Why Central Banks should encourage shoplifting

The European Commission reported earlier today that the Eurozone faced deflation of 0.2% in the year to February. Situation is hardly more positive in the UK, with the Consumer Price Index (CPI) only up by 0.3% in the year to January. And yet, as Central Banks are struggling to make ‘unconventional monetary policy’ work, there is one lever they have not resorted to yet: favouring shoplifting.

'Officer! Quick! A shoplifter!!'
Credits: www.jantoo.com

Shoplifting cost UK retailers an estimated £335m in 2013-14, according to the Financial Times. This excludes prevention costs such as hiring security guards, installing detectors at the entrance or fitting items with individual security wrapping – razor blades and smartphones are the usual candidates for the latter. This cost is borne by the whole community: retailers have to indistinctly increase public prices to offset for the revenues losses implied by shoplifting.

More precisely, retailers increase prices a priori based on the expected share of items which will be stolen. For instance, a retailer can plan to generate £1,000 of revenues by selling 10 copies of an item priced at £100 each. However, if he expects expects 1 out of the 10 copies to be stolen (and therefore not paid for), the ‘theft-adjusted’ price will be £111, so that revenues coming from the 9 ‘paid-for’ items (9 * £111 = £999) are equivalent.

The ‘theft-adjusted’ price evolves in a dynamic manner, based not only on the price of the underlying widget, but also on the evolution of the probability of theft. Price will increase if this probability goes up. As an example, if we raise the ratio from 1/10 (10%) to 2/10 (20%), the new adjusted price becomes £125, as the retailer will only receive payment for 8 widgets. That is an increase of 12.6% compared with the ‘10%-theft rate’ scenario.

Although completely immoral (and, to be fully clear, I do not seriously encourage this practice at all), favouring shoplifting would consequently lead prices to mechanically increase and ultimately raise inflation – which is defined as “the rate at which the general level of prices for goods and services is rising”. The bar would have to be raised quite a lot though, since the £335m mentioned earlier barely represent 0.01% of UK GDP in 2014…

In a later post I will address this topic from the angle of game theory, framing the issue as a game between the shoplifter and the shop itself. One of the rather obvious conclusions of this exercise is that excessive expected shoplifting will lead the shop to take drastic preventive measures which will fully deter shoplifters – there is therefore a ‘ceiling effect’ and a limit to this policy.

P.S.: Readers interested by this kind of ‘outside-the-box’ economic thinking may be interested in having a look at Levitt’s and Dubner’s famous Freakonomics blog.

On dividends and share buybacks

Note: Today’s post is solely based on French references. For once.

As some of you may know by now, corporate finance is one of my ‘little weaknesses’ and I am always fond of press articles illustrating – with very variable success – simple corporate finance theories. Last Friday the French newspaper Les Echos involuntarily published two great articles on the use and impact of dividends and share buy-backs.

In a nutshell, the first article voiced the disappointment of TF1’s shareholders – TF1 is the largest private TV media group in France – as the dividend in 2015 was lower than in 2014 and the share buyback program of €30m was less sizeable than expected. One expert quoted in the article stated that “one could have expected more cash return to shareholders after the Eurosport disposal”.

Credits: Jantoo.com.
Credits: Jantoo.com.

And yet this is a common fallacy in which many shareholders fall. Higher dividends can be seen at best as neutral, but more often than not they are send a negative signal to the investor community. Why? Dividends are by definition money paid by the company to its shareholders. It is simply a transfer of wealth, not a value-creating mechanism, and as a consequence any dividend payment is reflected in the share price ‘at cost’ – i.e. if a share is worth $100 pre-dividend and it pays a dividend of $5, the post-dividend share price is $95. Therefore, any shareholder can decide himself of the dividend he would like to receive, by selling (if the dividend is perceived as too low) or buying (if the dividend is perceived as too high) an appropriate number of shares. Worse, a ‘forced’ dividend payment implicitly assumes that the company cannot do anything better with the money than giving it back to its shareholders. This is a gloomy conclusion, if we consider the fact that many Treasury Bills pay a negative interest rate and stock markets stumble around.

And this is why the second article offers a more balanced view on the benefits of share buybacks. In one hand, several experts interpret this as a positive sign if the company is able to maintain its margins in the future and benefits from a strong cash position. On the other hand, many others perceive this as “waste” and missed opportunities in a low interest rate environment. France is by no means isolated, as the chart below shows.

