Thursday, September 19, 2019

Stocks v. Bonds - Again

Who owns a company?  The shareholders or the bondholder?  The real answer may surprise you.

Back in the olden days, if you wanted to start a widget company, you sold stock, which represented shares of ownership in the company.  If you made money, the shareholders were paid dividends, which represented their share of the profits of the venture.  It was really a pretty straightforward deal.

If a company needed to borrow, they went to the bank, or maybe issued bonds.   But bonds, as a percentage of the "Enterprise Value" of the company, were a pretty small fraction.

All that has changed.

Since those days, corporate bonds have become a thing, and it many cases the real owners of a company are the bondholders not the shareholders.   As bondholders, you are a creditor of the company - someone owed money, just as the suppliers might be, or even the company pension plan.   If the company goes bankrupt - which today seems to be more of a "when" thing than an "if" thing - the creditors often end up as shareholders of the new company and the existing shareholders are wiped out.

The Sears debacle is a case-in-point, and has been the world's largest slow-motion con-job to date.   We all saw this coming for years.   Mr. Eddie Lampert drove the company into the ground - perhaps by design - by failing to update the stores or product lines.   Over the years, unprofitable stores were closed and many of the assets, including brand-names, sold off - with the money often going into Mr. Lampert's pocket, directly or indirectly.

When the charade of turnaround plans and "shop your way" finally collapsed, guess who ended up owning the remains of Sears?   You betcha - Mr. Lampert.   You see, he "lent" money to Sears over the years until he became their largest creditor - also shareholder and CEO, but that's not a conflict of interest and donchuforgetit.   When Sears went bust, he lost his stock "investment" but walked away with the rest of the company.  Oh, and he got paid all those interest payments on the loans he made to Sears over the years - so he likely didn't even lose money in the bankruptcy.

Now, whether this turns out to be a smart move remains to be seen.  Mr. Lampert is apparently betting on either a revival of Sears, or making money by slowing selling off the remaining bits.  Sears probably would have failed in any event - but the way he dragged it out, he ended up making money from the carcass of this old company.

Other shareholders, of course, are outraged, but largely impotent.  Oh, sure, they'll sue, and lose - and the cost of litigation has already been factored into Mr. Lampert's scheme.   In the end, Sears will either finally dissolve, as Radio Shack did, or maybe emerge as a niche market retailer - but I think that is highly unlikely.   But you never know - tiny Sears stores still thrive in many small towns and in Alaska.

Multiply Mr. Lampert's scheme by 1,000 and you understand the scope of modern "Vulture Capitalism".   This is the same sort of scheme that made Mitt Romney rich - and totally unsuited to be President.  It is the sort of scheme Trump used to make money from failing casinos - and walk away from the wreckage unscathed.

Why do we let this happen?   Well, in short, there is no one else around.   Companies like Sears, or some small manufacturing company with a pension and hazmat problem are basically toxic assets.  No one wants the job as CEO of a failing company with no realistic turnaround options.  So the sharks come in, picking off the weaklings - cleaning up the environment and restoring balance to the ecology, in some respect.   The government could step in, I suppose, and slowly wind down a company like Sears, making sure the money received went into the pension and healthcare funds, and paid suppliers, instead of making a few people very wealthy.   But how could the government decide which companies should stay in business and which be wound down?  The results of such actions in response to the last recession illustrate that such actions could end up being arbitrary in nature - if not outright political.

So when a company is wounded, there is blood in the water, and the sharks start to circle.   And there is no one there to stop them, once they take over a company and start loading it up with debt - all in a complex plan to fail, while avoiding any obligations to suppliers, pensioners, or workers.

What can you do to stop it?   Probably not much, other that to make sure your company is healthy and has a good long-term healthy outlook, instead of, perhaps going on strike the first time the company shows a reasonable profit.   It also illustrates why relying on a pension is a sketchy thing these days, unless it is from the Federal government or some larger State or municipality (although, I guess California is the exception, perhaps other time bombs are waiting to go off).

Could we pass laws against this sort of thing?   Perhaps, but they would be hard to enforce.  Mr. Lampert can claim - with a straight face - that his turnaround plan, based on "shop your way!" was a serious attempt to revive the Sears brand, but that he was just a shitty manager and screwed everything up.  The classic "My Bad!" defense.   I'm not a criminal, just an imbecile - and he can say this and it is hard to disprove.   Of course, the fact he lines his pockets with Sears money sort of gives the game away.

But as an investor, what does this mean?   Well, for starters, owning stock isn't as attractive as it used to be.  I owned $5000 of the "old" GM stock, which went in value down to zero in short order.   The bondholders of GM bonds, however, ended up getting paid off - pennies on the dollar, of course - in "new" GM stock, which today has gone up in value to the point where those old bondholders might be doing pretty well.   They are doing better than I did, of course.   I ended up with nothing - as did a lot of other people.

This doesn't mean, of course, that bonds are the answer to everything.    I hate extremism - do all of this, none of that, eat all of this, none of that (which will surely make you sick).   Only that owning stocks isn't the end-all to investing, and can be quite risky, even if you are investing in "blue chip" stocks like IBM, GM, GE, and so on and so forth - few of which, of course, are "blue chip" anymore.

A diversified portfolio with reasonable rates of return is, in my opinion, better than some speculative investments that may pay off handsomely, or end up bankrupting you.