Sweet (Earnings Expectations) Dreams Are Made Of This

ConvergEx's monthly review of analysts' revenue expectations for the 30 companies in the Dow finds a ray of sunshine (let's call them 'sweet dreams') to counter the current humdrum market action. First, the 'good' news: analysts expect the current quarter to post some of the best top line growth in over 2 years. The 'meh' news: that’s still only a 2.5% comp to last year, and 2.9% excluding financials.  Still, that is better than the 0.3-0.5% growth of Q1 2014.  That acceleration, such as it is, continues into Q3 2014, where analysts have revenue growth pegged at 3.9%.  The 'bad' news: brokerage analysts have been spectacularly wrong in forecasting revenues of late. In Q1 2014 the Street expected 4-5% growth in May of last year, only to whittle those numbers down month after month and still prove too optimistic on earnings day. Still, things might work out this time and Q2 will actually see a rebound. At current valuation levels, the bulls better hope they do.

Via ConvergEx's Nick Colas,

There is an old joke on Wall Street: “What’s the difference between a bond and a bond trader?”  The answer: “Bonds mature.”  Yes, the fixed income group in a given brokerage firm or money manager may house more bon vivants than Soho House during NY Fashion Week, but scratch a bond guy/gal and you’ll quickly find the pessimist lurking within. That’s because this group knows that over the long run the best they can do is get their money back from a bond, plus interest.  Their upside is the issuer just keeps their promise.  Your downside is they don’t.  The chance for a surprise windfall is zero.

The real optimists of Wall Street sit on the equity desk.  They may play the bear from time to time, just to show they can.  But stock investing is ultimately about how things can go right in pleasant and unexpected ways.  The core argument for owning equities always ends with “And they lived happily ever after.”  Even the turmoil of the last 20 years hasn’t shifted that foundation.  Over the very long term, equities beat other asset classes because you are long human innovation when you own a portfolio of stocks.  And there’s no more optimistic perspective than believing in your fellow man and woman to deliver the goods and generate positive returns on society’s capital.

Silver screen vixen Mae West was famous for saying “Too much of a good thing can be wonderful”, but she probably never ran across a bulled up Wall Street stock analyst.  And if she did, they probably didn’t talk stocks.  Over the last few years we’ve been tracking this group’s expectations for revenue growth at the 30 companies of the Dow Jones Industrial Average.  The original idea here was to follow the nascent global economic recovery as it filtered through corporate financial results in the period after the Financial Crisis.  That story played out pretty well in 2009 and 2010, as revenue growth ran a healthy 10-15% year over year.  It was a happy, sunny, simple time.

Since then, however, the storyline has shifted to a darker tone where optimism is a great travelling companion but it can’t read a map or figure out the rental car radio.  We can summarize this transition by looking at the recently completed and reported Q1 2014:

In May of last year, the Wall Street brokerage analysts that cover the Dow stocks were very optimistic on Q1’s top line growth.  Their consensus perspective was that 4-5% year over year growth was achievable.

 

In the following months, they gradually lost their courage.  In April 2014, with these companies about to report, their collective wisdom held that revenue growth would average 1%.

 

They still missed the mark; average revenue growth came in at 0.3% for the Dow names, and 0.5% for the non-financial names.  On the bright side, at least it wasn’t negative, as it has been off and on since 2012.

In short, optimism certainly has a place in equities, as I have described.  But since the end of the snap-back in corporate revenues in 2010, we have seen nothing but the same pattern noted in the points about Q1.  Analysts start out with high numbers and slowly reduce them to something more realistic as the day of reckoning arrives.  Another old Wall Street aphorism: “Never hire analysts. In a bull market you don’t need them, and in a bear market they’ll kill you.”

