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In this anticipated follow-up to Mergers and Acquisitions Integration Handbook, distinguished M&A expert Scott Whitaker delivers his popular brand of solid, actionable guidance to the complex process of cross-border M&A.

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The Boards of the London Metal Exchange (LME) and LME Clear are pleased to announce the appointment of Antony Stuart as an independent non-executive director.

AxiomSL, the leading global provider of regulatory reporting and risk management solutions, announced today that PNC, one of the largest banks in the United States, will deploy the AxiomSL platform to meet regulatory reporting requirements, such as FR Y9c, 14 M/Q and 5G/2052a, across the U.S., Canada and the Bahamas.

IPC Systems, Inc., a leading global provider of specialised communications and managed network-as-a-service solutions for the financial trading community, today announced that it has been selected by Singapore Exchange (SGX) to manage the SGX Chicago Hub, which is available at CME Group’s facility in Aurora, Illinois.

Purdue University's Center for Commercial Agriculture and the derivatives marketplace CME Group are partnering to produce the Purdue/CME Group Ag Economy Barometer, a monthly nationwide measure of the health of the U.S. agricultural economy.

Intercontinental Exchange, Inc. (“ICE”) (NYSE: ICE), a leading operator of global exchanges and clearing houses and provider of data and listings services, confirms, in accordance with Rule 2.10 of the City Code on Takeovers and Mergers (the "Code"), that as of the close of business on 2 May 2016, it had 119,045,641 shares of common stock, having US$0.01 par value each, in issue and admitted to trading on the New York Stock Exchange under the International Securities Identification Number (ISIN) US45866F1049, excluding shares of common stock held in treasury.

The Financial Industry Regulatory Authority (FINRA) announced today that it has fined MetLife Securities, Inc. (MSI) $20 million and ordered it to pay $5 million to customers for making negligent material misrepresentations and omissions on variable annuity (VA) replacement applications for tens of thousands of customers. Each misrepresentation and omission made the replacement appear more beneficial to the customer, even though the recommended VAs were typically more expensive than customers' existing VAs. MSI's VA replacement business constituted a substantial portion of its business, generating at least $152 million in gross dealer commission for the firm over a six-year period.

The Boards of the London Metal Exchange (LME) and LME Clear are pleased to announce the appointment of Antony Stuart as an independent non-executive director.

Equities

Broadridge Financial Solutions, Inc. (NYSE: BR) today announced the introduction of its Global Post Trade Management (GPTM) solution, a next generation offering that allows investment banks and broker-dealers to transform their operating models to gain operational and cost efficiency. The solution enables transformation by streamlining operations across asset classes, markets and business entities globally, and enhances banks’ and brokers’ financial and risk management and regulatory compliance capabilities.

The European Securities and Markets Authority (ESMA) has published the responses received to the Discussion Paper on draft RTS and ITS under the Securities Financing Transaction Regulation (SFTR).

The Fidessa Fragulator has surpassed the one million mark.

In my last post on dealing with uncertainty, I brought up the margin of safety, the tool that many value investors claim to use to protect themselves against uncertainty. While there are certainly some in the value investing community who have found a good way to incorporate MOS into their investing process, there are many more who seem to have misconceptions about what it does for them as well as the trade off from using it.

The Margin of Safety: Definition and Rationale

While the margin of safety has always been around, in one form or another, in investing, it was Ben Graham who brought the term into value investing in The Intelligent Investor, when he argued that the secret of sound investment is to have a margin of safety, with the margin of safety defined as the difference between the value of an asset and its price. The definitive book on MOS was written by Seth Klarman, a value investing icon. Klarmanâs book has acquired a cult following, partly because of its content and partly because it has been out of print now for years; a quick check of Amazon indicates a second-hand copy can be acquired for about $1600. Klarmanâs take on margin of safety is similar in spirit to Grahamâs measure, with an asset-based focus on value, which is captured in his argument that investors gain the margin of safety by âbuying at a significant discount to underlying business value and giving preference to tangible assets over intangiblesâ.

