On a recent night out to dinner with friends, I had an argument with our companions, (pretty standard behavior on my part, actually,) that Groupon deals are a bad investment. Today's WSJ story about copycat problems for Groupon makes me even more concerned. Not surprisingly, huge numbers of competitors in the Boston area have sprung up.
After purchasing my first Groupon deal, (to Fascino Restaurant in Montclair, NJ, which we enjoy several times a year,) it hit me that Groupon and it's race to the bottom competitors act as completely unregulated finance companies, issuing junk bonds and credit guarantees on those same junk bonds. Groupon might be the worst financial guarantee insurer ever designed.
[DISCLAIMER: One reason I have not written much lately is that I am in the middle of setting up an insurance company over which I will exercise control. This officially means I cannot risk advising anyone about anything insurance related until we have completed licensing. Therefore, let me be very clear! I am not providing anyone insurance advisory services, attempting to sell insurance or anything like that!]
How does Groupon Financial Guaranty (GFG) work?
Imagine you own a restaurant.
You are broke. I know this because my wife's family business for god knows how long was restaurant and bar equipment and supplies. Three generations of her family can confirm you are broke!
Virtually all restaurant owners are broke, even the really good ones with multi-million dollar revenues.
You figure that GFG can help you raise some working capital and get great advertising at the same time. How? Hundred dollar Groupon deals! Sell $100 of food today for $50. You receive $25 today (the underwriter and guarantor of the coupon keeps the other $25) with the obligation to pay off $100 at some time in the next year, when the coupons expire.
Maybe at Applebee's or McDonald's you don't lose money with a 75% discount on the food alone, but with your labor costs and higher cost food, you are definitely losing here.
You argue, however, that the coupon makes good sense. It amounts to good advertising, getting your name in front of thousands of people who will become customers. GFG clients who carefully track this information will tell you that you are wrong. GFG raises capital from loan sharks (i.e. people willing to lend for an incredible deal and don't come back,) or your current customers who would have paid anyway. (Sorry, Fascino!)
Here's my scenario for what's really happening to you. Your restaurant cannot make payroll, (that's why Town, above, went bankrupt!) No bank will lend you money. So, you'll borrow from GFG to make payroll. You'll rationalize. Late August is always slow--everyone leaves town! Business will pick up in September.
By September, business starts to pick up. Coupons are rolling in! Expenses rise dramatically as you're buying more food, and face more spoilage because you cannot predict customer flow as you had in the past. Worse, your waitstaff is storming the Bastille because customers aren't tipping on the full price. You know you're not making any money.
By the second week of October, you're out of business because two waiters quit, but you couldn't make payroll anyway. Only 250 of the 1000 you sold made it to the restaurant.
You may be out of business, but you're not a public company with shareholders. GFG holds the risk on those coupons: They have to save their reputation. GFG just lost $18,750. (They need to refund $50 on 750 coupons, but on those coupons, they only made $25 each.)
Sure, this won't happen every time, but it will. Someone who understands accounting better than I do, please explain: Where on Groupon's balance sheet are the credit loss reserves?
Showing posts with label credit. Show all posts
Showing posts with label credit. Show all posts
Friday, July 8, 2011
Monday, July 26, 2010
Did We Learn Anything?
Where's the outrage? I started this post days ago. I didn't finish it because it seemed so obvious everyone would write about it. Not true. So, here it is:
It's really hard to believe GM, now owned by the US Taxpayer, announced they're buying AmeriCredit. AmeriCredit, in case you were unaware, is a subprime lender. Once again, "New GM" has realized what old GM knew: The products they sell are too expensive for anyone to buy for cash, so they have to be sold on credit. Furthermore, no (sensible) lender will sell these products on credit, so they need their own lender.
Let's look at some detail here. Apparently many people like the Chevy Impala. (I'm not certain I've been in one since my Aunt Bonnie drove one in the late '70s, but that's a different issue...) According to Edmund's, in my region, a 2011 Chevy Impala LS will set you back $24,782. (That's the "market price" not invoice or sticker.) The real problem, however, lies in the 2010 price. The brand new 2010 Impala LS costs you $20,347. That's nearly 20% depreciation on a new car.
The same depreciation hits a used one. An "Outstanding" condition, "Certified Used", 2009 Impala with 10 miles on it sells for $16,628. On a trade-in, it's worth $12,526. That's basically half the price of a new one.
I know, tell you something you don't know. We're planting the seeds of our own disaster.
GM will use AmeriCredit to finance dealer inventory. They'll lose money on that transaction, unless the cars move very quickly, before they depreciate at the wholesale level because a 2010 car is worth 80% of a 2011 one.
The dealers hope to move the cars more quickly because AmeriCredit will finance the customers too. We'll be lending $24,282, (that's after a $500 down payment, because, if you hadn't heard, "taxes, titles, fees and registration are extra!") We may even lend that much at 0.9% for five years.
