Just how will American apparel avoid a Halloween fright?

‘Trick or Treat’ has long been a tradition for going from house to house searching for goodies until you’ve taken on too much to carry, which in this case it exactly what American Apparel have done, in the form of debt. As a general principle, companies that have stable sale figures, assets that make good collateral for loans and a high growth rate can use the advantages of debt more heavily than other companies. Recall that the main benefit of increased debt on the capital structure is the increased benefit from the interest expense as it reduces taxable income. Given this statement and American Apparels situation, wouldn’t it make sense to maximize their debt? My answer is no.

In general, using debt keeps profits within the company, increases returns on equity for owners and helps secure tax savings, as well as retaining control of the company.  However, with an increased debt load, interest expense increases and this idea of financial distress becomes apparent. Debt issuers become nervous that company cannot cover its financial responsibilities and this comes no surprise to investors of AA as the company have filed for bankruptcy protection as substantial doubt surrounds the business and investors could incur big losses. So where did it go wrong for the retailer?

AA has high gearing and tried to take on as much debt as possible to increase the value of its company in the long run. As a result, its debt pile grew to 11.6 times its annual earnings before interest, tax, depreciation and amortisation as of March this year, an increase from 8.6 times in 2014. Consequently, it struggled to implement a turnaround fast enough to stem the sharp decline in its stock price, closing at 11 cents on Friday October 2^nd.

Why do you think that the management would allow such a highly leveraged capital structure? In 1963, Modigliani and Miller revised their original theory of capital structure to take into account a more real world approach and incorporated tax into it which showed a substantial benefit to borrowings. On one hand, I can understand why management at American Apparel would highly leverage its capital structure, mainly because the after-tax cost of debt is usually less expensive than equity; so firms will add debt up to the point where the risk of bankruptcy raises the WACC. As a result, the company will favour using debt as a source of its financing when it enjoys a tax shield.

On the other hand, I would look at my first question, how can we know when we’ve maximised our debt? American Appeal should have looked into the market conditions and its own financing before taking on too much debt. MM argues that in the presence of bankruptcy costs, firms should be concerned about having too much debt, this I would agree with. AA could have realised its capability in static trade-off models, which it could have used to maintain its optimal capital structure in the face of market imperfections such as bankruptcy, taxes and debt tax shields.

The current status of Capital Structure research and theory is perhaps best summarised by Baker et al. (2010) “The status of our understanding of how managers actually make capital structure decisions does not appear to be anchored by any of the extant academic theories. Despite several decades of theory development and refinement, none of the normative capital structure theories indicating how managers should act seem to fit the survey data.” This I would agree with as in the real world, managers decisions are altered by the several circumstances. In the case of AA, It depends on various factors such as the type of economic conditions and the time period. In light of the AA situation, maybe it’s time companies actually paid attention to theories, maybe they’d learn a thing or two.

The magician who made $65 billion disappear

Berard Madoff: The Madoff Hustle

‘The closer you look, the less you see’ is a great line for a magic trick, but an even better line for a fraudster, and in this case, Bernard Madoff nailed it. In his $65billion Ponzi scheme he ruined thousands of lives, from small time investors to sophisticated money managers in what is the largest stock fraud in history. So how did he do it? Once Madoff managed to revive his scheme, it required a constant influx of additional funds. On its surface, the fraud looked real enough to attract interest from new investors to help pay off client’s doubts and make the scheme look profitable for everyone.

So what went wrong? IT WAS A SCAM PEOPLE! Even for me, a young upcoming financial student this fraud sounds ludicrous, how does a man of Madoff’s background not only convince over 1000 wealthy people to invest but also manage to nutmeg regulators? Unbelievable tekkers if you ask me. Some could argue that Madoff was a trustworthy person and a huge credible man, promising returns of around 10% annually, which isn’t much, but is steady. Others could argue that because of the steady return, Madoff could have a source for insider information to help beat the market consistently.  I would argue that all people did was dump money in, do no due diligence and count their money, why did they think it was plausible? 

In my opinion, the fault is not with Madoff, rather with the investors who didn’t look beyond the promised rate of return and were gimmicked into this personification of wealth. Some of Madoff’s investors had been investing in his fraud for 21 years and as a result lost everything. I feel that through investing in one particular stock makes these people very vulnerable, I say ‘people’ because most weren’t real investors rather people wanting a good return.  