Which brings us to the current day.  U.S. equities are still up on the year (at least large cap stocks, anyway).  First quarter GDP was just as dismal as first quarter Dow stock revenue gains.  And the map light of optimism over future quarters still shines reasonably bright on domestic equities.  We can see this in the analysts’ revenue expectations for Q2 and Q3 2014 (see associated tables and charts immediately after this note):

The current consensus for Q2 top line growth is 2.5%, and 2.9% once you exclude the financial names in the Dow.  Despite a no-growth Q1, Street analysts have not really pared their Q2 revenue expectations since late last year.   The ex-financials estimate of 2.9% is actually an uptick – the first since last October.  Analysts clearly believe in the weather-related weakness explanation for sloppy Q1 sales.  The sun will (hopefully) come out tomorrow.  Bet your bottom dollar…

 

Analysts have also grown bolder about their Q3 expectations, which are now up to 3.9% as an average comp for the Dow 30 companies to last year.  This reverses a slow grind lower, which started at a 5% comp expectation in November 2013 and ended at a 3.6% expected improvement in top line growth last month.
 
It is still a little early to handicap Q4’s trends, but analysts are out with a 3.0% revenue comparison to last year’s fourth quarter.  Not much change over the last three months here.

Make no mistake – this is the single most important factor to consider when pondering the fundamental direction of U.S. stocks over the remainder of the year.  That’s because revenue growth fulfills the reason equities are worth owning.  Better sales drive better earnings and better returns on capital.  Should you own stocks here because analysts are optimistic about the balance of the year?  No.  The track record here is spotty at best.

The logic, however, that guides analysts to forecast a better Q2 and second half of 2014 is very much the same as that which defines the future direction of stock prices.  Without sales growth, equities just keep earning the same basic returns as they have in recent years.   What do you call a security where the cash flows are fixed?  Yes, a bond.  Only it is a bond that never matures.  And you probably don’t want that.




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Spot Japan’s “Cash-For-Machine-Clunkers” Pre-Tax Boost

Given the total and utter lack of response from USDJPY, it should be clear that the exuberance that will be expounded tomorrow regarding Japan’s Machine Orders 19.1% MoM jump (more than tripling expectations) should be taken with the proverbial Keynesian drag-demand-forward pinch of salt. This is the biggest monthly jump in machine orders in 18 years as non-ferrous metals manufacturing jumped an impressive 270%.

 

 

Of course, as we have seen throughout Japan’s checkered lost decades, this is entirely unsustainable as, while extrapolators will be quick to point out how this proves Abenomics is working (while bulls will demand moar QQE even though this impressive number should shun the BoJ for one more month at least) – as they say in porn business, what goes up, must come down and we suspect April will be an uncomfortable month for Japanese machine orders.




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Of Gold & Geopolitics

Submitted by Dan Popescu via GoldBroker.com,

“Gold is the sovereign of all sovereigns” Democritus

They say that gold is a geopolitical metal. Gold is real money with no counterparty risk and, furthermore, an excellent wealth preserver in time and space. Like fiat currencies (dollar, euro, yen, Yuan etc.), gold’s price is also influenced by political events, especially those having an international impact. Alan Greenspan, ex-chairman of the Federal Reserve, said that gold is money “in extremis”. This is why gold is part of most central banks’ reserves. It is the only reserve that is not debt and that cannot be devalued by inflation, contrary to fiat currencies.

Observe in chart #1 that central banks own 30,500 tonnes of gold, or 19% of above ground gold. However, this number is an underestimation, because several countries (e.g. China, Saudi Arabia) report only a portion or none at all of their gold holdings. In addition, if they do, they do not do it in a timely manner.

 

Global Gold Stock

 

I think that the official amount of gold held by some countries (through different institutions) is rather close to 40,000 tonnes. Even if this gold represents only 20% to 25% of the total gold stock, it can be quickly brought to market and in sufficient quantities to have an impact on the market price. The annual gold market is only 4,477 tonnes per year; it is thus easy for United States or the European Union to influence gold’s price, since they own respectively 8,333 and 10,779 tonnes of gold.

