Investment Industry – Page 2

CategoryInvestment Industry

Equestrian Polo Designer Fails to Score

The stock price of Ralph Lauren, an upscale apparel company renowned for its Polo brand, has taken a thrashing lately. The stock has declined by about 50% over the past one year because of sluggish demand in the US and a decline in the value of its overseas sales from a strong dollar. In the third quarter of this year, the company reported a colossal 39% drop in earnings.The company also lowered its fiscal 2017 guidance numbers. Investors fear that the company may be at the vortex of a long-term slump.

End of an Era

To energize the polo pony, Mr. Ralph Lauren, the iconic designer-founder of Ralph Lauren and its sole Chief Executive Officer (CEO) and Chief Creative Officer, finally decided to step down as the CEO after being at the helm for almost 50 years. Mr. Lauren is hoping to inject some youthfulness into the septuagenarian polo team. Stefan Larsson, who is a former H&M executive and president of Old Navy, was hand-picked by Mr. Lauren to take charge of a company that is under attack.

Mr. Larsson will report to Mr. Lauren, although Mr. Lauren characterized their relationship as a “partnership” which is understandable considering that Mr. Lauren is the largest individual shareholder in his company and is expected to play a role in major decisions. Essentially, the company is separating the roles of the professional manager from that of the creative manager. The separation of the two roles will help assure Wall Street that the creative aspirations do not bleed the financial foundations of company.

Brutal Cost Cutting

Under the new strategy labelled as “New Plan Forward,” the incoming CEO intends to slash costs to fashion a reversal in downward profits. The company intends to close 50 stores, lay-off about 1,000 employees (or 7% of its workforce), and remove three of the nine layers of management that stand between the CEO and sales team.

The clothing production lead times will be amended from 15 to 9 months. Certain clothing lines will be on a hyper fast production time whereby it will be moved from the development stage to the shop floor within eight weeks.

The cost cutting strategy is bold and brutal, the Swedish CEO intends to slash costs by about $180 million to $220 million per year which is in addition to the $125 million in cost cutting completed last year.

Restructuring Costs

According to the plans, the company is projecting $400 million in restructuring charges and additionally the company intends to write off as much as $150 million in inventory that is scheduled to be liquidated. Evidently, near term earnings numbers are going to take a big hit before increasing.

Uncertain Prospects

The reasons for Mr. Lauren giving up some operational and financial control of the company after 50 years are notable and praiseworthy. Once a founder-owner company becomes sufficiently complex, the natural economic progression for the company is to retain a high quality professional manager who is responsible for supervising day-to-day operations, mange investments, and make optimal financing decisions with the objective of maximizing firm value. The advent of a professional managers also assures investors that the financial aspects of the company are not being compromised as creative side blossoms.

However, some of the restructuring plans are hard to assess. Some immediate concerns include,

Why hire a CEO from outside the company? Why not hire an insider who understands the value of the brand?
Can young CEO render value while being under the influence of a powerful founder-owner?
Why pick a CEO from a low-priced apparel designer company that is not a direct competitor?
Why are the business models that helped revive the fortunes at Old Navy and H&M likely to be useful for Ralph Lauren?
Cost cutting strategies can only render value up to a point, eventually the principal driver of earnings is revenue growth.
Too much cost cutting can also harm the brand value because of a loss in human capital.

Considering all these questions, the future of Ralph Lauren remains highly uncertain.

Helsinki, June 21, 12.48P.

The Mexican Wall (Mart) Spectacle

May 30, 2016 / [email protected] / 0 Comments

Wal-Mart Stores, the leading private employer in the world, operates in 25 countries with a strong presence in Mexico. Roughly about 20% of Wal-Mart’s 11,500 locations are based in Mexico. Over the last three years, the Justice Department has been investigating allegations that Wal-Mart paid bribes in Mexico to obtain permits.

A group of beneficial Wal-Mart owners filed a complaint with the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) that Wal-Mart’s auditor, Ernst & Young (E&Y) was aware of the bribery long before the company disclosed this irregularity to U.S. authorities in 2011. According to the complaint letter, E&Y as the independent auditor should have reported the suspected bribery to the SEC as soon as it became aware of such improprieties in 2006.

Bribery Act

The Foreign Corrupt Practices Act of 1977 (FCPA) makes it unlawful for persons and entities to make payments to foreign government officials to assist in obtaining or retaining business. The Act was amended in 1998. The anti-bribery provisions of the FCPA now applies to foreign firms and makes it illegal for foreign companies to pay bribes in the U.S.