There are many reasons offered for maintaining a margin of safety. The first is that the value of an asset is always measured with error and investors, no matter how well versed they are in valuation techniques, have to recognize that they can be wrong in their judgments. The second is that the market price is determined by demand and supply and if it diverges from value, its pathway back is neither quick nor guaranteed. The proponents of margin of safety point to its benefits. By holding back on making investment decisions (buy or sell) until you feel that you have a margin of safety, they argue that you improve your odds of making successful investments. In addition, They also make the point that having a healthy margin of safety will reduce the potential downside on your investments and help protect and preserve your capital.

The Margin of Safety: Divergence across Investors

As a concept, I not only understand the logic of the MOS, but also its allure, and I am sure that many investors adopt some variant of it in active investing, but there are differences in how it is employed:

Valuation Basis: While MOS is often defined it as the difference between value and price, the way in which investors estimate value varies widely. The first approach is intrinsic value, either in its dividend discount model format or a more expansive DCF version. The second approach estimates value from accounting balance sheets, using either unadjusted book value or variants thereof (tangible book value, for instance). The third approach is to use a pricing multiple (PE, EV to EBITDA), in conjunction with peer group pricing, to estimate âa fair priceâ for the company. While I would contest even calling this number a value, it is still used by many investors as their estimated value.
Magnitude and Variability: Among investors who use MOS in investing, there seems to be no consensus on what constitutes a sufficient margin. Even among investors who are explicit about their MOS, the follow up question becomes whether it should be a constant (say 15% for all investments) or whether it should be greater for some investments (say in risky sectors or growth stocks) than for others (utilities or MLPs).

The bottom line is that a room full of investors who all claim to use margin of safety can contain a group with vast disagreements on how the MOS is computed, how large it should be and whether it should vary across investments and time.

Myths about Margin of Safety

When talking about value, I am often challenged by value investors on how I control for risk and asked why I donât explicitly build in a MOS. Those are fair questions but I do think that some of the investors who are most enamored with the concept fundamentally misunderstand it. So, at the risk of provoking their wrath, here is my list of MOS misconceptions.

Myth 1: Having a MOS is costless

There are some investors who believe that their investment returns will always be improved by using a margin of safety on their investments and that using a larger margin of safety is costless. There are very few actions in investing that donât create costs and benefits and MOS is not an exception. In fact, the best way to understand the trade off between costs and benefits is to think about type 1 and type 2 errors in statistical analysis. If type 1 errors refer to the fact that you have a false positive, type 2 errors reflect the opposite problem, where you have a false negative. Translating this proposition into investing, letâs categorize type 1 errors as buying an expensive stock, because you mistake it to be under valued, and type 2 errors as not buying a bargain-priced stock, because you perceive it wrongly to be over valued. Increasing your MOS will reduce your type 1 errors but will increase your type 2 errors.

Many risk averse value investors would accept this trade off but there is a cost to being too conservative and if that cost exceeds the benefits of being careful in your investment choice, it will show up as sub-par returns on your portfolio over extended periods. So, will using a MOS yield a positive or negative payoff? I cannot answer that question for you, because each investor has to make his or her own judgment on the question, but there are simple tests that you can run on your own portfolios that will lead you to the truth (though you may not want to see it). If you find yourself consistently holding more of your overall portfolio in cash than your natural risk aversion and liquidity needs would lead you to, and/or you don't generate enough returns on your portfolio to beat what you would have earned investing passively (in index funds, for instance), your investment process, no matter what its pedigree, is generating net costs for you. The problems may be in any of the three steps in the process: your valuations may be badly off, your judgment on market catalysts can be wrong or you may be using too large a MOS.

Myth 2: If you use a MOS, you can be sloppy in your valuations

Value investors who spend all of their time coming up with the right MOS and little on valuation are doing themselves a disservice. If your valuations are incomplete, badly done or biased, having a MOS on that value will provide little protection and can only hurt you in the investment process (since you are creating type 2 errors, without the benefit of reducing type 1 errors). Given a choice between an investor with high quality valuations and no/little MOS and one with poorly done valuations and a sophisticated MOS, I would take the former over the latter every single time.