Currencies mirror the health of the countries issuing them. When a country manages its economy well and offers a good social and political environment, demand for its currency increases and, thus, it appreciates, whereas the opposite happens when the economy and politics of the country are poorly managed. The fiat currency is the image of the country and its value only depends on the trust people have in its economy. When the international monetary system is on the brink of collapse because of an exorbitant global debt, there is a flux taking place toward real assets (land, buildings, jewelry, gold, silver etc.). Gold is real money, contrary to the different countries’ currencies, which are fiat money and can be devalued by monetisation of the debt.

Since the beginning of history, gold has taken center stage in geopolitics. History tells us that the Roman Empire invaded Dacia (Romania today) at the start of the 2nd century B.C. to take control of the rich gold mines of the Carpathians. The Empire had depleted all of its gold mines and its expenses were growing rapidly. The roman economy was based on war and those wars were costing more and more gold while they would bring in less and less. By that time, the Romans had taken a liking for luxury items that they did not produce themselves, like fine silk from China, pearls from the Persian Gulf, perfumes from India, ivory from Africa, etc. Roman gold was being used for those purchases and a lot of it was needed. Later, in the 1500s, the quest for gold became the objective of the conquest of the Americas after the return of Christopher Columbus who had discovered the Aztec and Inca gold. During the Second World War, Hitler put together a team with the mission of getting hold of the gold and other treasures of the conquered nations. Nazi Germany used all of its available resources to win the war, and gold was an important weapon in Hitler’s economic arsenal (gold stolen from occupied countries’ central banks between 1939 and 1942). It is interesting to note that private ownership of gold was forbidden, by left or right leaders, totalitarian or democrats, from Lenin in Russia, Hitler in Germany, Mussolini in Italy, Mao in China to Roosevelt in the United States.

In 1944, at the Bretton Woods Conference, the United States took advantage of the great weakness of world after the Second War and imposed a monetary system based on the dollar, but backed by gold. Following a crisis opposing the United States and Europe, but mainly France, gold backing of the dollar was abandoned in 1971. Deficits and debts brought about by less productivity and some costly wars (Korea, Vietnam) started to weigh heavily on the dollar. The US dollar has become, since 1971, the international monetary standard, without any gold backing. However, gold has remained the “de facto” standard lurking in the shadows, should a major monetary crisis occur, watching for the first mistake to regain its center role. Many countries, like Canada, sold all their gold in the 90’s but, in general, the official holdings, as can be seen in chart #1, have barely diminished.

A new era started in the 90’s with the end of the Cold War and, thus, the beginning of a world disarmament. An era of peace and prosperity seemed to have started under the almost absolute dominance of the United States. During this optimistic period, gold fell from $850 to $250 an ounce. This period was short lived, because the September 11 terrorist attack in New York, the war in Afghanistan, the invasion of Iraq, the 2008 financial crisis and, recently, the annexation of Crimea by Russia have changed all that.

During the 2008 crisis – that almost succeeded in bringing down the current international monetary system – gold made a stunning comeback into the system. During the crisis, gold became the only accepted guarantee in order to get liquidity. What was significant was that after having been ignored for decades, gold was coming back into the international monetary system via settlements of the Bank for International Settlements (BIS). These transactions themselves confirm that gold was coming back into the system. They revealed the poor state of the financial system before the crisis and showed how gold has indirectly been mobilized to support the commercial banks. Gold’s old emergency usefulness has resurfaced, albeit behind closed doors at BIS in Basel, Switzerland.

Starting in 2008, we can also observe that western central banks stopped selling gold and that emerging countries’ central banks accelerated their gold buying. The extreme indebtedness of Western countries coupled with a rebirth of the emerging markets economies have destabilized even more an international monetary system based on an already much weakened US dollar.

 

Global Gold Reserves vs Global Gold Production

 

A confidence crisis has also reappeared between countries, especially between emerging countries and the United States. We are in a transition period in geopolitics and we are witnessing an economic shift and transfer of wealth from West to East. The new wealth owners are also asking for accrued political power internationally, in all the institutions where the European Union and the United States have a dominant position.