Everyone in America knows about loan-to-value ratios now. What's the LTV on an Impala? It can't be that bad, right? We learned our lesson with houses! We cannot possibly make high LTV loans to people with no ability to pay, deteriorating willingness to pay, and collateral that could fall in value dramatically, like houses, right? Well, that Impala, the second it's driven off the lot, has an LTV of nearly 2...and we probably won't collect any interest on the loan!!!
This makes financing condos in Vegas in late 2007 look smart.
It's really hard to believe GM, now owned by the US Taxpayer, announced they're buying AmeriCredit. AmeriCredit, in case you were unaware, is a subprime lender. Once again, "New GM" has realized what old GM knew: The products they sell are too expensive for anyone to buy for cash, so they have to be sold on credit. Furthermore, no (sensible) lender will sell these products on credit, so they need their own lender.
Let's look at some detail here. Apparently many people like the Chevy Impala. (I'm not certain I've been in one since my Aunt Bonnie drove one in the late '70s, but that's a different issue...) According to Edmund's, in my region, a 2011 Chevy Impala LS will set you back $24,782. (That's the "market price" not invoice or sticker.) The real problem, however, lies in the 2010 price. The brand new 2010 Impala LS costs you $20,347. That's nearly 20% depreciation on a new car.
The same depreciation hits a used one. An "Outstanding" condition, "Certified Used", 2009 Impala with 10 miles on it sells for $16,628. On a trade-in, it's worth $12,526. That's basically half the price of a new one.
I know, tell you something you don't know. We're planting the seeds of our own disaster.
GM will use AmeriCredit to finance dealer inventory. They'll lose money on that transaction, unless the cars move very quickly, before they depreciate at the wholesale level because a 2010 car is worth 80% of a 2011 one.
The dealers hope to move the cars more quickly because AmeriCredit will finance the customers too. We'll be lending $24,282, (that's after a $500 down payment, because, if you hadn't heard, "taxes, titles, fees and registration are extra!") We may even lend that much at 0.9% for five years.
Everyone in America knows about loan-to-value ratios now. What's the LTV on an Impala? It can't be that bad, right? We learned our lesson with houses! We cannot possibly make high LTV loans to people with no ability to pay, deteriorating willingness to pay, and collateral that could fall in value dramatically, like houses, right? Well, that Impala, the second it's driven off the lot, has an LTV of nearly 2...and we probably won't collect any interest on the loan!!!
This makes financing condos in Vegas in late 2007 look smart.
Tuesday, March 16, 2010
Why Don't Start Ups Have Debt?
This is not quite a stupid question. Start-ups have a future. They have no present. No earnings, no assets. Maybe the management team has a track record. Why would you lend to them? Debt only has downside. Start-up investors take equity. If they're taking the downside, they want the upside.
So, why do student loans exist? Economically speaking, student loans look a lot like loans to start-ups. They're a lousy proposition for the lender because you only have downside. You can't take founders warrants in a career--slavery is illegal. And the asset you finance, an education, remains with the borrower even if the borrower willfully defaults on the loan.
This story gives another tale that, on the surface might deserve sympathy, (call me heartless.) The good doctor got herself $550k in the hole because she didn't "read the fine print" or keep track of the rules. If you cannot borrow on sensible terms and you don't take the time to read the fine print then maybe this is exactly what is supposed to happen. Entrepreneurs evaluate their cost of capital and attempt to make good investment decisions. This story signals really bad management and investment on the part of one individual.
I know, you say positive externalities (a better educated population means higher productivity, etc) mean we should subsidize education as a society. This may be true, but we still need to address moral hazard and we need to efficiently allocate capital. We shouldn't recklessly fund risky loans and let our sympathies after the fact worsen the situation.
So, why do student loans exist? Economically speaking, student loans look a lot like loans to start-ups. They're a lousy proposition for the lender because you only have downside. You can't take founders warrants in a career--slavery is illegal. And the asset you finance, an education, remains with the borrower even if the borrower willfully defaults on the loan.
This story gives another tale that, on the surface might deserve sympathy, (call me heartless.) The good doctor got herself $550k in the hole because she didn't "read the fine print" or keep track of the rules. If you cannot borrow on sensible terms and you don't take the time to read the fine print then maybe this is exactly what is supposed to happen. Entrepreneurs evaluate their cost of capital and attempt to make good investment decisions. This story signals really bad management and investment on the part of one individual.
I know, you say positive externalities (a better educated population means higher productivity, etc) mean we should subsidize education as a society. This may be true, but we still need to address moral hazard and we need to efficiently allocate capital. We shouldn't recklessly fund risky loans and let our sympathies after the fact worsen the situation.