Portfolio theory suggests that it is possible to construct an "efficient frontier" of optimal portfolios, offering the maximum possible expected return for a given level of risk. The theory suggests that it is not enough to look at the expected risk and return of one particular stock, which is what most investors did in Madoff case. If the investors were to invest in more than one stock, the investor can reap the benefits of diversification, particularly a reduction in the riskiness of the portfolio. Therefore, not putting their eggs in one basket and risking all of their investments falling at once. If they were to have created a portfolio of shares, investors wouldn’t have lost everything, rather just one stock, which is what I would have done as an investor.

The real scam in this is market manipulation, an inefficient market, which potentially could affect investor confidence in the future. The regulators in my opinion were responsible for the colossal amount of the scandal. Tighter regulations need to be put in place to prevent Ponzi schemes from ever happening through more thorough searches.

Seven years on from the scandal, it looks as though the majority of Madoff’s victims are going to get a big pay-out (Popken, 2015). I’m guessing along with his houses, they also sold Madoff’s winter clothes; he won’t need them in prison.

Until next time, I leave you with a quote from Harry Houdini, ‘My professional life has been a constant record of disillusion, and many things that seem wonderful to most men are the every-day commonplaces of my business.’

Leave a comment if you have something to add, whether agree or disagree!

Avengers Assemble

Financial Times: Fantasy Sports: Rule-playing games

Goooooooood morning Newcastle! In today’s rant of the week, I welcome you to a scandal which has erupted in the industry of fantasy sports, an online and apparent ‘regulated’ market. Sports enthusiasts build and assemble their elite avengers ahead of the national football league season, evidentially the busiest time of the year for fantasy sports.

In the last few weeks, the industry has attracted the interest from many law firms and government officials regarding its inefficient market over the controversy of a DraftKings employee winning $350,000 playing on its rival site FanDuel. This has led to the suspicion of misusing insider information for personal gain. A question that comes to mind - how and why are employees of the two companies allowed to participate in a pay to play league with the general public? Questionable corporate culture if you ask me. If more rules were in place and employee involvement was banned, the market would certainly be more efficient and this idea of ‘insider trading’ wouldn’t exist (perhaps). Moreover, if there was a separate area where employees from both DraftKings and FanDuel could compete with one another, this would allow the use of insider trading, just not against the public. Then again, what’s to stop employees from playing on other people’s accounts (say a friend)?

 “The single greatest threat to the daily fantasy sports industry is the misuse of insider information,” (New York Times).  

This industry is under real scrutiny unless real safeguards are put into position to make it more market efficient for investors of the industry. I myself as a huge fantasy enthusiast ponder on the idea of insider trading, especially when my own money is at risk. Withholding information from the public is unacceptable; again, questionable corporate culture. After all, the two companies are built on a shaky legal foundation, declaring their games “100% legal”. But an interesting question, if online-gambling is ‘illegal’ in America, what exempts fantasy sports, which is a form of online-gambling?

The Efficient Market hypothesis states that a market is ‘informationally efficient’, which means that it is good at pricing assets based on the information that is currently available. I’m going to look at the concept of EMH from a different angle, applying it to fantasy sports. In this scenario, NFL drafts are the market, although a market that trades in players instead of companies. For example, NFL franchises, like investors, have a strong financial stake in ensuring their valuations are as accurate as possible. Similar to investors, NFL franchises are gorgers for information, seeking information that might be relevant to a player’s future to make informed decisions. Furthermore, while investors might not be perfect at pricing the assets, the NFL draft involves an open competition between different agents who are looking to buy players when their price falls, or sell players if another team is willing to pay more than they’re worth. I believe that this market shares common characteristics with the stock market for this reason.

My questions to you, the reader, just like the stock market, how can we be sure the NFL draft is an efficient market?  Unlike the stock market, which is heavily regulated, fantasy sports have loopholes which need filling. If the NFL draft was an inefficient market, you would expect individuals would outperform the market consistently, compiling many strong drafts against a few weak over a long time period. If it was an efficient market however, despite recent successes, they’d perform no better.  This relates to this idea of a ‘random walk’.