Quarterly Share Repurchases ($M) and Number of Companies Repurchasing Shares. Source: FactSet.
Quarterly Share Repurchases ($M) and Number of Companies Repurchasing Shares.
Source: FactSet.

To conclude, the fact that share buybacks are making a comeback is worrying sign for the state of the global economy. Companies are struggling to spot even barely profitable investments while shareholders are ready to claim their money with limited investment alternatives available. At a global level, all the money leaving the economic circuit is ultimately harming the recovery – through what economists call the multiplier effect, more on that in another post. This is no more, no less the vicious circle Joseph Stiglitz was also condemning in his latest Les Echos column. Shareholders must be careful about what they ask.

Updated: As I was finalising this article, I came across this article from today’s Financial Times which not only provides further quantitative evidence to the rise of dividends in 2015 but also jeopardises my promise to only quote French articles…

Twitter or swansong?

Twitter released last week its results for the financial year 2015. The event offered mixed news, the significant increase in revenues (from $1.4bn in FY14 to $2.2bn in FY2015) being offset by the stagnation of the monthly active user base to 320m over the last 2 quarters of the year.

By judging at the share price evolution over the next trading day, stock markets were clearly not expecting such an outcome. Share price dropped by as much as 14% before recovering and closing the day with a limited loss of 1.9% – although no new data had been released in the meantime.

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Black or white swan?

This behaviour illustrates the difficulty analysts and investors have to value many of the ‘2.0’ companies. LinkedIn learnt it the hard way, giving up half of its market capitalisation in one day after announcing its 2015 results a couple of weeks ago. Other companies such as Google, Facebook or Amazon also had their own fights against the stock market but now offer relative steadiness in an industry known for dramatic and disruptive change.

SP evolution
Indexed share price evolution of Twitter, LinkedIn, Facebook and Google compared with the S&P500 (index 100 as of January 2014). Source: CapitalIQ.

Twitter is even more of a ‘tough beast’ since, contrary to the three other companies listed above, it keeps bleeding cash. Lots of cash. As much as $580m in 2015. The situation is not hopeless though. In one hand, the company’s operating cash flow (i.e. the cash generated by ‘day-to-day’ activities) increased significantly, from $82m in 2014 to $383m in 2015. On the other hand, over the last couple of years, the company spent an average of $1bn per year in investing activities. Investors are now trying to assess whether Twitter’s survival goes through colossal investment needs and, if so, whether Twitter will be able to generate sufficient operating cash flows to offset these costs.

Part of the answer lies in the purpose and the business model of Twitter. Both of which are not very clear and distinctive. We use Facebook primarily to interact with friends, LinkedIn is our professional ‘shop window’, Google provides services making our life easier (including email). Conversely, the ‘raison d’etre’ of Twitter’s 140-sign messages is far from obvious – and the way to monetise them is even less so. By judging at the relative variance in analysts’ target share prices, this questioning seems widely shared.

Rebased distribution of analysts' target share prices as of 16/02 for Twitter, LinkedIn, Facebook and Google (100 = share price as of 15/02). Source: Author research.
Rebased distribution of analysts’ target share prices as of 16/02 for Twitter, LinkedIn, Facebook and Google (100 = share price as of 15/02).
Source: Author research.

Last but not least, the Twitter case also embodies the shortcomings of EBITDA as a meaningful financial aggregate. Despite the Enterprise Value / EBITDA ratio being widely used by investors, the EBITDA aggregate is in this case meaningless and even more when it is ‘adjusted’ as per Twitter accounts. Losing $580m of cash is indeed not incompatible with the fact of reporting a highly positive adjusted EBITDA – $558m to be precise. The main reason is that the large investments Twitter agrees to today are by definition capitalised and amortised and therefore accounted for in the ‘Depreciation & Amortisation’ line of the P&L (that is to say, below EBITDA). As written earlier, disregarding these investment needs when valuing the company would be careless.