I am also uncomfortable with investors who start with conservative estimates of value and then apply the MOS to that conservative value. In intrinsic valuation, conservative values will usually mean haircutting cash flows below expectations, using high discount rates and not counting in growth that is uncertain. In asset-based valuation, it can take the form of counting only some of the assets because they are tangible, liquid or both. Remember that you are already double counting risk, when you use MOS, even if your valuation is a fair value (and not a conservative estimate of value), because that value is computed on a risk-adjusted basis. If you are using a conservative value estimate, you may be triple or even quadruple counting the same risk when making investment decisions. If you are using this process, I am amazed that any investment manages to make it through your risk gauntlets to emerge as a good investment, and it does not surprise me that nothing in the market looks cheap to you.

Myth 3: The MOS should be the same across all investments

I have always been puzzled by the notion that one MOS fits all investments. How can a 15% margin of safety be sufficient for both an investment in a regulated utility as well as a money-losing start-up? Perhaps, the defense that would be offered is that the investors who use MOS as their risk breakers would not look at companies like the latter, but I would still expect that even in the value investing spectrum, different investments would evoke different degrees of uncertainty (and different MOS).

Myth 4: The MOS on your portfolio = MOS on individual investments in the portfolio

I know that those who use MOS are skeptics when it comes to modern portfolio theory, but modern portfolio theory is built on the law of large numbers, and that law is robust. Put simply, you can aggregate a large number of risky investments to create a relatively safe portfolio, as long as the risks in the individual stocks are not perfectly correlated. In MOS terms, this would mean that an investor with a concentrated portfolio (who invests in three, four or five stocks) would need a much larger MOS on individual investments than one who spreads his or her bets across more investments, sectors and markets.

Expanding on this point, using a MOS will create biases in your portfolio. Using the MOS to pick investment will then lead you away from investments that are more exposed to firm-specific risks, which loom large on an individual company basis but fade in your portfolio. Thus, biotechnology firms (where the primary risk lies in an FDA approval process) will never make your MOS cut, but food processing firms will, for all the wrong reasons. In the same vein, Valeant and Volkswagen will not make your MOS cut, even though the risk you face on either stock will be lowered if they are parts of larger portfolios.

Myth 5: The MOS is an alternative risk measure

I know that many investors abhor betas, and believe it or not, I understand. In fact, I have long argued that there are replacements available for portfolio theory-based risk measures and that not only is intrinsic value robust enough to work with these alternative risk measures but that the discount rate is not (and should not) be the ultimate driver of value in most companies. That said, there are some in the value investing community who like to use their dislike of betas as a bludgeon against all financial theory and after they have beaten that straw horse to death, they will offer MOS as their alternative risk measure. That suggests a fundamental misunderstanding of MOS. To use MOS, you need an estimate a value and I am not aware of any intrinsic value model that does not require a risk adjustment to get to value. In other words, MOS is not an alternative to any existing risk measure used in valuation but an add-on, a way in which risk averse investors can add a second layer of risk protection.

There is one possible way in which the MOS may be your primary risk adjustment mechanism and that is if you use a constant discount rate when doing valuation (a cost of capital of 8% for all companies or even a risk free rate) and then apply a MOS to that valuation to capture risk. If that is your approach, you should definitely be using different MOS for different investments (see Myth 3), with a larger MOS being used on riskier investments. I would also be curious about how exactly you make this MOS adjustment for risk, including what risks you bring in and how you make the conversion.