In regards to my question, considering no individual is capable of judging a player at a rate that outperforms the market consensus, i’d like to say the market is efficient. Just like there is a weak form, a semi-strong form and a strong form in finance, I believe this can be related to the NFL draft, or fantasy sports.

“How can you build a brand when you value it so little?”

Digby Jones: The New Troubleshooter: Episode 1

In Great Britain over 180,000 people make, build and sell furniture. The marketplace accommodates for over £7 billion spent yearly by consumers, the equivalent of £100 for every person in the UK. Within this competitive environment is Hereford, a manufacturing furniture company questioning its survival among other major players in the industry. Having made a loss of £80,000 for the first time last year, there are questions that need answering.  Lord Digby Jones is first to the scene to transform a wounded business into a strong sustainable competitor.

As a generic principle, no business can succeed without understanding its customers, its products and services and the market in general. Competition in the furniture industry is often fierce, especially for a family run business like Hereford with no real financial backing from investors to help fund operations and growth. Within the industry, major players such as IKEA have a commanding presence and market share due to their resilience and constant need for innovation. In Hereford’s case, the market around them is contracting due to the influx of players in the market. IKEA for one have dominated through their ‘flat-packed’ products, offering customers affordable furniture. A major concern for Hereford is the huge product lines they offer, currently at 2,000 products in their portfolio, which is thought to be ‘killing the business.’

A question to be considered, 'how could the management at Hereford Furniture allow its company to approve over 2000 products into its portfolio and have no financial implications to the effect this would have?' It can be seen that managing production and range has had a dramatic impact on profits, perhaps a reason for an £80,000 loss last year. A solution to the company’s problems would be to cut its products down a sizable amount in order to cope with orders and to reduce costs. Such an operation would involve indicating which products are bestselling to worst selling. Unilever in the late 90’s had the same issue and cut 700 brands and saved over £1billion in the process, certainly something Hereford should consider. Certainly a lack of communication can be considered here between management and employees. Lord Digby’s response was to trim the products down considerably and focus on a small number of products and implement a make-to-order system. This is one way the company can cut back on costs and improve its profits for next year.


On first impressions of the workforce, the systems in place were not conducive to productivity enhancement, as departments were working independently from one another with no cohesion. Immediately a concern area here as a problem in one area could potentially stop all other operations. Digby’s response was to consult all departments in the business, only to find that everyone was unhappy with management decisions due to lack of factory floor appearances and lack of communication. Meetings were scheduled with managers from every department and also from top management in order to talk over improvements. A fun morale boost was to shut the factory for the day to organise a staff trip to an art college to build team cohesion through designing a new stamp for the furniture. Although only a few changes were made, it’s certainly a step in the right direction.


In terms of value management, the future of Hereford will depend upon its ability to diversify and innovate. Currently, the company doesn’t put its name on any of its products therefore not creating any value for its brand, which is why I named the title of my blog ‘How can you build a brand when you value it so little.’ Reflecting back to earlier in this blog about the importance of understanding customers and products and services, I don’t believe Hereford has a full understanding of its marketplace. The strategy seems to be focusing on profit maximization, hence three different business channels. This strategy has been beneficial in the short term; however the company has ignored the long term financial implications, another reason for its £80,000 loss.

Reflecting upon the operations of the company, Hereford had managed to over complicate it through operating three different channels; manufacturing, importing and retailing. Although Digby said to focus on one area (manufacturing), it can be argued that importing from China would be a route to take; UK manufacturing is still booming, but arguably it is cheaper to outsource. With the rise of IKEA and its flat packing, this can be considered an obvious concern for Hereford as they cannot be as competitive in their pricing as IKEA, therefore reducing their profitability and consequently, market share. From a shareholder wealth perspective, Hereford should be exploiting the opportunity to expand, however first must consider if it has the resources to continue operating three businesses, or whether one is more logical. Having researched into what the company is today in 2015, its original idea of changing the brand name to ‘Hygge’ has collapsed due to the brand already being owned by a Thai furniture store and Instead has become Oak Furniture Solutions. In terms of its products, there seems to be no indication of a decrease in its product portfolio however the company has decided to innovate with alternate colours and designs.

Overall I would rate Oak Furniture Solutions 5/10 for its little improvements.