8 similarities between MBAs and the Premier League (2/2)

[continued from last week]

5. The importance of diversity could lead to artificial price disconnects: In the article mentioned in the first part of this post, Bhavik Trivedi, managing partner of Critical Square, an MBA admissions service, put it simply: “Gender diversity is important to schools and competition to attract top female talent is steep”. Practically speaking, one could expect that, all other things being equal, business schools will be more willing to stretch their offer to attract talented female students. In Premier League, the ‘Home-Grown Player Rule’ requires any squad to include at least 8 (out of a maximum of 25) players who have played at least for 3 entire seasons or 36 months in English or Welsh leagues before the age of 21. And yet the depth of the England-raised talent pool has varied over time and this has led to episodes of relative supply shortage, and therefore inflated prices for English players. One may remember the £30.75m Liverpool paid to lure Andy Carroll away from Newcastle in January 2011 to replace Fernando Torres. Experts judged at the time Liverpool overpaid Carroll, primarily for two reasons: (i) having lost Torres, Liverpool was short of a striker 24 hours before the end of the transfer window and (ii) the club was also close to breaching the ‘Home-Grown rule’. Ultimately, Carroll scored only 11 goals in 58 games under the Reds jersey before being sold to West Ham in 2013 for £13m – probably not the best return on investment.

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Andy Carroll celebrating one of his £2.9m goals for Liverpool

6. The price to pay will increase for the general public: Tuition fees for MBAs have increased over the last decade much faster than inflation or growth for MBA salaries. In a 2013 article, The Economist criticised the London Business School (LBS), UCLA Anderson and the Hong Kong University of Science Technology for having excessively raised their fees since the beginning of the decade – +250% between 2000 and 2013 for the latter. The trend has not slowed down since; for instance LBS raised its fees from £57,000 in 2012 to £70,800 in 2016 – a 5.6% CAGR, well greater than inflation. The Premier League has also become increasingly onerous for all stakeholders since its creation in 1992. On the media right side, BSkyB and the BBC managed to broadcast the 1992-1993 season paying less than £65m in rights. This era is over. In the most recent round of negotiations, Sky and BT together had to pay a total of £5.2bn to secure TV rights for 3 seasons, from 2016 to 2019, representing a 71% increase compared with the price for the period 2013-2016 and leading each game to cost on average £10.2m in rights only. Spectators and TV viewers were not left out of the spiralling inflation, with ticket prices and TV subscription prices sky-rocketing. Even the English people’s legendary composure proved not sufficient to digest the bitter medicine. In Liverpool, fans organised a ‘Walk out on 77’ a couple of weeks ago to protest against the price of tickets for the game against Sunderland – the cheapest were priced at £77.

7. Coaches/teachers are highly paid but their impact on performance remains to be proven: The salary comparison website Glassdoor states that an Associate Professor at the London Business School earns an average of £155k, although the quality of teaching has a limited impact on the MBA graduates’ future career prospects. In football, coaches are very often pointed out and they are usually the first – because least expensive – fuse to be replaced when their team performs below expectations. Conversely, coaches with outstanding track records have seen their quote soar over the last few years, and ‘stars of the bench’ have nothing to envy with the likes of Messi and Ronaldo when it comes to salaries – Guardiola and Mourinho make close to €20m a year. Academic studies have nonetheless demonstrated that a mid-season change in coach has ‘no statistically significant impact’ on a football team’s performance, i.e. the performance evolution post-change is not better than the usual ‘regression toward the mean’ the team would have witnessed anyway, irrespective of the coach.

Merit or statistical artefact?
Merit or statistical artefact?

8. Clubs/business schools entering a downward spiral will struggle to survive: All business schools cannot brag about an impressive alumni network, state-of-the-art buildings and glossy school magazines. ‘Top-tier’ business school are just the trees that conceal the forest. Indeed, behind this handful of stellar brands, a significant share of the post-graduate education market struggles to survive financially, despite the aforementioned increases in fees. As explained in a Financial Times article dating back from 2012, some of the key reasons are simple to understand: if not protected by the ‘power of their brand’, MBAs face increasing competition from alternate ways of learnings, primarily MOOCs (Massive Open Online Courses), which offer highly customisable, great quality programs at a fraction of the cost of an MBA. Furthermore, MOOC platforms have developed a system of official certificates to ensure that students can get recognised for completing these online trainings. In football, a series of disappointing performances or poor (not to say unlawful) club management practices can lead a formerly European title contender to the abyss of minor leagues. Numerous examples have emerged over the last few decades across Europe, including Parma in Italy (which went bankrupt twice in the space of 10 years), Leeds United in England and the Glasgow Rangers in Scotland. Despite their old glory and impressive number of fans, it will take years for those three clubs to get back on their feet and play the top roles again.

