MARCH 2013
BITTER IN BRITAIN
By Matt Evans
MARCH 2013
in his speeches that more easing is on its way, but the international community is increasingly worried about whether he will indeed carry out his promises. In the G20 meeting this past week, global financial leaders committed themselves to preventing currency manipulation, but the body has very little power over the monetary policies of individual countries. Abe has recently said that he was not planning an expansion of his program and that the G20 should not be as critical as they are of his program, as his goal is not to artificially devalue his currency. There is truth to this argument, since Quantitate Easings main objective is to push down interest rates, and the eventual devaluation of the Yen is just a collateral effect of this measure. It has, however, given a strong incentive for central banks throughout the world to adopt these policies, as their short term results are anything if not desirable. In a recent Board of Governors meeting in the UK, the measure was proposed, but voted down by its members. However, the simple suggestion of it is a good indication that more discussion is on its way. With that being said, Europe looks as a likely target if not for QE-like monetary policies, then for some form of currency manipulation. Following the rebound from the economic crisis that has been plaguing European debt markets for over two years, the Monetary Union has seen renewed demand for its currency, with the Euro undergoing strong revaluation since January. Given the very delicate situation of several of its economies, and the peripheral European economies strong reliance on export based industries to even attempt an economic rebound, the European Central bank finds itself in a delicate situation regarding monetary policy. The ECB will be meeting on the 7th of March to discuss this, and lowering the value of the Euro will definitely be one of the topics on the table garnering attention from the Governors. Just when we though the Currency Wars had subsided, the issue comes rushing back into the economic spotlight. With new rounds of QE around the world, China still being accused of blatant currency devaluation and the emerging economies being forced to take measures to protect their currencies, the FX markets are undoubtedly going to the center stage of future monetary policy.
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MARCH 2013
Company Background Ituran Location and Control is an Israeli-based company that provides a variety of location-based products and services using their advanced tracking technologies. The majority of their revenues come from their stolen vehicle recovery (SVR) services, and other businesses include their fleet management services, personal location services, concierge services, and GPS/radio-frequency products. Much of Iturans SVR and automatic vehicle location (AVL) sales go to insurance companies that encourage or require customers to subscribe to AVL services or purchase vehicle location products in order to decrease their own costs of business. The company has 653,000 total subscribers at the end of Q3 2012, including a net subscriber growth of 14,000, the highest net growth in ten quarters. Excluding currency effects and a onetime gain relating to a sale of a segment last year, operating profit grew nearly 15% year-over-year. Geographically, the company operates a monopoly in Israel where they earn roughly 50% of their revenues, and they are developing an increasing presence in Brazil where they earn roughly 40% of their revenues. This thesis focuses on the growth of Iturans Brazil businesses, especially in light of Contran Law No. 245. Car Theft in Brazil Brazil has one of the worlds highest passenger theft rates at nearly 100 per 10,000 cars. Annual statistics show that more 400,000 vehicles are stolen annually, or roughly one every 78 seconds. Thieves steal cars for parts disassembly, whole-car cash sales, and use in organized crime. Together, this has amounted to $8 billion in annual losses due to vehicle theft and another $1 billion from stolen cargo. Immobilizers have been become a very effective means of preventing theft, but lately car thieves have opted towards carjacking instead. As a result, car insurance plans that provide theft coverage can be prohibitively expensive for individuals given the higher likelihood that insurance companies would payout. Nevertheless, auto sales in Brazil have increased every year since 2002 and have more than doubled since 2007 to 3.8 million last year, implying that the fast developing Brazilian economy and its consumer base have not let the high rate of asset loss deter them from obtaining the classic prestige symbols that cars represent. Contran Law No. 245 In response to the evolving strategy of car thieves, the Brazilian government has opted to focus on stolen vehicle detection
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MARCH 2013
draw negative attention until it was too late. The fallout from this incident has been monumental. Federal scrutiny with several investigations has been occurring over the past year. JP Morgan has been busy repairing its image, ousting several key players and executives, including Iksil, Martin-Artajo, and Chief Investment Officer Ina Drew. The board doled out many pay cuts, and Dimons compensation was slashed by 50% from the previous year for 2012 from roughly $23 million to $11.5 million. Finally, it launched its own internal investigation headed by Chief Financial Officer Mike Cavanagh. This investigation, after extensively reviewing records such as over one million e-mails, resulted in a 50-page report recently released to the public, citing lax supervision and risk control as primary reasons for the debacle. Steps have been taken to reduce the likelihood of similar future incidents, such as stricter risk measures and more narrow valuation range requirements. JP Morgan, despite this highly publicized trading loss, has churned out strong performance, with record profits for three consecutive years. Perhaps the true area of concern should not lie with JP Morgan, but with the government. Despite recent regulations in response to the global financial meltdown, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010, it appears that there are still weaknesses in the system and potential disasters like the one JP Morgan experienced looming in the future; perhaps an effective solution will require greater risk control mechanisms for Wall Street to prevent another London Whale incident in the near future.