In order to protect the actual monetary system based on the dollar and that gives it exorbitant privileges, the United States manipulates the gold price, the only possible alternative if the dollar were to be replaced (or a SDR baked by gold). The United States is also trying to discourage countries and individuals to sell the dollar by way of negative public statements, but also by selling short on futures’ markets. Let us not forget that 40% to 60% of the US dollars circulate outside the United States. For the same reason, emerging countries are worried, and rightly so, that their reserves, mainly in dollars, will be confiscated by way of devaluation of the dollar. It is also possible that their gold reserves stored in the U.S. will be confiscated for so-called “force majeure” political reasons, in the interest of the “nation”.

Gold is money “in extremis”, and this is why it should not be stored out of the country. Only exception being an exceptional situation like a war, and only for a short time. I think that the only motivation countries had to store their gold in New York was greed through the possibility to speculate on gold at the risk of losing this “in extremis” reserve. Actually, this is what happened to Portugal; during the 2008 crisis and the Lehman Brothers’ default, the country lost its gold it had lent out. In times of crises or wars, it is very important not only to have legal ownership but also physical possession of the gold. Geopolitical alliances may change at any time and access to this “in extremis” money could be restrained or even refused.

In the current geopolitical framework that Ian Bremmer has so well called G0 (no country dominates; each one has advantage but also disadvantages), an international power struggle is occurring between the United States, the European Union, Russia and China. In this new Cold War, albeit in a G0 environment rather than in a G2 (United States and Soviet Union), where the European Union is not really allied with the United States and where China is not really allied with Russia, uncertainty prevails. In addition, other actors may influence this new Cold War that just got started since the annexation of Crimea by Russia. In a previous article on the gold wars, I mentioned the role of accelerator, agitator or troublemaker that third parties like Russia or Saudi Arabia could play. That is what happened with Russia, in Crimea, one month later. There is a war on the price of gold led by western countries, but there is also a war for gold ownership between all the countries; eastern countries being the ones that wish to exchange their dollar reserves for gold and as fast as possible.

In this new Cold War, which also includes a currency war, the role of gold has become central in the international political strategies of all countries involved. During this period of major risks and uncertainty, and until the return of a new geopolitical, economic and monetary order, gold will shine. Gold is money “in extremis” and is the only real money without any counterparty risk. This is why gold is considered, and rightly so, a geopolitical metal.

 

Official Gold Reserves in Tonnes – Developed Countries vs Emerging Countries

 

Official Gold Reserves as a Percentage of Total Foreign Currency Reserves

 

Official Gold Reserves as a Percentage of GDP – Developed Countries vs Emerging Countries

 

Public Debt as a Percentage of GDP – Developed Countries vs Emerging Countries




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What Q2 GDP Weakness Will Be Blamed On

As we entered Q1 2014, hope was high that this was it – this was the quarter when, with stocks at record higs, employment data improving and a confident Fed tapering, the US economy would reach escape velocity and back we could all go to “believing” in the futures once again. The 2.6% growth expected at the start of Q1 quickly evaporated into a -0.5% contraction in the economy due to “cold” weather in the winter. Of course, the Keynesian-hockey-stick believers have marked up their “been-down-so-long-it’s-gotta-bounce-back” Q2 expectations to 3.3% growth… so what could go wrong. One glimpse at the following chart will explain it all – and it’s the weather that will be blamed once again…(with 48% of the nation now in drought conditions).

 

“Just Too Cold” Weather knocked 3 percentage points of growth off the world’s largest economy…

 

Just how much will the most widespread drought in a century knock off the 3.3% hope for Q2?