Monday, January 4, 2010
Bonds Now!...Part 2: Credit investors have delusional expectations
In this post, I begin my discussion of why corporate credit doesn't generally make sense to me as an investment. In this second installment, I'll look at the demand side of corporate bonds. What do the buyers seek?
Let's begin with a really simple assumption: The world is a risky place. Companies and people engage in risky activity in order to earn a living, thrill seek, whatever. Let's also assume that companies engage in risk in order to earn returns on capital, not simply because the managers seek risk for thrills. Then, it should be pretty clear that companies take risks that can turn out good (better than expected), or bad, (worse than expected.)
Bond buyers don't like variation. At all. At a fundamental level, the bond buyer seeks to know up front what the outcome of risky activity will be. They seek the maximum (assume fixed coupon bond, no conversion features, etc.) payment the company can support, accepting only downside variation. (This is the "put" feature described in my previous post.) The problem is, this is unknowable. The buyer of the bond wants to make activities that are inherently risky, variable in both positive and negative ways, into something else.
As a result of this framework, owners of bonds tend to set themselves up for diaster. Bond issuers understand this. That's why bond issuers exist! If bond buyers understood clearly the puts they were selling, they would not agree to sell them.
Wait, you say: The issuer of the bonds, if secured, give the lender a first claim on the assets of the company (just like your bank has a first claim on your house if they hold your mortgage.) I'll grant you that. I'll even grant you that the issuer has sold a call on the company's assets, contingent on disaster at the company (e.g. default on the bonds.) But guess what: Management issuing the bonds gets a call on the upside of performance because the bond coupons are fixed. And, Management either walks away, or gets a new contract to run the company when disaster strikes and the bond holders now own the company.
This is no different than the housing risk banks face today: Borrowers of money can always walk away when things go wrong. When things go right, lenders don't generally have any upside.
Let's begin with a really simple assumption: The world is a risky place. Companies and people engage in risky activity in order to earn a living, thrill seek, whatever. Let's also assume that companies engage in risk in order to earn returns on capital, not simply because the managers seek risk for thrills. Then, it should be pretty clear that companies take risks that can turn out good (better than expected), or bad, (worse than expected.)
Bond buyers don't like variation. At all. At a fundamental level, the bond buyer seeks to know up front what the outcome of risky activity will be. They seek the maximum (assume fixed coupon bond, no conversion features, etc.) payment the company can support, accepting only downside variation. (This is the "put" feature described in my previous post.) The problem is, this is unknowable. The buyer of the bond wants to make activities that are inherently risky, variable in both positive and negative ways, into something else.
As a result of this framework, owners of bonds tend to set themselves up for diaster. Bond issuers understand this. That's why bond issuers exist! If bond buyers understood clearly the puts they were selling, they would not agree to sell them.
Wait, you say: The issuer of the bonds, if secured, give the lender a first claim on the assets of the company (just like your bank has a first claim on your house if they hold your mortgage.) I'll grant you that. I'll even grant you that the issuer has sold a call on the company's assets, contingent on disaster at the company (e.g. default on the bonds.) But guess what: Management issuing the bonds gets a call on the upside of performance because the bond coupons are fixed. And, Management either walks away, or gets a new contract to run the company when disaster strikes and the bond holders now own the company.
This is no different than the housing risk banks face today: Borrowers of money can always walk away when things go wrong. When things go right, lenders don't generally have any upside.
Thursday, December 31, 2009
"Bonds Now!"...Not!...Part 1 of (probably) very many...
Driving to buy New Year's champagne this afternoon, I heard on "The Hayes Advantage" and interview with Marylin Cohen of Envision Capital Management. Shockingly, she's on the radio with a new book out called "Bond's Now".
Here's the thing: Bonds, by construction (with some exceptions) should be considered duration risk plus a put on equity in something. So, for example, any bond return may be decomposed into "riskless" duration (that trades off the highly liquid and extremely efficient U.S. Treasury market) and a spread above that rate that reflects the chance the company (or entity) won't pay back the principal. That spread looks very much like a put premia: The holder of the bond receives it when things are good. When things go bad the investor doesn't earn the coupon. When things go really bad the investor doesn't get the principal back. This is reasonably basic stuff.
Let's hit a couple of assumptions: Yield from duration is riskless. Yes, assumption here is that nominally, duration risk calculated off US Treasurys is riskless on a buy and hold basis, especially for the domestic US investor. Clearly this is not the case for real returns (net of inflation.) Nor is it true for other than held to maturity bonds. This yield (and return to duration, if the bonds are traded) passes through by definition to the corporate bonds.
Second, let me address "a put on something" very broadly. You buy debt in public company XYZ that is highly liquid. If the equity goes to zero, then there is no "protection" for the debt, and it starts to erode. What about asset based loans, or debt to private dompanies? More or less the same, it is just that the equity is not publicly traded. You are selling puts on private equity.
What about muni bonds? Let's leave that for later.