The Act levies criminal and civil liability for paying bribes to foreign government officials. The Justice Department has jurisdiction over the FCPA.

Investigations

The Justice Department launched an investigation following a 2012 New York Times article about the alleged Mexican bribes. According to the article, Wal-Mart Mexico unit paid middlemen to obtain permits and that Wal-Mart executives chose not to pursue an internal inquiry into the suspicious payments.

Although the three-year investigation remains incomplete, according to Wall Street Journal, the case could be resolved with a fine and no criminal charges against Wal-Mart executives because the charges may not be as severe as previously anticipated.

Auditor’s Obligations

According to the auditing standards (AU section 317), auditors have a responsibility to design procedures that provide reasonable assurance of detecting illegal acts. In cases of bribery, the auditor is also implicated because bribing a foreign government official is illegal in the US and also because any bribery is likely to have a material effect on a company’s financial statements.

Companies that pay bribes generally record the underlying transactions in their accounting books as legitimate operating expenses to avoid detection. Since bribes often involve disbursements of cash, recording a bribe as a legitimate operating expense results in false reporting of expenses on the income statement.

What are the duties of the external auditor when it becomes aware that its client is suspected of violating FCPA provisions?

The answer may surprise you.

If an outside auditor discovers an illegal act, it is required to notify responsible authorities within the company including the company’s board and audit committee.
The external auditor is not required to notify the government.
Only when the company refuses to take corrective actions or the company’s books are compromised is the auditor obligated to notify the government.

Essentially, the rules and obligations are suggesting that the company has the obligation to correct improper acts and also inform appropriate government authorities.

Top Gun: Tom (Cruise) Ray

According to Chief Tom Ray, past Chief Auditor of PCAOB and my colleague at Baruch College, external auditors are not legally obliged to inform outside regulators about potential scandals except in limited circumstances. Auditors are required to report those acts to management and the board’s audit committee, which is responsible for monitoring financial reporting and disclosure practices. The accounting firm also needs to evaluate whether the bribers would have a material impact on financial statements.

Top gun in auditing, Tom states that only when the company doesn’t take appropriate actions, an outside accounting firm may be legally required to report the problem to a federal agency,

Solipsism

Needless to say, Wal-Mart will become target of lawsuits. E&Y, with its deep pockets, is also likely to become a prime target. However, if the norm is to pay bribes to secure contracts, especially in developing and emerging countries, U.S. companies are at a disadvantage relative to almost all other countries that do not have anti-bribery provisions.

Maybe it is time to have an anti-bribery world statute.

http://www.wsj.com/articles/shareholder-group-ctw-says-ernst-young-knew-about-wal-mart-mexico-bribery-allegations-1432580954

Cookin’ Apple Strudel with Some Cinnamon

May 20, 2016 / [email protected] / 0 Comments

Apple Inc. recently reported its first-ever revenue decline in 13 years. The stock price of Apple has declined by about 30% over the past 12 months. The high flying stock was trading at a high of $135 around May of last year but today it trades around $95. The billionaire investor Carl Icahn announced last week that he had sold his entire stake in Apple citing China’s economic slowdown. He also worries that the government could make it very difficult for Apple to conduct business.

Some financial gurus disagree with the market’s negative assessment of Apple and the company’s future prospects. The Sage from Omaha, the Financial Guru Warren Buffet, does not share the market’s adverse outlooks on Apple. Buffett’s Berkshire Hathaway Inc. declared on May 16 that it had invested $1 billion in Apple Inc. stock earlier this year. Apple stock went up the same day by about 4% which created value of more than $18 billion.

China

Among various Apple products, the iPhone business is the prime driver of Apple’s profitability and global growth. Apple iPhones account for almost two-thirds of its global revenues. China plays a crucial role in propelling Apple’s business. Following the U.S., China is Apple’s second-largest market in the world. Tim Cook, the CEO of Apple, has visited China 8 times since taking up the reigns of the company.

Many investors have serious doubts whether China can contribute towards Apple’s growth. With a slowing Chinese economy, phone sales have declined in China which is a key reason for Apple’s deceleration in revenues. To confront the decay in revenues, Mr. Cook visited China earlier this month and met with senior government and Communist Party leaders. Apple also announced that it would invest $1bn in Chinese ride-hailing app Didi Chuxing to better understand the Chinese market.

Is the China commentary likely to lead to “one bad apple?” Carl Icahn seems to believe so.