 

with 48% of the nation abnormally dry and almost 15% in extreme drought…

 

We suspect phrases such as “it was just too hot to shop” or “due to unseasonably hot weather, sales of XXXXXXXXXXXXXXXXX were dramatically affected” will be prevalent in Q2 earnings calls…




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Ron Paul Explains Why “They” Hate Peace

Submitted by Ron Paul via The Ludwig von Mises Institute,

The most succinct statement about how governments get their people to support war came from Hermann Goering at the Nuremberg trials after World War II:

Why of course the people don’t want war. Why should some poor slob on a farm want to risk his life in a war when the best he can get out of it is to come back to his farm in one piece? Naturally, the common people don’t want war; neither in Russia, nor in England, nor for that matter in Germany. That is understood. But, after all, it is the leaders of the country who determine the policy and it is always a simple matter to drag the people along, whether it is a democracy, or a fascist dictatorship, or a parliament, or a communist dictatorship. Voice or no voice, the people can always be brought to the bidding of the leaders. All you have to do is tell them they are being attacked, and denounce the peacemakers for lack of patriotism and exposing the country to danger. It works the same in any country.

It is rather frightening that a convicted Nazi war criminal latched onto an eternal truth!

It should be harder to promote war, especially when there are so many regrets in the end. In the last 60 years, the American people have had little say over decisions to wage war. We have allowed a succession of presidents and the United Nations to decide when and if we go to war, without an express congressional declaration as the Constitution mandates.

Since 1945, our country has been involved in over 70 active or covert foreign engagements. On numerous occasions we have provided weapons and funds to both sides in a conflict. It is not unusual for our so-called allies to turn on us and use these weapons against American troops. In recent decades we have been both allies and enemies of Saddam Hussein, Osama bin Laden, and the Islamists in Iran. And where has it gotten us? The endless costs resulting from our foolish policies, in human lives, injuries, tax dollars, inflation, and deficits, will burden generations to come. For civilization to advance, we must reduce the number of wars fought. Two conditions must be met if we hope to achieve this.

First, all military (and covert paramilitary) personnel worldwide must refuse to initiate offensive wars beyond their borders. This must become a matter of personal honor for every individual. Switzerland is an example of a nation that stands strongly prepared to defend herself, yet refuses to send troops abroad looking for trouble.

Second, the true nature of war must be laid bare, and the glorification must end. Instead of promoting war heroes with parades and medals for wars not fought in the true defense of our country, we should more honestly contemplate the real results of war: death, destruction, horrible wounds, civilian casualties, economic costs, and the loss of liberty at home.

The neoconservative belief that war is inherently patriotic, beneficial, manly, and necessary for human progress must be debunked. These war promoters never send themselves or their own children off to fight.

Some believe economic sanctions and blockades are acceptable alternatives to invasion and occupation. But these too are acts of war, and those on the receiving end rarely capitulate to the pressure. More likely they remain bitter enemies, and resort to terrorism when unable to confront us in a conventional military fashion.

Inflation, sanctions, and military threats all distort international trade and hurt average people in all countries involved, while usually not really hurting the targeted dictators themselves. Our bellicose approach encourages protectionism, authoritarianism, militant nationalism, and go-it-alone isolationism. Our government preaches free trade and commerce, yet condemns those who want any restraints on the use of our military worldwide. We refuse to see how isolated we have become. Our loyal allies are few, and while the UN does our bidding only when we buy the votes we need, our enemies multiply. A billion Muslims around the world now see the US as a pariah.

Our military is more often used to protect private capital overseas, such as oil and natural resources, than it is to protect our own borders. Protecting ourselves from real outside threats is no longer the focus of defense policy, as globalists become more influential inside and outside our government.

The weapons industry never actually advocates killing to enhance its profits, but a policy of endless war and eternal enemies benefits it greatly. Some advocate cold war strategies, like those used against the Soviets, against the unnamed “terrorists.” It’s good for business!

