blog #3: Deutsche Bank's issue on its capital structure.

In this week's lecture and seminar, I learned about the capital structure theory, and mainly about the Weighed Average Cost of Capital (WACC). So it is related to the previous week's lessons about cost of capital. I have learned about WACC back in high school but I definitely have learnt more about it in this week's classes. Other than that, I also have learnt about the theories of capital structure such as the trade-off models and pecking order models, debts and equity, how debts have lower risk than equity and so on.

In the recent news, I have found out that Deutsche Bank (German Bank) has more debts than equity. According to YCharts (2015), the debt to equity ratio was 3.00, as of 31st of December, 2015. Deutsche Bank's debt to equity ratios have always been high. It automatically means the bank have been taking high risks. It also implicated that by 31st of December 2015, Deutsche Bank held debts of three times more claim on assets than equity holders. Deutsche Bank had unhealthy capital structure because they have high level of debts and low level of equity. They really have negative signs of investment quality. If I were an investor, I don't think I would invest in Deutsche Bank.

According to NotQuant (2016), as of April 2014, Deutsche Bank was forced to raise an additional 1.5 billion of Tier 1 capital to support its capital structure. In May 2014, Deutsche Bank announced that they were selling stocks that worth 8 billion euros, which was up to 30% discount of the price. It truly shocked the media. I am thinking they were trying to raise liquidity. In March 2015, Deutsche Bank has failed the banking industry's "stress test" and is given warning on its capital structure. It is as expected because their debt to equity level has never been low, which really is disappointing to know.

Early this year, according to Financial Times (2016), Deutsche Bank's bond fell further and the 1.75 billion euro bond is trading below 76 cents on euro (see image below). Also, the 1.5 billion bond fell to 81.5 cents on the dollar. It wasn't a good start of the year for Deutsche Bank. The losses made their capital structure look even worse. The bank's CoCo bond of 1.75 billion had lost about 19% of its value (Financial Times, 2016). It was really bad news. This can result in investors not getting paid on their coupon payments. According to Bloomberg (2016), the investors were also worried that the capital and funds can decrease the value of its stock and bond even further.

Image source: Financial Times( 2016b)

Even their Returns on Invested Capital (ROIC) is lower than their Weighted Average Cost of Capital (WACC). The amount of Deutsche Bank's WACC and ROIC can be seen from Guru Focus (image below). It demonstrates that the WACC was 5% in average during last year and the ROIC was mostly negative in the past year. This shows rather bad sign and calls for a need to readjust their capital structure, to find the "optimum" amount of WACC in order to maximize wealth of shareholders. Companies should focus on lowering their WACC as low as possible to get higher returns.

Deutsche Bank's Ratios

Image source: Focus Guru

Can Deutsche Bank repay their debts (by having such low ROIC and high WACC) and make adjustments on their capital structure? This is one serious issue for investors and for the bank itself. In my opinion, I think they could, but not for long. There is still help for Deutsche Bank if they could come up with an action to the existing issue, such as, choosing or finding the optimal financing mix/ capital structure. I think they have incurred too much debt which leads to risks of bankruptcy.

There has always been a debate on whether optimal capital structure exists (M&M theory vs traditional theory). I respect both of the points but honestly, I think it does exist and it is quite logical to have not too much gearing (because the company can suffer from all the costs like bankruptcy costs, agency costs and taxes) BUT also not to have too little gearing (as it can decrease the WACC). Anyway, I also think capital structure matters to EVERY companies, big and small.

References:

YCharts, 2015 https://ycharts.com/companies/DB/debt_equity_ratio

Bloomberg, 2016 http://www.bloomberg.com/news/articles/2016-02-08/deutsche-bank-says-it-has-at1-payment-capacity-of-1-1-billion

Financial Times, 2016a http://www.ft.com/fastft/2016/02/08/deutsche-coco-bonds-plumbing-new-lows/?ftcamp=engage/capi/widget/client/openft/b2b

Financial Times, 2016b http://ftalphaville.ft.com/2016/02/09/2152719/the-coco-that-popped/?ftcamp=engage/capi/widget/client/openft/b2b

NotQuant, 2016 http://notquant.com/is-deutsche-bank-the-next-lehman/

http://www.gurufocus.com/financials/DB

Blog #2: The last days of Lehman Brothers (Documentary)

Today, I am going to blog about the Lehman Brothers, a global financial service firm, which unfortunately has declared its bankruptcy on September 15th, 2008 due to subprime crisis. Although 7 years have passed, it is still an issue that is talked about. I remember back when I was at high school in year 2008, the news was talking about the Lehman Brothers for a period of time, mostly in TV and newspapers. I was still a teenager and wasn't interested with such news, though I kept hearing about it from my family and relatives. It was such a big news that it was difficult to ignore.

