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Tuesday, January 26, 2010

Ponzi Of the Day - ADBE

From the NY Times Dealbook:

"Adobe Systems, the company best known for its Adobe Reader and Photoshop software, said Monday it priced $1.5 billion in new notes, and that most of the proceeds would go to repaying its existing debt.

The notes are to be issued in two batches: $600 million with a 3.25 percent interest rate maturing in February 2015, and $900 million with a 4.75 percent interest rate maturing in February 2020, The Associated Press said.
Adobe said it intended to use the net proceeds of the sale to repay $1 billion outstanding on its credit facility and use the rest for general corporate purposes.

The offering is expected to close Feb. 1."

Relevant portion: "most of the proceeds would go to repaying its existing debt."  And now, courtesy of Wikipedia, the definition of a Ponzi Scheme:

"A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned."

Kinda like paying off old investors by issuing new debt to new investors...

EDITa commenter points out that refinancing debt into a lower interest rate is perfectly reasonable, and not a ponzi scheme, which is absolutely correct.  Said differently, it definitely matters if the old debt ADBE is paying off is 8% debt due in 2020 (which would imply refinancing), or if it's debt due in 2010 or 2011 - which would imply ROLLING (ponzi).  When I read "proceeds go to repaying existing debt" I interpreted it as the latter - using proceeds from new debt sales to pay off debt that will be due imminently, as opposed to "proceeds go to refinancing existing debt," which would imply the former.

-KD

25 comments:

1090rule said...

Agreed, however, the reason we are seeing such an abundance of corporate debt is that the banks that are running the lines of credit are squeezing the borrowers dry.
What was Libor + 50 for BBB+ short term revolving credit in 2007 has become Libor + 300 now.
"We are still eager to lend" say the banks... sure they are, at the right price.
Yet, the market will buy that debt at Treasuries + 120, locked in with looser covenants? Who wouldn't roll?

Kid Dynamite said...

1090 - i can't blame the issuer... who is buying this debt though? T+120, and the explicitly stated purpose of the offering is to payback PRIOR investors!! AIYAHHHHH!

Anonymous said...

Everybody is shy about stocks but I can't believe how expensive corporate debt is relative to stocks.

There are good stocks, with constantly increasing dividends, that yield 2-3%.

Anonymous said...

Refinancing existing debt is Ponzi?
What about when IBM pays off 9% debt by borrowing @ 6% or I refi my mortgage.

Kid Dynamite said...

"Refinancing existing debt is Ponzi? What about when IBM pays off 9% debt by borrowing @ 6%"

yes anon - you are correct. sometimes it makes sense to refinance at lower market rates - frequently it does.

the wording of repaying existing debt, rather than refinancing existing debt into a lower interest rate may be a technicality, but it certainly has a connotation of being typical of the ponzi economy.

said differently, it definitely matters if the debt ADBE was paying off is 8% debt due in 2020 (which would imply refinancing), or if it's debt due in 2010 or 2011 - which would imply ROLLING.

Kid Dynamite said...

ps, anon - a mortgage refi is different - because mortgages get paid down on an amortizing schedule, while MOST corporate debt does not.

if you had a mortgage which required you to make small monthly payments (like bond coupons) for 10 years and then pay a giant lump sum at the end, and you got around that lump sum final payment at the end by taking out a new mortgage for 10 more years - then YES - that's ponzi!!!

wcw said...

Commercial paper is a Ponzi scheme? Who knew?

I do not think that word means what you think it means.

1090rule said...

Couldn't agree more KD. Debt has become revolving in all forms, rather than the original purpose which was to borrow to invest in a "project" (or business), generating income from that project that eventually allows the issuer to pay it off.

Finance and CFA types (a club to which I belong, for better or worse), decided there was an "optimal" amount of debt/leverage for a company to have (which depends on the business type) to maximize shareholder returns. Unfortunately, that amount has been increasing for the past 25 years and the "maximized returns" for shareholders has yet to be proven - at least without precise timing of ownership.

Kid Dynamite said...

@wcw - yes - absolutely - commercial paper is a ponzi scheme. you don't believe that? i'll give you two simple examples of what happens when the scheme collapses.

1) lehman brothers
2) CIT Group.

Kid Dynamite said...

ps - wcw - i should say that REVOLVING commercial paper (which i believe most of it is) is a ponzi scheme. not all short term debt is revolving, though.

1090's recent comment "Debt has become revolving in all forms," gets to the crux of my post - i have no beef with ADBE - but debt in all aspects of our society (credit card, mortgage (maybe not anymore!) government, corporate) is increasingly revolving... ponzi-esque.

Oddlot said...

No way, revolving debt is not Ponzi. To be Ponzi, it is necessary that returns to early investors be paid using principal from later investors.

Kid Dynamite said...

oddlot - didn't you just describe exactly how REVOLVING DEBT works? new debt (later investors) pays off old debt (early investors)... that's exactly my point.

when you run out of later investors and can't sell new debt (see: CIT!) the whole thing collapses.

Oddlot said...