Many neoconservatives are not bashful about this:

Thus, paradoxically, peace increases our peril, by making discipline less urgent, encouraging some of our worst instincts, and depriving us of some of our best leaders. The great Prussian general Helmuth von Moltke knew whereof he spoke when he wrote a friend, “Everlasting peace is a dream, not even a pleasant one; war is a necessary part of God’s arrangement of the world. … Without war the world would deteriorate into materialism.” As usual, Machiavelli dots his i’s and crosses the t’s: it’s not just that peace undermines discipline and thereby gives the destructive vices greater sway. If we actually achieved peace, “Indolence would either make (the state) effeminate or shatter her unity; and two things together, or each by itself, would be the cause of her ruin …” This is Machiavelli’s variation on a theme by Mitterrand: the absence of movement is the beginning of defeat. (Michael Ledeen, Machiavelli on Modern Leadership)

Those like Ledeen who approvingly believe in “perpetual struggle” generally are globalists, uninterested in national sovereignty and borders. True national defense is of little concern to them. That’s why military bases are closed in the United States regardless of their strategic value, while several new bases are built in the Persian Gulf, even though they provoke our enemies to declare jihad against us. The new Cold War justifies everything.

War, and the threat of war, are big government’s best friend. Liberals support big government social programs, and conservatives support big government war policies, thus satisfying two major special interest groups. And when push comes to shove, the two groups cooperate and support big government across the board — always at the expense of personal liberty. Both sides pay lip service to freedom, but neither stands against the welfare/warfare state and its promises of unlimited entitlements and endless war.




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Take A Dive In The “Dash For Trash” Waterfall With Goldman Sachs

As we have discussed numerous times, the dash-for-trash in US equities has been insatiable as any and every consequence of screwing up is slowly removed from capitalism (and capital markets). As Goldman's David Kostin notes, companies with weak balance sheets have outperformed peers with strong balance sheets by 49 percentage points during the past two years (89% vs. 40%) with realized volatility of just 7%.

 

 

Although the trend is daunting – to say the least – Goldman believes it will continue for three reasons

(1) our economic outlook calls for strengthening growth and modest inflation;

 

(2) corporate leverage remains low; and

 

(3) the current outperformance is consistent with past episodes of leadership by weak balance sheet companies.

 

However, all 3 of these reasons are entirely ridiculous…

(1) Goldman itself has been dramatically downgrading its GDP expectations over the past few weeks and consensus for the year is also fading…

 

 

(2) Corporate leverage is at record highs and credit spreads are well off cycle tights…

US companies are carrying far more net debt than in 2007

 

Another curiosity is this notion that US companies have substantially reduced their debt pile and are therefore cash rich. The latter is indeed true. Cash and equivalents are at historically high levels, but rarely do those who mention the mountains of corporate cash also discuss the massive increase in debt seen over the last couple of years.

 


 

In fact, debt levels have been growing to such an extent that net debt (i.e. excluding the massive cash pile) is 15% higher than it was prior to the financial crisis.

And Credit spreads are not exactly supportive of equity risk right now…

 

We have seen this "credit cycle end, equities ramp" before – in 2007 – where leverage (both firm-wise (debt/EBITDA) and instrument-wise (CDOs)) provided the extra oomph to send stocks higher on the back of credit fueled extrapolation of earnings trends.

 

(charts: Barclays)

 

In the end we know this is unsustainable – the question is when (in 2007 it lasted 10 months or so…).

 

Of course, just as in 2007, things change very quickly once collateral chains start to shrink.

 

Perhaps this is why Carl iCahn called the top – because he knows the ability to re-leverage (his bread and butter trade) is over…

(3) This is the 5th longest busiuness cycle on record!!

