Stripnomics

and I just know they don’t make sense. My problem is that I’m not an accountant. It’s not that I didn’t understand or enjoy Accounting (took a few quarters), but disciplines can be like women. Even though there are a lot of cool, sexy ones, there are a lot fewer that you can really get to know well. Some of them are real bitches too :) 

This is a spreadsheet detailing the “Net Cash from Financing Activities” for Berkshire Hathaway, Lehman Brothers and ProLogis for 2003-2007:

	NET CA$H FLOWS FROM FINANCING
	2003	2004	2005	2006	2007
Berkshire Hathaway*	-$61,000	-$156,000	$5,751,000	$2,490,000	$1,366,000
Lehman Brothers**	$3,435,000	$11,619,000	$12,112,000	$38,255,000	$48,592,000
ProLogis***	-$13	$37	$1,713	$1,645	$2,742
	All data is shown in millions.
*   Compiled from 2007 and 2005 annual reports
**  Compiled from 2007,  2006 and 2005 annual reports
*** Compiled from 2007 annual report

If these numbers applied to you, they would represent the net effect of all your borrowing on liquid cash reserves in all your bank accounts or pocket money. Everyone needs some amount of cash reserves in case something goes bad. You can rely on borrowing from others for rainy days but that’s risky because it’s not always within your control.

Ideally, your business is always spittin’ off enough cash that you never need to borrow any, but that’s just not realistic. Sometimes shit happens: perhaps it’s hard times, maybe it’s a growth opportunity or simply just some crazy times partying.

If there are not a lot of stable growth opportunities that require capital, I view increasing numbers in each series as a bad thing. It’s comparable to the annual dirty little list of cash advances you take out on the Visa that are not paid off (including those 8am sunrise ones at Spearmint Rhino).  You can’t maintain that kind of lifestyle over the long-run. That’s why a real playa like Jay-Z rolls with the Black Amex and pays it off every month. 

However, in business this is an acceptable and recognized strategy for maximizing profits by optimizing your capital structure. But like credit card cash advances, they can get out of control fast. That’s why I think it is a good proxy for determining overrall leverage and the propensity for bankruptcy. I would call it “Implied Leverage”.

You will notice that the trend for Berkshire Hathaway’s numbers varies while Lehman and ProLogis increase. Warren knows that you can lever at times but you can’t lever all the time. Leverage is best employed when the probability of growth is high because if you get caught in a stagnant or negative growth situation you can fall prey to my oft mentioned term, “Gambler’s Ruin” or “Leverage Cancer”.

In gambling, this occurs when you lose your bankroll and your ability to obtain a bankroll. In the context of a firm, it is when the firm’s debt can no longer be serviced or restructured. In the context of life, it is death. Here is a graph of Bershire Hathway:

You can see that Warren uses cash-flow leverage but employs it carefully. In 2003 and 2004 he didn’t use any leverage. in fact, he reduced his cash reserves to pay down financing. He put a bunch of chips on the table in 2005. SInce then he has reigned it in. Even then, he is levered relatively small in comparison to his annual revenue stream.

Here is Lehman’s:

And Prologis:

Notice anything similar between the last two? Look at the slope. You will recall that slope = rise ÷ run. Thus, a curve with a slope = 1 looks like the hour hand exactly halfway between 1 and 2 on a clock. The slope of the curve approaches infinity as it goes vertical (like 12 on a clock). As the slope approaches infinity, the likelihood that the firm becomes bankrupt also becomes infinitely more likely since it is not realistic for a firm to have infinite borrowing capacity.

You can also think of the graphs in terms of it representing a see-saw. The fulcrum x-axis. The slope represents the angle of the the see-saw to the x-axis. When the slope is less than one, the see-saw can be controlled and moved an object on the otherside upward  - which is good leverage. When the slope of the stick lever is greater than “1″, you start moving the an item on the otherside of the see-saw sideways, so your leverage is getting bad. While, the solution is usually to try to get make your side of the see-saw bigger (longer), in reality there is not always a bigger see-saw. In other words, you can’t always just borrow more. That is also why there are table limits in Casinos.

The firm will need to hit a major home run to reverse the trend. If its current business is stagnant or deflating, the firm will fail. Smart people come up with complicated transactions to conceal this. With my dirty little mind, I can come up with a few.

It is more likely that you can get out of the mess if you maintain strong cash flows and own liquid assets. You can sell those assets to raise capital. This relationship another a good indicator of a firm’s susceptability to Gambler’s Ruin.  Like Liver Cancer, which becomes more realistic with every passing day for me, Leverage Cancer is deadly when it spreads beyond control.  So the greater portion of the body (Assets) that the Leverage Cancer (Net Ca$h from Financing) consumes, the more likely the death. We know that Implied Leverage has been increasing between 2003-2007, which means that there is definitely a growing cancer. The next question is: Is it too late? Is the firm beyond repair?

Here are the numbers for Berkshire Hathaway, Lehman and ProLogis’ 2007 Total Assets and 2007 Net Ca$h from Financing (in millions):

	2007	Net Ca$h
	Assets	Financing
Berkshire Hathaway	$  273,160,000	$  1,366,000
Lehman Brothers	$      691,063	$     48,592
ProLogis	$       19,724	$      2,742

Here is a pie chart for Berkshire-Hathaway:

As you can see, as old as he is, Warren’s firm is more or less cancer free.  Remember, implied leverage was low anyways because it’s slope was less than 1. He didn’t even need a check-up. In fact, the older your Assets, the more likely that this metric is worthless because many of the Assets are artificially low due to depreciation.

Here are Lehman and ProLogis:

I think ProLogis’ assets might only be worth $10B-12B. If I am right, where does that put the Common Stockholders? That topic is for another day.

I don’t know if anyone has thought about leverage and firms like this before. If so, I apologize for not giving you credit but I simply can’t acknowledge exactly what I don’t know or don’t remember I know. Also, everything contained herein is my OPINION ONLY. I HAVE NOT VERIFIED THE INFORMATION CONTAINED HEREIN FOR ACCURACY, INCLUDING TYPOS, MATHEMATICAL ERRORS OR THE LIKE. I AM NOT AN ACCOUNTANT, CPA, MATHEMATICIAN, ECONOMIST, HAIRDRESSER OR PROGRAMMER. I AM NOT PERFECT. I MAKE ERRORS AND MISTAKES ALL THE TIME. I AM WRITING MY ANALYSIS AS AN EXERCISE OF MY RIGHTS UNDER THE BILL OF RIGHTS TO U.S. CONSTITUTION AND I AM NOT GIVING ANY TYPE OF ADVICE - LEGAL, TAX OR OTHERWISE. NO ATTORNEY-CLIENT RELATIONSHIP CAN BE ESTABLISHED BETWEEN ME AND ANY NATURAL PERSON OR ENTITY WITHOUT A WRITTEN AGREEMENT AND A FEE DEPOSIT. BY BEING ON THIS SITE YOU AGREE TO THE ABOVE AND DISCLAIMER AND TERMS OF SERVICE.

This entry was posted on Sunday, September 21st, 2008 at 2:40 am and is filed under Accounting, Economics, Gambling, ProLogis (PLD). You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.