Cookin’ With Spices

The solution for Apple is to replicate the Chinese success story with another country with comparable population and one that is hungry for smartphones. Low and behold, Cook landed in India this week just in time for a monsoon wedding. Mr. Cook is hobnobbing with the Indian Prime Minister, meeting with key industrialists, and boogying with the Bollywood starlets. Mr. Cook is cookin’ Apple strudel with a hint of cinnamon!

India accounts for only 1% of iPhone sales. Why? The answer is simple. India’s market is dominated by phones under $75, while Apple’s models start at around $500. As a price sensitive market, it is not surprising that Apple with its expensive iPhones has been unable to make a dent on the smartphone market in India. Apple is now aiming to grab the Indian smartphone market share and resurrect its growth story.

Bilateral Trade

Apple has announced major investment in India. It plans to set up the first development Centre in India in Hyderabad. Apple also announced a “design and development accelerator” in Bangalore. Although, Apple is expected to continue to have its manufacture hub in China, the company had announced last year that it plans to invest $5bn in India to make Apple devices.

But what does Apple want in return for its massive investments in India? According to the Economist, Mr. Cook is hoping that the Indian government will allow Apple to sell its refurbished phones in India, which has the dual advantage of finding an outlet for its used phones and also meet the lower price barrier of smartphones in India.

Future of Apple stock?

Hard to say, but winners like Apple have a way of figuring out how to win even when the odds are stacked against them. They defy all odds, which is why we call them winners.

It is safe to ride the apple wave with the King of Omaha.

New York, May 20, 2016; 12.12P

The Curious Case of Elon Musk

May 13, 2016 / [email protected] / 0 Comments

In the first quarter of 2016, Tesla Motors reported total revenues of $1.15 billion and an adjusted loss per share of 57 cents. Investors and capital markets rely on positive earnings, a measure of profitability, to value companies. Since 2010, the company has reported a loss every year. If positive earnings serve as a barometer for stock valuation, Tesla stock is unlikely to capture your imagination.

Yet, investors have driven up the price of Tesla as if they are driving the Aventador, the Italian stallion, on the Autobahn. The stock price of Tesla was around $20 in 2010 and today it is worth $207, which translates into a heart pounding growth rate of more than 900%. If you had bought 1,000 Tesla shares in 2010 for a modest investment of $20,000, the same investment would be worth almost a quarter of a million dollars.

Irrational Exuberance

What is the basis for such irrational exuberance? Are investors assessing “value” of Tesla based on its revenues or expected future profits? The company’s total revenues grew from $117 million in 2010 to $4,030 million in 2015, which is an astounding growth of 3,400%. Estimating equity value based on revenues and disregarding economic profits is like chasing James Bond’s Aston Martin in a Cinderella Carriage. Could investors be arriving at intrinsic value using expected future profits. Sure, I could also win the New York lottery!

Most analysts have a sell recommendation on Tesla yet investors are treating the stock like Malva Pudding served with Witblits. So what is the rational explanation for the fascination with Tesla? Most likely, investors are really betting on the ingenuity and brilliance of Elon Musk.

The Musk of Zorro

Elon Musk is a South African-born Canadian-American entrepreneur, engineer, innovator, and investor. He is the CEO and product architect of Tesla Motors. He is also the founder CEO of SpaceX, co-founder and chairman of SolarCity, co-chairman of OpenAI, co-founder of Zip2; and co-founder of PayPal. As of April 2016, he has an estimated net worth of US$14.2 billion, making him the 68th wealthiest person in the US.

Mr. Musk has stated that the goals of SolarCity, Tesla Motors, and SpaceX are based on his vision to change the world. His desired goals include reducing global warming through sustainable energy production and consumption, reducing the risk of human extinction, and setting up a human colony on Mars. He has envisioned a high-speed transportation system known as the Hyperloop, and has proposed a VTOL supersonic jet aircraft with electric fan propulsion, known as the Musk electric jet.

Tesla Models: Bevy of Beauties

The company caught the attention of the avant-garde driver when they produced Tesla Roadster, the first fully electric sports car. The company’s second vehicle was Model S, a fully electric luxury sedan, which was followed by the Model X, a crossover. Its next projected vehicle is the heavily hyped mass-market electric car Model 3.

The price of eco-friendly and curve enhancing beauties is not cheap. Models S and X are around $100,000. Only Model 3, a Musk gift for the masses, is priced around $35,000. According to Tesla, reservations for Model 3 is approaching the 400,000 mark. The expected shipping date is not until the end of 2017. Many of the later orders fulfilled may not be available until 2019 or 2020. Model 3 should be renamed “Phantom of the Opera.”