The curveball for 2014 – A US recession

 

One topic no-one is really discussing is a US recession in 2014. We should start to at least consider the risk given the maturity of this cycle. By the end of May 2014 this expansion will be 59 months old which is longer than the average of 39 months (median 30) since data started to be compiled on US business cycles in 1854. The average in the 100 years since the Fed was formed in 1913 is 50 months (median 42). This cycle is now the sixth-longest of the 34 cycles since 1854. Economists will explain that recessions don’t die of old age but because of imbalances that they might argue are not yet present. However consensus never forecasts a recession in advance so one has to find other ways to help us identify the end of the cycle. Across most other regions, business cycles have shortened post the GFC with many economies experiencing a dip into negative territory again sometime between 2011 and 2013 after the recovery in 2009 and 2010. A lack of policy flexibility (fiscal and monetary) post crisis is our main explanation. The US has just about escaped this due to extraordinary monetary and fiscal stimulus. However with both likely on the retreat at the same time in 2014 it’s prudent to acknowledge the already mature length of this cycle.

 

 

So the most obvious driver of financial markets in 2014 does seem likely to be how the Fed, the global economy and the market manage to handle the question of the QE taper. Whether the ECB need to implement negative deposit rates or introduce QE will also be a big driver. However experience teaches us that it’s not usually the obvious theme that ends up dominating in the following 12 months.

So apart from all 3 of the reasons for a continued dash-for-trash outperformance being rubbish – we can only imagine Goldman telling its clients to take a dive in the dash-for-trash waterfall is designed to help Goldman build a "strong balance sheet" company position…




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Nick Gillespie on How to Make Obamacare Less Totally Awful

Last month, even as President
Obama touted the “8 million people” who signed up for individual
coverage under the Affordable Care Act, he granted that
the program was far from perfect—or even complete. “There are going
to be things that need to be improved,” he told the press,
insisting that there wouldn’t be “any hesitation on our part to
consider ideas that would actually improve the legislation.”

“OK then,” writes Nick Gillespie. “Even though I think Obamacare
is a truly epic mistake (more on that later), here are three
obvious ways to make the president’s signature legislative
achievement better, cheaper, and more cost-effective.

View this article.

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AT&T Buys DirecTV In $67 Billion Deal; Pfizer Makes “Final Proposal” To Buy AstraZeneca, Boosts Offer By 15%

In what is setting up to be a scorching merger Monday, moments ago we got confirmation of news that had been leaked days in advance, namely that both the boards of AT&T and DirecTV had agreed to a transaction whereby AT&T would buy DirecTV in the latest chapter of what we dubbed several months ago the “M&A bubble”, for $95/share in a $67.1 billion transaction including debt, consisting of $95/share in stock, $28.50/share in cash. According to the public announcement, the DirecTV purchase represents a 7.7x multiple of its 2014E EBITDA.

The terms of the transaction from the press release:

DIRECTV shareholders will receive $95.00 per share under the terms of the merger, comprised of $28.50 per share in cash and $66.50 per share in AT&T stock. The stock portion will be subject to a collar such that DIRECTV shareholders will receive 1.905 AT&T shares if AT&T stock price is below $34.90 at closing and 1.724 AT&T shares if AT&T stock price is above $38.58 at closing. If AT&T stock price at closing is between $34.90 and $38.58, DIRECTV shareholders will receive a number of shares between 1.724 and 1.905, equal to $66.50 in value.

 

This purchase price implies a total equity value of $48.5 billion and a total transaction value of $67.1 billion, including DIRECTV’s net debt. This transaction implies an adjusted enterprise value multiple of 7.7 times DIRECTV’s 2014 estimated EBITDA. Post-transaction, DIRECTV shareholders will own between 14.5% and 15.8% of AT&T shares on a fully-diluted basis based on the number of AT&T shares outstanding today.

 

AT&T intends to finance the cash portion of the transaction through a combination of cash on hand, sale of non-core assets, committed financing facilities and opportunistic debt market transactions.

 

To facilitate the regulatory approval process in Latin America, AT&T intends to divest its interest in América Móvil. This includes 73 million publicly listed L shares and all of its AA shares. AT&T’s designees to the América Móvil Board of Directors will tender their resignations immediately to avoid even the appearance of any conflict.

