottom line, not to mention the large market shares of Costa in the UK.

In short, this is a smart move by the company as coffee is considered as a necessity for all the coffee lovers. Exaggeratedly, I bet many of the coffee lovers couldn’t survive a day without a cup of coffee, even they were lucky to make it, they would be probably half-dead already.

Assessed Blog 2 -The last days of Lehman Brothers Moral Hazard 2008

The last days of Lehman Brothers 2008

       I’ve gained a lot of insights on the financial crisis of year 2008 after watching the finance documentary of “The Last Days of Lehman Brothers Moral Hazard 2008” that produced by BBC. On top of that, I had a better understanding of the development of the world economy, its development is closely related to the judgment and decision-making of policy makers, hence the mistakes of policy makers may cause financial crisis within the country and worldwide which makes the economy extremely fragile. The documentary also emphasis on the difficulties of making decisions by the bankers and minister of finance in the U.S whether to save Lehman Brothers from bankruptcy especially when they were running out of time and it gave me a mini heart attack while watching it.

          

             

                 

                  The main reason that causes Lehman Brothers to bankrupt is the human nature of greed. The CEO at the time of 2008, Dick Fuld could have sold Lehman Brothers with decent price few months before the collapse happened, but the price was never high enough to fulfill his greed. Lehman Brothers was burdened by too much of toxic assets and no other banks would want to buy it or bailout the drowning bank. In my opinion, the credit default swap was a very clever and profiting financial instrument derivatives which made the banks tons of profits. However, they neglected the risk behind it and could only see the profits where they were giving out credits rating on the CDS which they didn’t even analyzed the value of it. In addition, the subprime mortgages had created a giant bubble back then and it eventually burst when the borrowers were not able to repay their loans. It reminds me a saying of “You reap what you sow”, thus risk management is very important which not only for banks, individuals like us must manage risk carefully in order to prevent any unwanted events.

           

“Someone has to fail”, a sentence fill with sorrow but truthful from Paulson in the documentary. Lehman Brothers had to fail, Dick Fuld had to fail in order to curb the terrible situation from going worst. Perhaps it explained why the Barclays Bank did not bailout Lehman Brothers in the end. From my point of view, if the acquisition were to succeed, it was only to extends the life of Lehman Brothers but the problem wouldn’t be solved and it might lead to a more powerful crush towards the financial world. Besides, are banks like CitiBank, JP Morgan, HSBC Banks too big to fail? If I were in the situation which before the financial crisis of year 2008, I could never imagine that Lehman Brothers, with a history of 150 years in banking industry would have end up like this, and I personally think that 95% of people couldn’t see that coming as well. However, the fall of Lehman legacy had proven that a bank was never too big to fail. Even with the size of Lehman Brothers, a bank would still collapse if the risks are not properly managed by the directors.

           

To conclude, the collapse of Lehman Brothers is a very useful example and warning for the financial world. Banks regulators are now more stringent on the minimum capital requirement as well as emphasizing on liquidity risk. Besides, leverage is a “double-edged knife” as it could generate decent profits for banks but over-leveraging would hurt the banks. Countless of people had suicided, went bankrupt, and vary tragedies happened during financial crisis of year 2008. Nevertheless, ten years has past and the economy is on the track to recover. According to rumors, there is a curse saying that financial crisis would happens once in every ten years which shown by the financial crisis of Southeast Asia in 1997-98, the collapse of Lehman Brothers in 2008. However, would there be another financial crisis occur in year 2018-19? I have no idea, and I am certain that nobody has an accurate answer because it is not predictable, but I am sure that it would happen in the future due to the human nature of fear and greed, which is said by one of the greatest investor of all time, Sir Warren Buffet. In fact, that are many issues rising globally which are harming the economy system such as the trade war between US and China, currency crisis on emerging markets due to the increasing interest rate, fluctuation of oil prices due to the sanctions against Iran and the case of reporter killed in Saudi and etc. Even though we are unable to predict the next financial crisis, but we are able to prepare and take cautious action to minimize the impact it could bring to us by managing risks and diversify out portfolio effectively.