Don’t forget, the end price of every corporate stock is $0.
Back a couple of months there was the interesting argument made that no stock market investment has ever made money. There were charts and lots of addition to back this up too. The only slight problem being that the measurements were only of companies that had come to the end of their life. And, obviously enough, the end of life price of any corporate stock is $0. If it were still higher than that it wouldn’t be at the end of its life.
So we can put that idea to one side – except we should take that $0 price as being a useful warning. For over some time scale, companies not being immortal, the stock price will one day reach that zero. We want to make sure we don’t ride it down, obviously enough.
Which brings us to another piece of stock market wisdom, about trying to catch a falling knife. A dangerous occupation and the reference is to trying to call the bottom on some stock that has just had a disaster. At some point, surely, the tumble in price will stop and there will be a bounce. Well, yes, or perhaps maybe, for we must not forget that that proper bottom is that end of life – the bankruptcy – price of nothing. For everything that isn’t about to go bust then yes, there’s a price at which buying in the face of everyone else’s panic can be highly profitable. The question being, well, what is about to go bust? Toys R Us did, after all. Actually, so have quite a lot of retailers just recently. There was no above zero price at which it was sensible to buy in.
So, some stock crashes in price, should we buy in? After all, there is that phenomenon known as the dead cat bounce – anything will bounce at least once if you drop it from high enough. The question becomes one of, well, is this crash a result of something that can be reversed, or perhaps something that’s not going to be terminal for the organisation? Or is this just the start of that realisation process that the organisation is coming to the end of its life and going to that final resting place of a zero dollar valuation?
Two stocks and problems to illustrate. Not because this is a detailed examination of either of the two, they’re examples to be used for the purpose of the argument here.
So, Boeing and the 737 Max. The changes in airframe had the unfortunate consequence of diving a couple of the planes into the ground. We’ve had a drip of stories about how the development process wasn’t all we would wish it to be. The FAA isn’t going to let it back up into the air until the summer at earliest. The Dreamliner seems to be having demand problems and, well, things aren’t looking good.
But is this the start of some spiral to zero? No, don’t be daft. Partly because the American government simply would not allow that. Boeing’s too much part of the backdrop of the US economy for that to be left to happen. The military business is also of significant value whatever happens to the civil aviation side. And of course the numbers we’re talking about here could be painful to stock holders – they are already in part of course – but at the very worst we’re looking at some tens of billions of problem here. That’s just not enough to drive a company Boeing’s size down to zero. Not in this decade at least, given that the only reasonable competition is Airbus. Global duopolies don’t end that way.
So, at this point there’s an argument to say that trying to catch that falling knife of the Boeing stock price might be worthwhile. So, when might that be? At which point another idea, kitchen sinking. This is when a new management team decides to make themselves look good by declaring how bad things had got under the previous one. Absolutely anything and everything that looks like, it might even smell of a problem in the future is taken out and declared. Provisions are made for this problem on this contract, for that problem that might occur over there, add a bit more and then heck, why not, double it! This has, assuming the company survives this balance sheet massacre, the obvious effect of making the new management team look good over the years. Not just because everything starts from this new low place. But also because many of those provisions – those over-provisions – won’t be needed and can be written back from reserves into the P&L.
Yes, of course this is slightly cynical but then who looking at the modern world isn’t at least a little bit that?
With Boeing there is indeed that new management team. The results are coming up at the end of January for Q4. There are going to be some provisions against the 737 Max problems. But how much? That’s the thing. My best guess is that something around $5 billion would be regarded as being not cautious enough about that specific problem. And that anything above $10 billion would be regarded as kitchen sinking. And if it’s that second then there will be the stock price drop on announcement and then Boeing’s a good company to go buy into. Because of course market watchers know about this idea of over-provisioning and are wise to it.
The other example is Intu. That’s the British property company, not that American software one. Intu’s market is pretty much commercial, retail, property. This has been taking a significant beating in recent years. It’s not a coincidence that some 20% of retail sales are now on the internet and also that some 20% of British retail properties are empty. We simply have a structural overdose of that retail property.
So, obviously, the retail property price is going down. And there are people catching that knife. A couple of recent deals of people buying into second rank and outmoded malls (shopping centres to the English). However, these prices are low, low, low. Very much closer to simply the price of urban land with a development licence than anything like the valuation of a shopping centre with paying tenants. So, we can say that there’s that underpinning to Intu’s valuation, right?
Which would be true except there’s a certain amount of debt around. Without being too accurate the estate itself – the buildings, land etc – has a valuation of some £8 billion. The company has a stock market valuation of £350 million or so. And that might be too high, as there’s a debt burden of £5 billion or so in there too. It’s doesn’t take all that much of a fall in retail commercial property values to wipe out that equity above the debt burden. Something that then leaves the stock equity valueless. Sure, we might consider people trading out of it and all that but loans come with covenants and bankers start to demand early repayment if those are broken. Broken by, say, having not enough equality value in the properties over and above the debt burden.
And are UK retail commercial property prices down 40 to 50%? In any form of forced or firesale yes indeed they are.
It’s certainly possible to see Intu going to zero as a result. And the current gossip is that they’re going to try to do a £1 billion capital raise to stave it off. As you can imagine raising £1 billion on a £350 million market cap is going to involve some dilution.
My best guess here though is that this isn’t – even after such a capital raise – a knife worth catching. I think the sector itself is in decline and that near no amount of prettying up the balance sheet is going to aid Intu in the long term. Hey, that’s just an opinion but it is how I’m reading this now.