Are you ready to test drive a Tesla or invest in the Tesla stock? You will certainly enjoy the “ride.”

Chatham, May 13, 2016; 12.30A

Kingdom Turns to Goldilocks Capitalism

April 30, 2016 / [email protected] / 0 Comments

The Saudi royal family controls the world’s biggest oil reserves in Saudi Arabia. The riches from the black gold is the basis of the royal families’ power, influence, and legitimacy. The family is considering to take Saudi Arabia’s Oil Company (ARAMCO), which is a state owned enterprise, public. ARAMCO is one of the world’s most secretive oil companies which reveals almost no information on revenues and offers only limited information on its hydrocarbon reserves.

According to media speculation, Crown Prince Salman, who is the son of the current King and often considered the power behind the throne, made public statements about the sale of ARAMCO shares. The Prince claims that the IPO is being initiated to confront corruption and usher in transparency. In a monarchical autocracy, which is renowned for lack of democratic freedom and beholden to absolute power, it remains unclear how he intends to deliver on his promise.

So the billion-dollar question is why consider an initial public offering (IPO) at all and then why now when the oil prices are rock bottom?

ARAMCO

The value of ARAMCO is derived from its massive reserves of crude oil, which the company claims to be around 265 billion barrels. The cost of oil extraction is around $4 per barrel, which happens to be the cheapest exploration cost compared to the extraction cost anywhere else in the world. In the United States, lifting that same barrel of oil could cost anywhere from $25 to $80 per barrel. The efficiency with which the Saudi company can extract oil is faster than any of its rivals. According to Forbes, ARAMCO can mine as much as 13.5 million barrels of oil a day, which equals 15% of the world’s daily oil needs.

The IPO

If ARAMCO goes public, it is estimated to have a market capitalization as high as $10 trillion, which easily exceeds the market value of the world’s largest publicly traded energy company ExxonMobil. If ARAMCO were to float just 5% of its shares in an IPO, it would raise somewhere around $500 billion. Any IPO by ARAMCO would make history as the largest IPO in the world.

The investment banking industry must be doing the belly dance in anticipation. The standard IPO fee for an investment bank is 7%. Even for a 5% IPO of the oil company, an investment bank would collect around $35 billion.

Why Now?

The Economist writes that when they asked whether Saudi Arabia was undergoing a “Thatcherite revolution”, Prince Salman replied “Most certainly.” However, it certainly does not make obvious financial sense. Why cash-in on your hidden treasures and then do it when the price of that treasure is at a historic low.

Is there some rational reason for the colossal decision? Considering how deftly the royal family has managed to retain power for the longest period in the world’s most volatile region, the answer most definitely is yes.

So what is that hidden reason? Is the explanation for the IPO a financial, political or geo-political one? Only time shall tell the hidden story …… Until the story unfolds, we can only keep guessing.

New York, April 29, 2016; 10.07P

http://www.economist.com/news/middle-east-and-africa/21685529-biggest-oil-all-saudi-arabia-considering-ipo-aramco-probably

Discord in Brazilian Samba

April 21, 2016 / [email protected] / 0 Comments

The fifth largest country in the world, exceeded in land size only by US, Russia, Canada, and China, and home to a population of nearly 200 million people, Brazil is one of the most vibrant, multicultural, and multiethnic countries of the world. The country’s government is organized as a multiparty federal republic with two legislative houses. The country of samba, soccer, carnival, haute cuisine is in the vortex of a multibillion dollar embezzlement scandal. The incumbent President Dilma Rousseff was impeached on Sunday by Brazil’s lower house for allegedly violating financial responsibility laws.

Putin Style Caipirinha – Shaken and Stirred

Prior to Ms. Rousseff, Luiz Inácio Lula da Silva, also known as “Lula,” was the President of Brazil from 2003 to 2011. Lula is the founding member of the Workers Party, a left-leaning socialist party regarded as a champion of unions and the working class. The Party is dominated by trade unionists, intellectuals, Trotsky-style communist thinkers, and church activists. President Lula pumped billions of dollars into social programs, which largely explained his unprecedented popularity. He increased the minimum wage well above the rate of inflation, which is quite high to being with, and also started began a state funded family grant program, the Bolsa Familia, which benefited nearly 44 million people and thereby cemented his support with the poor and the working class. In 2010, Time magazine featured Lula as one of the 100 Most Influential People in the World.

Unable to run for office for a third term constitutionally, Lula got his hand-picked former Chief of Staff Dilma Rousseff elected into office in 2010 using his popular mandate at that time. Regrettably, Brazil is being rocked by a multibillion-dollar corruption scandal involving alleged kickbacks from the state-run oil company, Petrobras, and some of the country’s largest construction firms.

