Oh, Poor Me!
By Adrian Ash
January 19, 2008
All investing is risky –
all the way down to zero if you settle for paper and credit...
LET'S IMAGINE you'd forgotten – or you've
just set up a hedge fund in London – but shareholders come
last in line when a listed company goes bust.
Yes, you get to vote on who joins the board of
directors. You might even get first grab of any new shares that
will dilute your investment.
But you'll typically get nothing if the company
goes bust. And any business that hits the wall, as a rule, tends
to go bankrupt because it's run out of cash.
Standing behind creditors and bondholders,
therefore, waiting to collect whatever money is left, you can
forget about how you'll spend your share of the pay-out.
Which might be worth remembering when you next spot
a stock chart like this...
See that precipitous plunge starting in June of
last year...?
That's where two chunky hedge funds, RAB Capital in
London and SRM Global of Monaco, began piling into Northern Rock
– one of the UK's top five biggest mortgage banks. Between
them they built a stake that's now worth much less than it was.
On New Year's Eve, for example, RAB raised its
stake to fully 7.5% of Northern Rock's shares in issue, even
though its September investment had already shrunk by more than
one half. (The price of NRK has since lost another fifth, going
from £0.84 to just £0.68.)
The hedge funders' logic?
"The Company is a strong and viable
business," claims SRM, now holding some 10% of the stock.
In an open letter to other Northern Rock shareholders at the
start of January, "it is nothing like the 'lame duck' that
some would have you believe," the Monaco money-men said.
"We are shareholders in a company that has
true value in its assets, its brand and its employees."
Trouble is, SRM and RAB are indeed merely
shareholders – and Northern Rock's "true value" also
includes an emergency loan of £26 billion ($50bn) funded by UK
taxpayers, plus an explicit promise from government of a further
£30bn ($59bn) guaranteeing the cash deposits of the bank's
saving customers.
Those cash savers stand right at the front of the
creditors' queue (and they are mere creditors, too). Anyone
caught holding bank stocks today might want to recall that fact
before bleating about "true value".
"SRM believes that the Company's book value is
materially in excess of its current share price," the hedge
fund lamented in its open letter, "[and] SRM believes that
any sale of assets and/or business of the Company at below its
true value is detrimental to the Company and to its
shareholders...
"The Company's liquidity can be restored [but]
the Company currently finds itself in exceptional circumstances
and in these circumstances shareholders cannot rely upon the
usual safeguards, including those of seeking shareholder consent
for significant transactions."
Hence the Extraordinary General Meeting called for
this week by RAB and SRM. Both were desperate to stop the
nationalization of NRK's debts becoming a nationalization of its
assets as well. So they raised a motion to limit how far the
Board of Directors could dilute existing stockholdings in any
private-sector rescue plan.
"Roughly two-thirds of shareholders, taking
into account proxies, voted in favor of all of SRM and RAB
Capital's four resolutions," notes Martin Flanagan in The
Scotsman.
"The trouble was that three of them required
75% majorities."
So much for shareholder activism! Fewer than 600
people attended the EGM in person, according to The Daily
Telegraph. The two hedge-fund managers had hoped for 8,400
to fill the arena they'd hired in Newcastle.
And as for "exceptional circumstances"
whacking Northern Rock back in September, its perfectly sound
strategy relied on short-term credit to such an extent that it
had to beggar the Bank of England for emergency loans within
days of the credit crunch biting. If RAB thought the assets and
balance-sheet were so solid then, why didn't it pile in above £10
a share?
SRM now claims – and City rumor agrees – that
the sudden and vicious shutdown of the world's short-term credit
markets in the summer hit several other major UK mortgage banks,
too. No naming names, but if the City dumped NRK because it knew
the true extent of Northern Rock's woes, then what are private
investors – you know, the little guy – to make of NRK's
major competitors?
Their average 44% loss since the start of '07
compares with a mere 6% drop in the broader FTSE All-Share
index.
And given that UK house prices have only just
tipped lower after surging for 12 years, you might think the
City bankers trying to arrange short-term loans for the mortgage
lenders had "a word" or two with their equity desks,
too.
Glancing at Northern Rock's chart, you might even
guess you were right. But of course, that wouldn't be allowed,
not with the City's much-vaunted "Chinese walls" to
prevent it. Regulations forbid it!
"One of Britain's biggest property funds was
forced to shut its doors to withdrawals [this week] after the
slump in commercial prices triggered panic selling by small
investors," reports The Guardian. "Scottish
Equitable said that 129,000 small investors in its £2 billion
property fund [$3.9bn] will not be able to access their money
for up to a year..."
"It emerged yesterday that staff at some of
the property managers have been informing key clients in advance
that a fund is heading for suspension. The [financial watchdog]
FSA said that such trading may fall foul of its rules regarding
treating customers fairly."
Ooh, get you! Wouldn't want to let "key
clients" find their way to the exit while private investors
use nothing but Google as a flashlight now, would we?
"There are lots of rumors going about that
other providers may be considering following Friends Provident
and Aegon," says Jason Hemmings of Albannach Financial
Management in Edinburgh.
Friends Provident closed its property fund to
withdrawals in December. Aegon runs the Scottish Equitable fund,
now closed to new business and closed to withdrawals for 12
months or more.
Whoever's next, you can bet the City regulators –
the Financial Services Authority – will be right on top of any
"unfair treatment". Just like they kept on top of the
collapse at Northern Rock, avoiding disaster, panic and a huge
tax-funded bail out with no near-term hope of repayment.
"I was surprised they were not more
angry," said Bryan Sanderson, chairman at the Northern Rock
EGM, of the smaller investors who attended the meeting this
week.
"They behaved very well indeed, which is a
testimony to them all."
Well, maybe. Either that, or the little guys' good
behavior shows that NRK's smaller stockholders have accepted
what the hedge funds will not:
All investing is risky – all the way down to
zero. If you want property rights with no risk of default, then
you should Buy Gold
outright. Shareholders get squat when things go to the wall.
(Even cash-savers are mere creditors, sitting on risk that few
if any accept.)
And if government steps in to bail out a business,
it should've gone to the wall anyway.
Sure, the mortgage-book assets of NRK outweigh the
tax-funded obligations, net-net. But a bank that needs a $50bn
loan just to stay afloat...after suffering the first British
banking run in well over a century...is hardly what you'd call a
going concern.
Not unless you're trying to nick a quick profit,
buying the shares amid a 95% plunge, and gambling on a
free-market takeover in the teeth of a very tax-funded rescue.