Additionally, as the press release states, “AT&T expects the deal to be accretive on a free cash flow per share and adjusted EPS basis within the first 12 months after closing.”

The combination provides significant opportunities for operating efficiencies. AT&T expects cost synergies to exceed $1.6 billion on an annual run rate basis by year three after closing. The expected synergies are primarily driven by increased scale in video.

Where will the upside come from:

The combination diversifies AT&T’s revenue mix and provides numerous growth opportunities as it dramatically increases video revenues, accelerates broadband growth and significantly expands revenues from outside the United States. Given the structure of this transaction, which includes AT&T stock consideration as part of the deal and the monetization of non-core assets, AT&T expects to continue to maintain the strongest balance sheet in the industry following the transaction close.

 

AT&T’s 2014 guidance for the company remains largely unchanged. However, the company’s intention is to divest its interest in América Móvil, which will result in an approximately $0.05 reduction in EPS, as the América Móvil investment will no longer be accounted for under the equity method. Adjusted 2014 EPS growth is now expected to come in at the low-end of the company’s mid-single digit guidance.

As always, there is risk the FCC will nix the transaction which forms a telecom behemoth with over $100 billion in combined debt:

The merger is subject to approval by DIRECTV shareholders and review by the U.S. Federal Communications Commission, U.S. Department of Justice, a few U.S. states and some Latin American countries. The transaction is expected to close within approximately 12 months.

* * *

Almost concurrently with the AT&T announcement, Pfizer also did what many expected it to do, when it announced that as part of its “final offer” it would boost its proposed purchase price for AstraZeneca by 15%, representing a total transaction value well north of $115 billion. From the press release:

  • AstraZeneca shareholders would receive, for each AstraZeneca share, 1.747 shares in the combined entity and 2,476 pence in cash, representing an indicative value of £55.00
  • Substantial increase of approximately 15% over the current value of Pfizer’s 2 May proposal
  • Cash consideration increased by £8.78 per AstraZeneca share, or approximately £11.3 billion ($19.0 billion)
  • Cash component increased as a proportion of the total consideration from approximately 33% to 45%
  • Pfizer calls on supportive AstraZeneca shareholders to urge the AstraZeneca board to begin substantive engagement with Pfizer and extend the period for such talks prior to the 26 May deadline for making an offer

Most importantly:

  • Pfizer will not make a hostile offer directly to AstraZeneca shareholders and will only proceed with an offer with the recommendation of the AstraZeneca board

Indeed, as Bloomberg clarifies, citing the Pfizer CEO, “Following a conversation with AstraZeneca earlier today, we do not believe that the AstraZeneca board is currently prepared to recommend a deal at a reasonable price,” Pfizer CEO Ian Read says in e-mailed statement.

  • Pfizer sent a letter on May 16 to AstraZeneca Chairman Leif Johansson offering GBP53.50/shr, or 1.845 shares in the combined co., 2,157p/AstraZeneca shr
  • AZN said its board thought that proposal “substantially” undervalued co., said it’s not prepared to accept a price close to Pfizer’s £53.50 proposal
  • Pfizer confirms that it won’t make a hostile offer directly to AstraZeneca holders, will only proceed with offer with recommendation of AstraZeneca board

And while Pfizer said the deal expires in 8 days, on May 26, BBC’s Mark Kleiman makes it clear that a deal is hardly assured even despite what appears now to be a 15x purchase multiple:




In any case, as the scramble to take advantage of ever lower rates accelerates (because oddly enough rates are not rising for whatever reason, despite the so-called recovery), even if the AZN deal falls through, expect many more M&A deal to take place in the coming weeks and months as the final traces of the liqidity bubble manifest themselves in an M&A blowoff top now that the buyback frenzy appears to be fading and acquisitions are the last bastion before companies finally have to allocate capital to that one most hated of activities, if only by shareholder activists, capex.




via Zero Hedge http://ift.tt/1jt4v1X Tyler Durden