Operation Car Wash

The probe by the Brazilian prosecutor dubbed “Operation Car Wash” has led to arrests of dozens of businessmen and politicians including high-ranking Congress members and executives at state-owned oil giant Petrobras, major construction firms, and individuals in Latin America’s largest investment bank, BTG. Prosecutors claim that the individuals were involved in a scheme to defraud Petrobras by awarding inflated contracts and then paying the excess cash as bribes to executives and funneling money into campaign contributions of political parties, especially the Workers Party.

At least 53 politicians are under investigation. The federal judge Sérgio Moro indicated that he believes former president Lula had profited from the scheme. Those facing criminal charges include the former treasurer of Ms. Rousseff’s Workers’ Party and politicians close to Lula.

Proverbial Coup d’état

After the police raided Lula’s home and prosecutors sought his arrest earlier this year, President Dilma Rousseff, his protégée and successor, announced in March that she was appointing Lula the Chief of Staff. By acquiring the rank of a government minister, the Economist claims that Lula was hoping to achieve partial immunity from any prosecution including a criminal one. As a member of the executive branch, only the country’s supreme court could try him.

Recently, a court judge suspended Lula’s appointment as a Chief of Staff in the Rousseff government which means investigations and incriminations will proceed with full force.

Discord in Brazilian Samba

Under Ms. Rousseff, Brazil has a deficit equal to 10% of GDP, which is the highest in the world. Brazil’s GDP growth rate has fallen from 7.5% in 2010 to -3.5% last year. Rousseff’s approval rating has collapsed from a high of 60% in 2013 to a meagre 11%, an approval rating mimicking those of current US Congressional members.

In a Wall Street Journal op-ed article, Ruchir Sharma, Head of Emerging Markets and Chief Global Strategist at Morgan Stanley Investment Management, opines persuasively that even an impeachment is unlikely to solve Brazil’s current economic quandaries for the following reasons.

Brazil’s GDP growth rate track commodity prices more closely than any other nation in the world which is a key concern.
While the country has some internationally competitive private companies in auto parts, aerospace and other industries, they are busy dodging a growing bureaucracy that smothers the rest.
Spending by local, regional and national governments amounts to 41% of Brazil’s GDP, the largest for any country in its middle-income class.
Brazilians face the heaviest tax burden of any emerging country, with collections amounting to 35% of GDP.
Public pensions have increased from 3% to 7% of GDP. Brazilian men typically retire at age 54 and women at 52, earlier than in any major European country.

Even if Ms. Rousseff is inclined to pushing serious reforms, it is questionable whether she has any political cache left to make radical economic changes needed to reduce the colossal size of Brazil’s government programs and to get the economy back on track. With taxes already high, and commodity prices at bottom low levels, the government is unable to afford welfare programs. The country’s deficit is bound to increase in size unless it initiates major cut-backs on social programs.

Mr. Sharma interjects that to revive and diversify its economy and control government spending, Brazil needs a powerful reformer—a Brazilian Deng Xiaoping.

China – A Triumphant BRICS Story

Relative to the BRICS countries, which also includes India, Russia, Brazil and South Africa, China has been the sole Dragon Warrior worthy of accolades. From a country grappling with economic deprivation, poverty, inadequate infra-structure and illiteracy even a few decades ago, China has confronted its basic ills with Confusion wisdom into an economic and political giant.

The American diplomat and political scientist, Henry Kissinger, who served as the Secretary of State under Nixon and Ford, had the brilliance and prescience to comprehend the true potential of China more than 50 years ago and began the rapprochement between the two countries then.

For the rest of the BRICS countries, unfortunately, it remains a story of unfulfilled promises. If only the BRICS country-governments would consider emulating China by focusing on investments in infra-structure, primary and secondary education, health-care and not pander for votes by providing short-term government subsidies, or higher taxes on wealthy, these countries would begin to harness their “incredible” latent potential.

New York, April 21, 2016; 12.55P

http://www.wsj.com/articles/impeachment-wont-save-brazil-1461021625

Mickey’s Marine Magic

April 15, 2016 / [email protected] / 0 Comments

The Walt Disney Company, headquartered at Walt Disney Studios in Burbank, California, is the ranked as the second largest media and entertainment conglomerate after Comcast. In addition to owning and operating studios, parks, resorts, and media, Disney has been successfully navigating a relatively small cruise line since 1998 having a worldwide cruise market share of 3%.