TEMPEST IN A TEAPOT
By Karan Parekh
In May 2012, the tempest in a teapot that JP Morgan CEO Jamie Dimon described took Wall Street by storm. With an estimated $6 billion lost, JP Morgan was forced to reshuffle management positions, launch an internal investigation, and repair public image in what otherwise had been a time of recovery. What caused this large loss for JP Morgan? What steps have been taken to correct it? Who is the London Whale. The London Whale, Bruno Iksil, was a credit derivatives trader for JP Morgan in the London office. Iksil had a reputation for riskheavy trades that often ended in large profits for JP Morgan during his history with the company. He was rumored at times to even single-handedly have moved the index with some of his actions. Although Iskil had historically enjoyed consistent success, much of the blame fell on him in this debacle. Iksil engaged in CDSs (Credit Default Swaps), a complex type of insurance that hedges against changes in credit markets or loan defaults. He bet big on a large basket of investment grade credit default swaps known as CDX IG 9 in order to hedge against corporate debt that JP Morgan already had positions in. This was essentially a bet that investment grade bonds would not default. However, JP Morgan then hedged against its own bet, and began taking such large positions that it shifted the market; other investors saw this and, seeing opportunity, they bet against JP Morgan. When European financial worries spiked again, CDX IG 9 rose in value, and JP Morgan lost a great deal of money because of its large positions. Of course, the transactions occurring were complicated in nature. But how could JP Morgan overlook the risks it was taking that amounted to such a large loss? Firstly, Iksils boss, Javier Martin-Artajo, encouraged the transactions and pushed him to persist despite initial losses. Furthermore, Iksil made purchases at high valuations. JP Morgan does have a valuation control group, but the control group checks valuations by setting valuation ranges; if purchases are made in between these ranges, which often were very broad, they do not draw red flags. In this risk management error, Iksil made purchases at the high end of the spectrum, but did not
MUNICIPAL DEBT:
Resilient or Vulnerable?
By Matt Parmett
The safety of municipal debt has been scrutinized as American cities, counties, and states have grappled with budget issues over the past several years. Since 2010, there have been 31 municipal bankruptcy filings, with the most notable filings coming from Jefferson County, Alabama and San Bernardino, California.[1] While some of these bankruptcies have been highly publicized, especially in the context of the European debt crisis, experts disagree on the severity of the threat of widespread municipal bankruptcy. For many local and state governments, default carries serious consequences: aside from bondholders swallowing losses on debt holdings, governments may not be able to fully cover their public expenses. What is a municipal bond? Municipal bonds are issued by governments to raise money for project and public expenses. For example, a city may issue municipal debt to finance the construction of a bridge or sports arena. Debt financing is often used to offset the burden that major projects place on the municipality's taxpayers.
MARCH 2013
Overview This intensive workshop is designed to develop an understanding of merger consequences and leveraged buyout analyses through actual hands-on construction of both an M&A model and an LBO model. Each participant will build their own interactive M&A model and LBO model to better understand the dynamics of merger consequences and leveraged buyout analyses. The completed products allow for a dynamic evaluation of (1) whether or not a company should acquire a competitor or sell itself (merger consequences analysis) and (2) whether or not the company is a strong LBO candidate. Specifically, participants will construct and analyze the following: Merger Consequences Analysis (morning) - Transaction summary detailing sources and uses of funds - Earning impact, including accretion/dilution analysis and synergies analysis - Purchase price allocation Leveraged Buyout Analysis (afternoon) - Transaction summary detailing sources and uses of funds - Pro forma income statement and cash flow schedule - Debt schedule with repayments, pro forma debt balances, iterative interest expense calculations - Returns analysis to the financial sponsor **Credit Suisse will be providing free lunch** Learning Methodology Through practical examples, the lectures will discuss theories, approaches and applications of modeling. Personal one-on-one assistance will be available to answer questions and give guidance while participants are working on computers. Target Audience This intensive one day workshop will benefit students interested in: - Working at a private equity firm or dedicated leveraged buyout firm - Working at an investment bank in their M&A, leveraged finance or financial sponsors group - Working at a venture capital firm or hedge fund potentially making LBO investments - Enhancing the learning experience in finance and transaction analysis NOTE: The workshop will take place in a computer lab. You can use computers in the lab or bring your computer. If you have a MAC, it is recommended you run Windows (via Parallels, VMware or Bootcamp). How to Register Registration Link: http://trainingthestreet.force.com/register; Class code: 4DDD5C Class Details: 9am-5pm on March 23rd (Saturday) at JMHH 375 Cost: $40 About Training the Street Training The Street (TTS) offers state-of-the-art, instructor-led courses in financial modeling and corporate valuation. Founded in 1999, TTS is the worlds leading financial learning services company offering targeted and customized training courses to corporate and academic clients. * Modeling classes are optimized for Office 2010, 2007, 2003 and earlier versions.
MARCH 2013
states, making it hard for governments to raise money and pay off their debts. As a result, governments would have to declare bankruptcy, and debt holders would be forced to take losses on their bond portfolios. In the years since 2010, however, the municipal bond market has not deteriorated with the severity suggested by Whitney's prediction. Bloomberg observed that such a crash is "far from the case. Despite those bankruptcies, and even though fewer muni bonds are now insured than before the financial crisis, investor demand points to unshaken confidence."[4] According to Bloomberg, states have been able to increase tax revenues, decrease the size of their budget gaps, and increase their ability to service debt. Experts also tend to disagree with Whitney's analysis. Alexandra Lebenthal, CEO of well-known municipal bond specialist Lebenthal & Co., observed that in 2012 57% of municipalities are in a more favorable financial position than they were in 2011.[5] To better balance their budgets, state governments have restructured expenses associated with public pension plans. Most importantly, investor demand for municipal bonds has remained strong, and tax-exempt yields have outperformed aftertax yields of comparable corporate bonds. Although investors and analysts have speculated that the municipal bond market would collapse and trigger another financial crisis, pessimistic predictions seemed to rely heavily on the extrapolation of trends observed in Europe during the European debt crisis. Interest rates, investor demand, debt rating upgrades (particularly in California), and a continuous stream of new municipal debt issuances suggests that the public sector debt markets are still strong. A major risk looms, however, as the markets await the increase of interest rates when the Federal Reserve scales back its interest rate intervention through Quantitative Easing.
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Vice President of Financial Analysis
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Managing Editor