Since I have heard about the Lehman Brothers, there is a bit of acknowledgement. This is why I chose to blog about it. I have watched the documentary on Lehman brothers, namely The Last Days of Lehman Brothers. The drama was inspired by the real events that occurred leading to the bankruptcy of Lehman Brothers. They were in trouble after six months of turbulence in which their real estate investments have lost billions of dollars, causing a huge drop in their stock. I have also found out that Merrill Lynch was also having the same trouble. Fortunately, they have avoided the situation with luck. Even Barclays and Bank of America backed off from purchasing Lehman Brothers as they are fully loaded with toxic assets. In the end, Lehman Brothers has not been saved.

I have noticed two reasons that have led to Lehman Brother's bankruptcy.

Firstly, they did not take the situation seriously. Dick Fuld, the boss of Lehman Brothers kept repeating that 'the situation is not critical' when their stock has gone down. How can it not be taken seriously? Or is he trying to perceive that his company can manage to get away from critical situation like this? It is a fact that Lehman Brothers used to be the fourth biggest investment bank in the U.S. But in my honest opinion, if a situation like this was not taken seriously, it can lead to serious trouble for the company, such as, in this case, bankruptcy. Other than Dick Fuld, the management groups were also responsible for the fall. As they were too optimistic about the whole situation. In my opinion, one of the biggest mistakes that they have made was that they believed that Lehman Brothers was too big to even go bankrupt. Personally, I do not agree with this thinking. In the clip, Dick Fuld keeps repeating on the statement on who would want his company. I feel that he have always been desperate and thinking too positive towards everything.

Secondly, there was no good risk management in the company and got criticized for it. Dick Fuld has denied that and said "regardless of what you heard of Lehman Brothers' risk management, I had 27,000 risk managers, because they all owned a piece of the firm" explaining that the staffs had owned more then 30% of the bank's stock (The Guardian, 2015). According to Hutchinson (2008), in the annual report of Lehman Brothers in year 2008, they stated that they had a culture of risk management at every level of the firm. But, if there was a culture of risk management, why would they allow the leverage ratio to rise from 26.2:1 to 30.7:1 from year 2006-2007? This is the question. I think they could have done it better managing their strategic risk a little bit better. According to McConnell (2012), strategic risk is one of the greatest risk facing of all firms because of the uncertainties in the global economy. It should really be taken more seriously to avoid such problem.

I send my heartfelt regards to the 27,000 employees that had lost their jobs from the bankruptcy of Lehman Brothers. I have learned to not take things lightly, even if they won't be as serious as I thought. It is because everything is unpredictable and we have to make sure that we try our best to leave no regrets. In the future, if I were to own a business or become a manager at any level, I have to be a good example or a role model to the staffs. Dick Fuld has definitely taught me some lessons.

Links:
http://www.theguardian.com/business/2015/may/28/lehman-brothers-former-ceo-blames-bad-regulations-for-banks-collapse

http://moneymorning.com/2008/09/12/lehman-brothers-holdings/

http://www.capco.com/uploads/articlefiles/308/file_0_1420620061.pdf

Blog #1: portfolio investments in relation to Queen Elizabeth II's investments

Today, I am going to blog about Queen Elizabeth II's portfolio investments and whether portfolio investment is a good idea.

I have learned about portfolio theory back then when I was at college. It is deemed to be a quite an important topic relating to investment and finance. I remember that I came across the word 'investment' even before learning about it in college. My dad has a lot of experiences on investments as he has already been doing it for 25 years. He taught me to not invest all my money on one particular investment, but to diversify them.

I came across a news on Queen Elizabeth II's portfolio's investment and found it to be quite interesting. Here is a little background-
Queen Elizabeth II is the longest-reigning monarch in the British history today. According to an analysis by Bloomberg Billionaires Index, her personal fortune is estimated to be $425 million, while $75 million of it consists of her investments. According to Financial Times, most of her investments are UK equities, art, property, UK bonds and sterling bills.

Image source: (Financial Times, 2015)

As you can see from the graph above, the returns on investments have increased over the years since 1952 up to today. The highest return from the investments is the UK equities, followed by art, property and others. 

I am impressed with how artworks can have such big returns on investment. As much as I know from the graph, it is seen as one of the best assets over the years (even bigger return than property). Financial Times states that it is making 3% a year above inflation, which means it has resulted in good amount of profit. It is also said that the price of art at London sales has risen. It proves to be quite a good investment. Kudos to the Queen for having artworks as one of her investments and collection. I believe that prices of artworks will continue to rise as they age. As quoted by Telegraph (2015), "the global art market is booming, with last year's sales reaching a record £37bn, a 7pc year-on-year increase and a little above the 2007 high of £35bn, according to the most recent figures from the European Fine Art Foundation (TEFAF)". If i have the money, I would invest in artworks too, as there are chances of getting better returns in the future.