It appears that Mickey has been more successful in charming its marine customers than its terrestrial customers. Two of its four fleets, Magic and Wonder, have generated better returns than any of the company’s theme-parks.

Why are Disney Cruise Lines so profitable? The business model is not very intricate but one that may be a bit salty in taste.

Background

Disney cruise line operates four ships: Disney Magic, Disney Wonder, Disney Dream, and Disney Fantasy. The company also owns Castaway Cay, a private island in the Bahamas designed as an exclusive port for Disney’s ships. The number of staterooms in each ship varies between 875 to 1,250. Therefore, a Disney ship can accommodate anywhere between 3,500 and 5,000 guests, which excludes the 1,000 crew/staff members working round the clock to make the experience magical for its on-board guests. In 2016 Cruise Critic Cruisers’ Choice Awards, three of Disney’s ships won 11 category awards.

Disney ships are the first in the industry to be designed and built as family cruise liners with the ultimate objective of accommodating parents and children into the travel plans. Unlike most other cruise liners, Disney ships do not house casinos.

The Magical Numbers

The accounting of income from cruise lines must carefully match revenues against expenses for the current reporting period. The cost of a ship, which can be hover around $750 million, is capitalized and typically depreciated over 40 years. Therefore, the cost of the ship allocated as an annual expense is around $18.75 million. Much of the cost of building Disney ships resides on Disney’s balance sheet as an asset, which is reduced over time by the amount of accumulated depreciation. Each ship is conjectured to generate between $75 million and $150 million in profits depending on the size of the ship.

While Disney cruise lines may charge a small premium over other cruise lines, cruise fares are set quite low. The key goal is to generate large volume of passengers by charging low tariffs but subsequently charge additional funds for on-board services which include purchases of alcohol, Disney paraphernalia, paintings, rental equipment, tax free items, use of SPAs, massages, bottled water, and various activities on land. It is not unusual for families to end up paying 25% to 50% added surcharges accrued during the voyage.

Cruise lines are most cost efficient. Much of the staff and crew is international with a high proportion of the crew drawn from emerging and developing countries which means that Disney pays a tiny fraction of competitive wages. There is also a large deep-sea buried surcharge. The company has a policy of centralized tipping system and participation in the Disney tipping program is almost mandatory for all passengers. Nearly 10% of the cruise ship tariff is levied on all customers as an added surcharge for rendering high quality service. Moreover, cruise lines are typically registered in countries with very low taxes which lowers effective taxes.

Low and behold, you have a hefty stream of profits because total revenues are large while expenses are low. An initial capital investment of $750 million is able to generate a stream of high cash flows for 20 plus years. In the case of Disney, the profits are sizeable because it is able to leverage the Disney name.

Navigator Igor

Disney Chairman and CEO Bob Iger announced last month at the company’s 2016 annual shareholders’ meeting that the company plans to build two new ships which are anticipated to be much larger than the current ships. These ships are expected to join the Disney Cruise Line fleet in 2021 and 2023. Once operational, according to Goldman Sachs analysts’ predictiosn, Disney’s cruise revenues are estimated to reach $1 billion a year.

Are you ready to set sail on one of Disney’s cruises or would you rather buy a Disney stock? Either way you and your kids would become winners!

Miami, April 15, 2016; 12.33A

http://www.frommers.com/deals/cruise/thats-ridiculous-cruise-lines-and-the-passengers-they-carry#ixzz45jsG2j39

Mr. Minister and Malaysian Malaise

March 5, 2016 / [email protected] / 0 Comments

The Swiss Attorney General’s office declared that approximately $4 billion has been misappropriated from state-owned companies in Malaysia much of which originated from the Malaysian State Fund, named 1MDB. Using a network of intricate financial transactions, more than $1 billion was transferred from 1MDB into the Malaysian Prime Minister’s personal bank account between 2011 to 2013.

The Malaysian Attorney General who was investigating the illegal use of public funds concluded that the money transfer into the Malaysian Prime Minister’s private bank account was a legal donation from Saudi Arabia’s royal family. The Saudi government officials, however, have publicly denied making any such donation. In the meantime, the Malaysian Prime Minister continues to serve as the chairman of the board of advisors to 1MDB.

Why Swiss Authorities

Swiss Attorney General’s Office have found evidence of unlawful money transfers linked to 1MDB relying on the Swiss banking system. Swiss officials became interested in suspicious financial activities around 1MDB because of concerns that their banking system is being used to bribe public officials, launder money, and other criminal activities.