KD - the distinction between principal and return is important. if interest is paid out of cash flow, there is nothing unsustainable about rolling debt. if there is no cash flow, and new debt is sold to pay return promised to earlier investors, that is ponzi.

i have no problem with CIT or anyone else going bankrupt. people lose money. no one gets their head cut off.

taken as a whole, the cap structure of houses was negative amortizing for years - HELOC's, cash-out refi so you could get your granite did - in addition to mortgages which had increasing principal by contract. then the whole thing collapsed, etc. that was ponzi.

Daniel said...

There is nothing wrong with leverage. But it is a two edged sword. And if you have idiots at the controls that lack experience and judgment then yeah, you get Lehman and Cit. But I strongly disagree with equating what you describe as a ponzi scheme.

Kid Dynamite said...

Daniel - CIT is a business that depended on its ability to issue short term debt to survive. when it lost its ability to issue short term revolving debt, it blew up immediately. how is that not Ponzi?!?!?!

once the new investors disappear, the game is over. that's the definition. and that's what happened.

oddlot said...

i would say CIT collapsed due to a maturity mismatch, not because it was a ponzi scheme

Kid Dynamite said...

oddlot - yes, its true that CIT had borrowed short and lent long. it's also true that if CIT had continued to be able to borrow short term, it wouldn't have collapsed...

look - any company that needs to repeatedly roll debt in order to survive meets the definition of a ponzi scheme. CIT seems to be a clear poster child for this phenomenon. Their cash flow didn't sustain them - their ability to roll debt did. PONZI!

oddlot said...

hahaha - no way man! NOT PONZI!

The SEC says:

"Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi"

You wouldn't argue CIT or ADBE have done anything illegal, right?

SEMANTICS!

Daniel said...

Ponzi implies an intent to defraud. It is the deliberate misuse of capital to defraud later investors to benefit early investors. Think about it this way: a retail store opens and floats debt to buy its initial inventory. As it turns its inventory over it makes a profit (hopefully) on what it sells. But it needs to replenish that inventory and always will and so constantly requires cash. Unless it can generate so much profit and cash in order to pay off the original debt it will always revolve the debt until the business winds up. Take another case, CAT. CAT revolves debt continuously and HUGE amounts because of the capital required to buy the raw material to build its inventory. And it will always do this. This is not a ponzi scheme. The terminology is completely erroneous.

Kid Dynamite said...

oddlot, Daniel -

1) i am definitely not accusing CIT, ADBE or any other company of doing anything illegal. fraudulent intent is merely one possible part of a Ponzi Scheme - and was Charle's Ponzi's mission objective. but
2) the point is that revolving debt ends badly at some point. this is true for individuals rolling credit cards, taking out HELOCS to pay off other debts, and even for the United Stated Treasury - even though we think that we have an unlimited ability to issue debt (and of course, if that fails, simply print our own money!)

now, daniel, you wrote "Unless it can generate so much profit and cash in order to pay off the original debt" - yes - that is the exact point of a business. to generate profits to pay off the debt they acquired to start their business! If they don't generate profits, but only survive because they sell new debt to pay off their old debt - guess what - THAT IS A PONZI SCHEME - fraudulent intent or not...

that doesn't mean they need to be debt free - as we all know, capital structure theory dictates optimal debt levels - but any company that will fail if it cannot sell new debt to roll its own debt is a house of cards. I use the term house of cards / ponzi scheme interchangeably, and again, i use it to imply nothing in the way of fradulent intent.

as for CAT, Daniel - they use their debt to buy capital equipment - which can be sold to pay down debt (although we know it depreciates rapidly). if they are unable to access the capital markets, they wouldn't blow up - they'd just have to stop growing and shrink, until they could access debt markets again. contrast that to CIT, which was instantly dead as soon as it lost access to debt markets.

Daniel said...

I think we are just going to have to agree to disagree.

Kid Dynamite said...

how about if i say "ponzi-like" scheme instead? or "revolving debt scheme destined to collapse like a ponzi scheme" (Aka: RDSDCLAPS)

Daniel said...

lol, ok, ok.

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Jabroni said...

KD,

Be careful here. Yes, there are no guarantees in life and even the most stable company can falter. But have you looked at the financial statements? Enterprise software is one of the best businesses around. The biggest software companies have margins (30%+ net income margins) that any other industry would die for. They have mad crazy cash flow. Most of the revenue for the biggest s/w companies, ADBE included, come from corporations, who are on multi-year contracts.

For years, software companies had zero debt and ridiculous amounts of cash. (Really, look at the cash on the balance sheets.) Then about 3-4 yrs ago they started taking on small amounts of debt (small in relation to cash on the balance sheet and/or cash flow). I think pressure from shareholders for more efficient capital structures had something to do with taking on debt, which I think is silly.

Anyways, accusing someone of a Ponzi scheme (either directly or indirectly) is a stiff charge. I don't think that it's applicable here and I don't think that this ADBE post is up to par with your other outstanding posts.

Note: I'm not involved with ADBE either professionally or personally.