Good morning. The Facebook note yesterday drew a lot of responses. We respond to some readers below, after having another look at the (apparently) benign credit landscape. Later today we get the January CPI report, so we can all go back to doing what we enjoy most: arguing about inflation. Meanwhile, email us: Robert.Armstrong@ft.com and Ethan.Wu@ft.com.
It’s a great time to go bankrupt!
Last month, with equities going wild, we toured high-yield credit land and found things pretty calm. The gap between the riskiest corporate bond yields and Treasuries was 6.9 per cent — a tick up but no higher than November or December.
Things are just a touch less calm now. In late January, high-yield spreads neared 7.4 per cent, a one-year high, and haven’t fallen much since. High-yield bonds are selling off, ever so gently:
The Federal Reserve is the obvious culprit. Financial conditions are set to tighten so yields should rise. What surprises us is other risky corners of finance, which are still partying like it’s 2021.
As Bloomberg’s Tracy Alloway pointed out, leveraged loans — bank loans to indebted firms — have shrugged off rising yields. The Credit Suisse total return index charted below has even gained a bit in 2022:
The divergence between leveraged loans and high-yield corporate bonds is partly mechanical. While bonds yield fixed payments, leveraged loans usually pay a floating rate, meaning their payouts rise as the Fed hikes. Roberta Goss of Pretium, a private credit firm, said these floating rates make bundles of leveraged loans (called collateralised loan obligations or CLOs) look especially attractive now:
Further adding to the stability of the bank loan asset class has been the significant appetite of the CLO market, which has seen continued demand from debt investors given the floating rate nature of CLO liabilities.
The trade-off is that higher interest payments on the loans could increase credit risk, given that the underlying companies tend to have fragile balance sheets. But Peter Gleysteen, CEO of AGL, another private credit outfit, thinks that’s not a big problem given the macro environment:
Credit quality is not a concern for either [leveraged loans or high-yield bonds], except on an issuer-specific basis, as the economy is expanding, credit quality is good and cost-pressure concerns appear manageable from a corporate profitability standpoint.
Part of the credit story is that there are just not that many defaults. Globally, there have been only five in 2022, reported Nicole Serino of S&P. With investors hungry for yield, the balance of power still rests with debtors, at least relative to recent history. Many are able to put off default and negotiate lighter-touch arrangements.
Even when default does happen, creditors are getting less of their money back. Kenny Tang, also of S&P, calculated that between 2020 and June 2021, the highest-priority investors got 68 per cent back from bankruptcy deals, versus a post-2008 average of 79 per cent.
While it’s rotten for the lenders, this is not bad economic news. Companies are getting historically cheap and flexible financing. The biggest worry is that easy credit is seeding future financial chaos — and that Fed rate increases and quantitative tightening will water and fertilise those seeds. It is important to remember that rates have not risen, and the Fed is still buying billions in bonds. For now, though, credit investors seem happy to take on risk and block out the noise coming from equities. (Ethan Wu)
Facebook is controversial
Readers have a very wide range of opinions about Facebook’s value. Here’s Charles Monot, president of Monocle Asset Management, on the plus side:
If you look at operating income by division, you have 1) the “classic” Facebook which made around $50bn net income in 2021, 2) a bet on the Metaverse, and 3) $40bn cash. So at current level, you can buy the classic Facebook for 12 times earnings, you get the Metaverse for free + $40bn cash. And don’t forget the potential monetization of WhatsApp (mentioned by Zuckerberg during the call).
I should have mentioned the point about WhatsApp yesterday. Surely Zuck et al can make money — serious money — out of messaging software with two billion users. I disagree on the Metaverse, though. It is not “free”. It may be worth a lot, but the most likely outcome over the life of the investment is a loss. As I said yesterday, it is a speculative technology. It should have a minus sign in front of it in any sum of parts analysis (though not necessarily a big one).
Cash is an interesting question, and on my maths Facebook has $47bn of it, or $17 a share. Subtracting this from the share price, the PEG (PE ratio/growth) ratio drops from 1.1 to 1, a smallish but not meaningless difference. Here is the valuation comparison from yesterday, updated to reflect net cash positions:
A word about this, though. You cannot treat cash on a balance sheet like cash in investors’ pockets; a haircut must be applied. Companies, especially tech companies, do dumb things with money. (Apple and Amazon are exceptions to this. They tend to do very smart things with money. But then they are the two greatest, best-run companies I’ve ever known; everyone else’s cash, you haircut).
Another reader sums up the haters’ view of Facebook, writing:
You say that Facebook will figure out what hurt them [on user growth], but I certainly don’t see how. They are losing young subscribers, and old people die . . . TikTok came out of nowhere.
This is the tough one. Active users, on the classic Facebook app and the other apps, stopped growing in the fourth quarter. Will they begin to decline? Will they decline faster than revenue per user is growing? I don’t know how I would begin trying to answer theses questions. My guess that, with the financial and data resources at their disposal, Facebook can arrest a decline is just that, a guess. But I’m certain of this: if active users decline, Facebook’s PE ratio is headed down from here, not up.
Here is an even more sensitive question. How much confidence we have in Facebook’s user numbers? To be absolutely clear: I do not think Facebook is lying about its user base. My question is how sure we are that the numbers the company reports are reflective of users level of engagement with the products. We know the overall number of daily visits for Facebook+Instagram+Messenger+WhatsApp collectively (2.8bn last quarter) and for Facebook independently (1.9bn).
But we don’t know how long the visits are, or how good the counting mechanism is at excluding incidental, accidental or otherwise meaningless visits. We also don’t know how normal human bias, of the “my boss needs to see these numbers go up what can I do” variety, might work its way into the process. On the other hand, Facebook’s advertising revenue keeps rising, which is an indication that advertisers are happy with the results they are getting from their Facebook ad campaigns.
I still think the stock looks too cheap, but there’s a lot to chew on here.
One good read
From the Economist, a clear demonstration of why ESG investment principles will do nothing to help the climate. In a world with a glut of capital, divestment of “dirty” assets does not de-fund them or increase their cost of capital meaningfully (Anjli Raval made this point even better, in my view). The entire intellectual edifice of the ESG industrial complex is built on a toxic slurry of good intentions, greed and dumb ideas.