So, let's assume an investor knows they are taking these risks. (Big assumption here. I don't think many people seriously consider this.) You want to take duration risk and write puts on diversified equity. (Investor is buying corporate credit index, for example.) Which makes more sense? Option A: Buy duration in a moderately liquid corporate market, and combine that with selling puts in a moderately liquid market only on the selection of companies that happens to need to raise cash, and does so via the debt market instead of the equity market. Or, option B: Buy duration in the single most efficient market in the world using your choice of instruments, and sell puts on broad baskets of all companies?
Generally speaking, option B sounds better to me. That certainly reflects my bias toward wanting to trade in the most efficient markets, (unless I think I have an edge,...which is rare...and I usually talk myself out of it.)
Many more thoughts on in the new year...enough for now.
Here's the thing: Bonds, by construction (with some exceptions) should be considered duration risk plus a put on equity in something. So, for example, any bond return may be decomposed into "riskless" duration (that trades off the highly liquid and extremely efficient U.S. Treasury market) and a spread above that rate that reflects the chance the company (or entity) won't pay back the principal. That spread looks very much like a put premia: The holder of the bond receives it when things are good. When things go bad the investor doesn't earn the coupon. When things go really bad the investor doesn't get the principal back. This is reasonably basic stuff.
Let's hit a couple of assumptions: Yield from duration is riskless. Yes, assumption here is that nominally, duration risk calculated off US Treasurys is riskless on a buy and hold basis, especially for the domestic US investor. Clearly this is not the case for real returns (net of inflation.) Nor is it true for other than held to maturity bonds. This yield (and return to duration, if the bonds are traded) passes through by definition to the corporate bonds.
Second, let me address "a put on something" very broadly. You buy debt in public company XYZ that is highly liquid. If the equity goes to zero, then there is no "protection" for the debt, and it starts to erode. What about asset based loans, or debt to private dompanies? More or less the same, it is just that the equity is not publicly traded. You are selling puts on private equity.
What about muni bonds? Let's leave that for later.
So, let's assume an investor knows they are taking these risks. (Big assumption here. I don't think many people seriously consider this.) You want to take duration risk and write puts on diversified equity. (Investor is buying corporate credit index, for example.) Which makes more sense? Option A: Buy duration in a moderately liquid corporate market, and combine that with selling puts in a moderately liquid market only on the selection of companies that happens to need to raise cash, and does so via the debt market instead of the equity market. Or, option B: Buy duration in the single most efficient market in the world using your choice of instruments, and sell puts on broad baskets of all companies?
Generally speaking, option B sounds better to me. That certainly reflects my bias toward wanting to trade in the most efficient markets, (unless I think I have an edge,...which is rare...and I usually talk myself out of it.)
Many more thoughts on in the new year...enough for now.
Thursday, December 17, 2009
Why I hate gift cards
Every economist on the planet loves to remind us that gift giving is inefficient, here's a good one from The Economist.) Yes, cash is king. Gift givers think it's too impersonal, so they roll out the gift cards.
They're telling themselves they aren't so boorish as to give cash. Giving cash pre-allocated to the store or enterprise of the giver's choice is so much more expressive. Right.
But it's worse than that. Cash gifts can go directly to the bank. Given FDIC, they're safe. Or, you spend them, however, wherever you want. If you are so inclined, you can buy something in particular that will remind you of the gift giver.
Gift cards are a monitoring disaster waiting to happen, not just simply because you lose them. Imagine someone gave you a gift and said "Here's a hundred bucks. But, it might not be worth $100 because this is actually a claim on $100 from a counterparty that really isn't particularly credit worthy."
From the store's perspective, these things are incredible. They borrow money very cheaply because the buyers don't account for the risk, or this risk is viewed as less "important" than the "thoughtfulness" of the gift. Why do you think Target will sell you a gift card for iTunes? Because Target takes a cut to distribute non-interest bearing, unsecured bonds for Apple Inc.! Target
They're telling themselves they aren't so boorish as to give cash. Giving cash pre-allocated to the store or enterprise of the giver's choice is so much more expressive. Right.
But it's worse than that. Cash gifts can go directly to the bank. Given FDIC, they're safe. Or, you spend them, however, wherever you want. If you are so inclined, you can buy something in particular that will remind you of the gift giver.
Gift cards are a monitoring disaster waiting to happen, not just simply because you lose them. Imagine someone gave you a gift and said "Here's a hundred bucks. But, it might not be worth $100 because this is actually a claim on $100 from a counterparty that really isn't particularly credit worthy."
From the store's perspective, these things are incredible. They borrow money very cheaply because the buyers don't account for the risk, or this risk is viewed as less "important" than the "thoughtfulness" of the gift. Why do you think Target will sell you a gift card for iTunes? Because Target takes a cut to distribute non-interest bearing, unsecured bonds for Apple Inc.! Target
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