Margin of Safety â Incorporating into a Strategy

I would not put myself in the MOS camp but I recognize its use in investing and believe that it can be incorporated into a good investing strategy. To do so, though, you would need to do the following:

Self examination: Even if you believe that MOS is a good way of picking investments, it is not for everyone. Before you adopt it, you have to assess not only your own standing (including how much you have to invest, how risk averse you are) but also your faith (in your valuation prowess and that markets correct their mistakes). Once you have adopted it, you still need the effects it has on your portfolio, including how often you choose not to invest (and hold cash instead) and whether it makes a material difference to the returns you generate on your portfolio.
Sound Value Judgments: As I noted in the last section, a MOS is useful only if it is an addendum to sound valuations. This may be a reflection of my biases but I believe that this requires intrinsic valuation, though I am willing to concede that there are multiple ways of doing it right. Accounting valuations seem to be built on the twin presumptions that book value is an approximation of liquidation value and that accounting fair value actually means what it says, and I have little faith in either. As for passing of pricing as value, it strikes me as inconsistent to use the market to get your pricing number (by using multiples and comparable firms) and then argue that the same market misprices the asset in question.
A Flexible MOS: Tailor the MOS to the investment that you are looking at: There are two reasons for using a MOS in the first place. The first is an acceptance that, no matter how hard you try, your estimate of value can be wrong and the second is that even if the value estimate is right, there is uncertainty about whether the market will correct its mistakes over your time horizon. If you buy into these two reasons, it follows that your MOS should vary across investments, with the following determinants.

Valuation Uncertainty: The more uncertain you are about your estimated value for an asset, other things remaining equal, the larger the MOS should be. Thus, you should use a smaller MOS when investing in mature businesses and during stable markets, than when putting your money in young, riskier business or in markets in crises.
Portfolio Tailoring: The MOS that you use should also be tailored to your portfolio choices. If you are a concentrated investor, who invests in a four or five companies, you should use a much higher MOS than an investor who has a more diversified portfolio, and if you the latter, perhaps even modify the MOS to be larger for companies that are exposed to macroeconomic risks (interest rates, inflation, commodity prices or economic cycles) than to company-specific risks (regulatory approval, legal jeopardy, management flux).
Market Efficiency: I know that these are fighting words to an active investor, red flags that call forth intemperate responses. The truth, though, is that even the most rabid critics of market efficiency ultimately believe in their own versions of market efficiency, since if markets never corrected their mistakes, you would never make money of even your canniest investments. Consequently, you should settle for a smaller MOS when investing in stocks in markets that you perceive to be more liquid and efficient than in assets, where the corrections will presumably happen more quickly than in inefficient, illiquid markets where the wait can be longer.
Pricing Catalysts: Since you make money from the price adjusting to value, the presence of catalysts that can lead to this adjustment will allow you to settle for a lower MOS. Thus, if you believe that a stock has been mispriced ahead of an earnings report, a regulatory finding or a legal judgment, you should demand a lower MOS than when you invest in a stock that you believe is misvalued but with no obvious pricing catalyst in sight.

Finally, if MOS is good enough to use when you buy a stock, it should be good enough to use when you sell that stock. Thus, if you need a stock to be under valued by at least 15%, to buy it, should you also not wait until it is at least 15% over valued, to sell it? This will require you to abandon another nostrum of value investing, which is that once you buy a great company, you should hold it forever, but that is not just unwise but is inconsistent with true value investing.

Conclusion

Would I prefer to buy a stock at a 50% discount on value rather than at just below fair value? Of course, and I would be even happier if you made that a 75% discount. Would I feel even more comfortable if you estimated value very conservatively. Yes and I would be delighted if all you counted was liquid assets. That said, I don't live in a world where I see too many of these investments and when I do, it is usually the front for a scam rather than a legitimate bargain. That is the reason that I have never formally used a MOS in investing. I did buy Valeant at $32, because my valuation of the stock yielded $45 for the company. Would I have still bought the stock, if my value estimate had been only $35 or if it was a big chunk of my portfolio? Perhaps not, but I have bought stocks that were priced at my estimated fair value and have held back on investments that I have found to be under valued by 25% or more. Why? That has to wait for my coming post on simulations, since this one has run its course.