The investigators allege that funds were transferred into private accounts using a web of complex financial transactions with the help of two senior former officials of a state-owned Abu Dhabi company called Aabar Investments PJS. Abu Dhabi is the largest of the United Arab Emirate’s (UAE) seven member emirates. It is also the capital of UAE.

Malaysian State Fund

Malaysia Development Berhad (1MDB) is a strategic development company, which is wholly owned by the Government of Malaysia, established to fund strategic long-term economic development projects through global partnerships and foreign direct investment. 1MDB Fund began as a sovereign wealth fund under the name “TIA” to propel economic development of one of the states of Federal Malaysia. In 2009, the Malaysian Prime Minister broadened TIA into a federal entity and renamed the wealth fund as 1MDB.

What Transpired

In 2009, Aabar Investments PJS, a state-owned Abu Dhabi company, pledged to help 1MDB acquire power plants and build a finance center in Kuala Lumpur. Aabar Investments PJS is a fully owned subsidiary of International Petroleum Investment (IPIC), an Abu Dhabi sovereign-wealth fund. IPIC guaranteed billions of dollars of 1MDB bonds.
In 2012, to facilitate illegal wire transfer, about $1.4 billion was paid to Aabar Investments PJS Ltd, which was a company registered in British Virgin Islands with a name similar to Aabar Investments PJS but additionally had the word “Ltd.” This company was created by senior former officials of Aabar Investments and IPIC.
The money was then moved from Aabar Investments PJS Ltd to Tanore Finance Corp., which was also registered in British Virgin Islands.
Among other bank accounts, Tanore Finance Corp. holds bank accounts in Singapore and an account in a Swiss private bank named “Falcon Bank,” which is owned by Abu Dhabi sovereign-wealth fund. Falcon Bank had business dealings with 1MDB.
Via these various interconnected accounts, Tanore Finance Corp was able to transfer funds from its bank account in British Virgin Islands, to a bank account in Singapore, to another account in a Swiss private bank where names are concealed, and then eventually to the Malaysian Prime Minister’s personal bank account.

Corruption and Economic Development

Corruption involves the abuse of entrusted power for private gain. Because of the concentration of entrusted power in politics, the most outrageous cases of corruption involve high level politicians. According to a “Corruptions Perception Index” constructed by Transparency International, where 1 is the least corrupt country, Malaysia is ranked 54^th in corruption and UAE is ranked 74^th.

Emerging markets and less developed countries must rely on reputation to attract much needed private and public funds to spur economic development. Therefore, the costs to society from corruption in these countries are disproportionately higher than wealthier countries. Yet, much too often, the most egregious cases of corruption are confined to poorer countries. Because of the massive benefits of corruption, there are few incentives to institute legal and enforcement structures to confront corruption in poorer nations, which in turn hinders economic development.

The vicious circle of corruption!

March 5, 2016; 1.48P

http://news.yahoo.com/more-1-billion-transferred-malaysia-pms-accounts-wsj-035217879–sector.html

http://www.wsj.com/articles/swiss-attorney-general-expresses-concern-over-halt-of-malaysian-1mdb-probe-1454083061

http://www.wsj.com/articles/deposits-in-malaysian-leaders-accounts-said-to-top-1-billion-1456790588

Death, Taxes, and Goddess Helvetia

February 21, 2016 / [email protected] / 0 Comments

Switzerland is the world’s largest offshore financial center with more than $2.2 trillion of offshore assets. Earlier this year, the U.S. Justice Department declared that it expects to collect more than $1.36 billion from 80 Swiss banks as part of a broad legal settlement. Numerous Swiss banks admitted to planning illegal tax strategies to enable U.S. taxpayers conceal income from U.S. tax authorities through an intricate web of offshore accounts.

In 2009, UBS paid $780 million to the U.S. government and turned over more than 4,000 names to avoid criminal charges. In 2014, Credit Suisse pleaded guilty to one charge of encouraging tax evasion and paid $2.6 billion as part of a settlement to the Justice Department.

Collectively, in the last 6 years, the U.S. has collected more than $13 billion from individuals and financial firms in connection with secret offshore accounts whose singular objective is to evade paying taxes.

Why Swiss Banks?

Swiss banks typically offer two prominent rewards for depositors ― privacy and the low risk. Because Swiss laws forbid their bankers from disclosing the existence and identity of individual accounts without the consent of the account holder, depositors are able to hide their financial assets under a cloak of secrecy. Additionally, because the Swiss franc has virtually zero inflation with the backing gold reserves (at least 40%), depositors’ exposure to foreign currency risk is negligible. The political neutrality retained by the Swiss government in world affairs ensures very little political risk as well. Given these distinct benefits, Swiss banks have become a notorious haven for parking (un)accountable money.