The Glasgow Rangers playing a league game in 2015 against Alloa, a town with a population of 19,000.
The Glasgow Rangers playing a league game in 2015 against Alloa, a town with a population of 19,000.

Any other idea? Feel free to share it as a comment below!

Updated: The Financial Times reported this morning that Liverpool was indeed offering the most expensive Premier League season tickets when adjusting prices for local income levels.

8 similarities between MBAs and the Premier League (1/2)

A cynical mind could defend that the ultimate goal of both education and sports is to rank people according to intellectual or physical ability, and this at all levels. At the top of the pyramid, MBAs tend to be regarded as the most prestigious diplomas, while high-flying professional leagues, such as the Barclays Premier League in football, dominate the world of sports. Interestingly, interesting parallels can be drawn between those two areas. I have listed 8 points, but I am sure there are many others. I have split this post in two parts to make it more digestible. The second half will follow early next week – in  the meantime please feel free to comment and add your own.

barclays-premier-league-logo-wallpaperivy_league_pennant_set_9152big

  1. The objective economic value of both MBAs and the Premier League is debatable: For MBAs the question has been around for years, and actually a straightforward Google UK search for the terms ‘Is it worth doing an MBA?’ will return an excess of 24 million results. The opportunity cost of taking one or two years off often outweighs the accelerated career progression an MBA promises – and even when it happens it is never possible to cleanly delineate the benefits directly attributable to MBAs. When it comes to the Premier League, one could adopt a relatively harsh viewpoint and declare that this competition does not manufacture any product or does not create any value-added service – although this statement obviously neglects the economic activity induced by the organisation of such events as well as the social and health benefits of physical exercise.

2. Competition between top schools/clubs is increasing and happens on a worldwide basis: MBAs have been fighting against each other for years, trying to make it to the top of world-famous rankings such as the Financial Times’ Global MBA ranking. Competition has undoubtedly reached a worldwide scale if we look at the origin of the business schools contained in the latest FT ranking: 19 countries are represented in the top 100, from the US (50 schools) to the UK (13), China (6) and more ‘exotic’ locations such as Portugal (1) or South Africa (1). In football, the 1995 Bosman ruling facilitated the transfer of players within the EU and the net has since then widened to allow clubs to recruit a limited number of non-European players.

3. The price for top talent will keep rising: In football, the globalisation of the market for top talents, coupled with the development of football as an economic powerhouse, has led to an explosion of the price paid for top players. A Wikipedia article has listed the highest player transfer fees over time. Even when adjusting for inflation, some of the best players of the past decades would be considered as bargains by today’s standards: Johan Cruyff’s 1973 move from Ajax to Barcelona cost the Spanish club the equivalent of a mere £922k and no transfer fee had ever exceeded the £15m mark before 1996 with Alan Shearer – the same mark would apply to an ‘average plus’ player today. Since then inflation has been more and more pronounced, culminating with Cristiano Ronaldo’s and Gareth Bale’s transfers to Real Madrid for £80m and £85m at the beginning of this decade. The rising role of Mid-Eastern and Asian clubs witnessed during the recent transfer windows – in particular China last month – will only accelerate this trend.

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A £165m hug

Competition for MBA students has not reached this extreme – and will likely never do so -, although an interesting article from the Financial Times concludes that business schools are more and more using their scholarships as a way to attract the best students rather than broadening the pool of potential applicants. On top of fiduciary benefits some schools also offer ‘benefits’ such as “preferential access to certain faculty members or guest speakers” according to the same article.

4. Schools/clubs are building a strong intake/team not only to reign now, but also to facilitate recruitment in the future: The quality of the alumni network is a key component of the MBA offering and top business schools need to maintain their status as a regular supplier of blue-chip executives. The recruitment of high-quality students can therefore be considered more as a long-term investment aiming at improving the executive pipeline in the future – for an example see this page listing selected famous Harvard alumni. For football clubs, the recruitment of a star is a way for a club to signal a step change in standing and to lure other strong players as part of this ‘transformation project’. Putting aside Real Madrid, who has been spending huge amounts in top-class players for years, Fulham for instance (unsuccessfully) tried to do so in the early 2000s, then Manchester City, and more recently Paris Saint-Germain with the recruitment of Zlatan Ibrahimovic, without whom PSG would certainly not have signed the likes of Di Maria, Cavani and Thiago Silva.

Zlatan and his gang of lads
Zlatan and his gang of lads

[To be continued…]