Queen Elizabeth II has also invested in British housing. I truly believe that the price of British (especially London) housing would rise in the future as you can see from the graph below:

Graph showing the prices of London housing property
Source: Telegraph UK 2014

The graph shows that the price of London housing increased sharply since early 2009. The overall price of UK housing is also increasing. Is investing in British housing a good idea? In my opinion, it 'can' be. Few months ago, I have read news regarding the housing crisis of London. London property has been an attraction for foreigners to invest in. London has been suffering from a severe shortage of housing. According to YouGov survey, it is said that almost half of Londoners think wealthy people from overseas buying top-end property as an investment has been the main cause of London house price boom. Therefore, house prices have been rising rapidly over the years. Furthermore, average house prices have rose to over 15 times more than average incomes. This made renting property in London to be very expensive which can result in faster return on investment. Fact: London housing has risen up to 44% over the past seven years (Financial Times, 2015). This happens in other parts of Britain as well. Yes, I can't deny the fact that there might be risks in investing such big sum of money on housing. Who knows house prices are gonna fall late this year or next year? We can't be 100% optimistic about it. 

When it comes to investments, we would picture them going up and up. Of course I wouldn't invest if I believed that I was going to lose money, but a degree of realism is useful. We need an appreciation of the risk involved. Although history might show rises over the long term investment, however we have to be prepared that it may go down the next day/ month/ year. Potential growth is not the same as promised growth. With the credit crunch crisis on 2008, Queen Elizabeth has also lost an amount of money. There is never a guarantee of positive returns on investment. 

Everything sums up to a question: is portfolio investment a good idea? Well, it really depends. But if you ask me, I would be more on the 'yes' side. I believe the theory about don't put all eggs in just a basket. With more investments, the lower the risk of you losing everything. There is at least some backups if one or two of them has gone bad. Personally, I think it would be more reasonable to invest in projects with lower risk even if it means there will be lower returns. Also, the investments that I am going to make, I would make sure they are not co-related to each other to avoid risks of losing more.How people invest depends on what kind of risk taker they are. Therefore, there is no real answer to that question. 

Sources:

http://www.ft.com/cms/s/0/1c728c46-5634-11e5-9846-de406ccb37f2.html#axzz42iBIGV6G

http://www.telegraph.co.uk/news/uknews/theroyalfamily/3386353/The-Queen-asks-why-no-one-saw-the-credit-crunch-coming.html

http://www.bloomberg.com/news/articles/2015-09-08/the-longer-she-reigns-the-less-wealthy-queen-elizabeth-ii-looks

http://www.theguardian.com/society/2015/mar/14/britain-housing-crisis-10-ways-solve-rowan-moore-general-election

http://www.ft.com/cms/s/2/8ef50668-63b3-11e5-9846-de406ccb37f2.html#axzz42iBIGV6G

http://www.telegraph.co.uk/finance/personalfinance/investing/11519612/Beware-the-risks-before-investing-in-the-booming-art-market.html

Digby Jones on Hereford Furniture

Furniture is an absolute necessity in this society. Every home needs furniture. There are several types of furniture with different designs to match the wants of different types of consumers. Hereford Furniture, a family owned business with over 40 employees, was making a loss of £80,000 the past year, therefore, the hero, Sir Digby Jones helps them by identifying the problems they have. "His mission is to turn survival into success and secure the future of the workforce" (BoB National).

Hereford Furniture's focus

After watching the video of Digby Jones: The New Troubleshooter episode 1, I realised that it is very important for businesses to put their focus on a particular area rather than having all at once. As for this case, having to manufacture, retail and import are the three main things that Hereford Furniture is focusing on, which is quite a lot and the focus can be diversified. Furthermore, they were producing up to 15,000 pieces of furniture with different designs, colours and shapes in a year. With the number of employees, it is really difficult for them to handle when they are also not expertise in every area. Therefore, according to Digby, it is best for Hereford Furniture to focus on one area with the most knowledge to increase the chance of being successful.

Hereford Furniture's communication

Communication is one of the keys to success. During the interview of Mike Muxworthy, the owner of Hereford Furniture, and the employees, Digby Jones found out that they have poor communication and that the employees' relationship with Muxworthy was not adequate. Without effective communication, the level of productivity will decrease. This is one of the issues that Hereford Furniture has to work on.

Rebranding Hereford Furniture

Another problem that Sir Digby Jones addresses is the name of the brand. They have changed their company's name to 'Hygge', which changes the whole feeling and meaning of the company. The name stands for warm, big home and love. It is also a very unique and catchy word, which can be easily remembered. By having a special and meaningful name, it can totally change the outlook of the company. They also came up with a logo for their product. It is an effective way to promote their product and to create brand awareness.

With the case, Sir Digby Jones has successfully changed the nature of the company and helped them to become more successful by lending a hand that they needed.