Private vs. Retail Banking

Switzerland offers a wide array of private and retail banking services. Private banking refers to services provided by banks to private individuals with unusually large assets. Historically, exclusive private banking service has been reserved for those with liquid assets over $1 million. The services in a private bank include private counseling in wealth management, investments, tax concerns, and estate planning. Many private banks require a special invitation or referral by current customers.

Retail banking, on the other hand, is your traditional mass-market banking system offering checking, savings, personal loans, mortgages and other types of accounts for individuals. While many retail banks also offer investment services, they are not at the level of those offered by private banks.

EU and Swiss Banking Agreement

The European Union (EU) and Switzerland have agreed to exchange information on the bank accounts with the intention of preventing EU citizens from hiding undeclared income in Swiss banks from 2018. The pact means that EU countries will automatically receive the names, addresses, tax identification numbers and dates of birth of their residents with accounts in Swiss banks thereby making it almost impossible for EU citizens to hide wealth from EU-based tax jurisdictions.

The European Commission is negotiating similar agreements with Andorra, Liechtenstein and Monaco, which are three European microstates with very low levels of taxation and a popular destination for depositors intending to hide their financial assets from tax authorities.

Tax-Free Rest of the World

Unfortunately, there are no such agreements between Switzerland and the rest of the world. Therefore, for the time being, citizens of non-EU and non-US jurisdictions are relatively free to evade taxes by tapping into the sophisticated Swiss banking system.

The irony is that countries with the maximum need for resources to fund investments in infra-structure, education and healthcare are unable to rely on tax-based revenues to fund their growth because of the private banking system. Largely because of corruption, governments of developing countries and emerging markets have very little economic incentives to enact measures, or to create bilateral agreements, to limit tax evasion.

Benjamin Franklin once famously said “In this world nothing can be said to be certain, except death and taxes.” For much of the world population, while death is a forgone conclusion, paying taxes is not; thanks to Goddess Helvetia.

The link below identifies ways financial transactions were structured to evade the origin of funds and avoid taxes.

http://www.wsj.com/articles/inside-swiss-banks-tax-cheating-machinery-1445506381

February 20, 2016; 7.58P

Banks Banking on Their Debt

February 16, 2016 / [email protected] / 0 Comments

Under the “Fair Value Option,” accounting rules allow a bank to book income when its debt has declined in value should they elect fair value accounting for their debt. Once adopted, the decision is irreversible.

Now consider a bank whose financial health has been deteriorating (a decline in credit ratings or an increase in credit default swap spreads). Under accounting rules, a financially constrained bank would record an accounting gain! Therefore, other things remaining unchanged, a healthy bank would report a loss on the income statement, while an unhealthy bank would report a profit on the income statement. Very counter-intuitive.

Prominent Example

In 2011, JP Morgan Chase in its third quarter earnings reported a whopping $1.9 billion pretax gain because of debt valuation adjustments (DVA), i.e., it recognized a gain because the market value of its publicly traded debt had decline in value. Similarly, in the first quarter of 2012, Morgan Stanley ’s earnings were reduced by nearly $1.5 billion in losses which were tied to this rule. In the third quarter of 2011, the bank had a gain of $2.1 billion because of debt valuation adjustments. In the nine months of 2015, Morgan Stanley recorded a gain of $477 million related to the DVA rule.

You can notice the volatility in earnings that results from valuing debt at fair value. Moreover, the recording of the debt value adjustment on the income statement made it difficult for investors to value a bank’s earnings.

Background

In 2008, when the accounting rule first came into play, which coincided with the financial crisis, banks were only too keen to adopt the fair value option for valuing their own debt. This is because, with overall deteriorating health, banks were able to mask their economic performance by booking a large accounting gain which arose from a decline in the market value of their own debt.

The Great Escape

Based on investor feedback, the US accounting rule-making body, FASB, is finally giving banks an “opt out.” Going forward, if a bank elects to adopt fair value accounting to value its own debt, it does not have to report any gain or loss from decline or rise in its market value of debt on its income statement. Instead, the gain or loss related to debt valuation adjustment is to be reported under “other comprehensive income,” which is not included in the income statement.

Accountability of accounting in banks!

February 16, 2016; 4.30P

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Al (Aloke) Ghosh

Distinguished Professor of Accounting, Belk College of Business, UNC Charlotte

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