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Uncertainty Posts

DCF Myth 3: You cannot do a valuation, when there is too much uncertainty
The Margin of Safety: Excuse for Inaction or Tool for Action?
Facing up to Uncertainty: Probabilities and Simulations

DCF Myth Posts
Introductory Post: DCF Valuations: Academic Exercise, Sales Pitch or Investor Tool

If you have a D(discount rate) and a CF (cash flow), you have a DCF.
A DCF is an exercise in modeling & number crunching.
You cannot do a DCF when there is too much uncertainty.
The most critical input in a DCF is the discount rate and if you donât believe in modern portfolio theory (or beta), you cannot use a DCF.
If most of your value in a DCF comes from the terminal value, there is something wrong with your DCF.
A DCF requires too many assumptions and can be manipulated to yield any value you want.
A DCF cannot value brand name or other intangibles.
A DCF yields a conservative estimate of value.
If your DCF value changes significantly over time, there is either something wrong with your valuation.
A DCF is an academic exercise.

Beecher Carlson Insurance Services, LLC (âBeecher Carlsonâ), a specialized large account insurance broker, announces further expansion of the National Private Equity and Mergers & Acquisition team with the appointment of Rammy Streit and Robert Streit. Their focus will be on developing risk financing solutions for Private Equity funds and associated portfolio companies. Rammy and Robert will work out of the Woodland Hills and Orange County, California offices and report to Kevin Maloy, Executive Managing Director and National Practice Leader of Beecher Carlsonâs M&A practice.

Unmasking the Men Behind Zero Hedge, https://t.co/zoY7UWZjwo â moneyscience (@moneyscience) May 3, 2016

The Post-Trade Distributed Ledger (PTDL) Group, which brings together major post-trade industry participants and regulators to share information and ideas about how distributed ledger technologies could transform the post-trade landscape, has announced the appointment of three external advisers.

Download this month's dashboard

Click here to download the April edition of Tradeweb’s monthly DataSheet for global government 10-year benchmark bonds.

It shows how government bond yields changed across Europe, North America and Asia-Pacific over the month, comparing monthly highs, lows and spreads against significant historic numbers.

All data and charts are courtesy of Tradeweb, the electronic fixed income marketplace, through which a significant portion of sovereign debt is traded.

Many people often think that creativity flourishes when people are not constrained in any way. Give people total freedom to think and generate ideas, and they will be highly creative. That's the conventional wisdom. However, some research shows that constraints actually can enhance creativity. The Boston Globe reported this weekend on a study by Catrinal Haught-Tromp. The forthcoming article is titled, "The Green Eggs and Ham Hypothesis: How Constraints Facilitate Creativity." The scholar chose this title because the highly creative book by Dr. Seuss only uses 50 words. Haught-Tromp conducted experiments to examine whether constraints can stimulate creativity. Haught-Tromp asked the research subjects to develop two-line rhymes for greeting cards. In some circumstances, she required the subjects to include a particular noun in their rhyme. Outsiders judged the rhymes developed with this constraint to be more creative. Moreover, she found that subjects working without the constraint tended to be more creative when developing a rhyme after they had worked in the constrained condition (as opposed to before they faced the constrained condition). The constraint did not just generate more creativity in the moment; the effect seemed to persist.

Is there a practical example of how constraints can fuel creativity. Consider IDEO, one of the world's leading product design firms. At first glance, when you walk into their offices, you might think that they provide their staff members the freedom to design as they wish. However, a closer look reveals a clear method/process by which they work. Moreover, as IDEO staff members brainstorm, they follow certain ground rules for how such sessions should take place. In short, constraints do exist at the firm, and they seem to enhance rather than detract from the creativity of the solutions that they design.

Seung Jung Lee and Viktors Stebunovs | We exploit the cross-state, cross-time variation in bank tangible capital ratios--brought about by bank branch deregulation on a state-by-state basis--to identify the effects of bank capital pressures on employment and firm dynamics during two waves of changes in bank capital regulation. We show that stronger capital pressures temporarily slowed down growth in employment in industries that depend on external finance, retarding growth in the average size of firms rather than in the number of firms. Such effects were particularly strong for smaller firms that may not have had access to national capital and bank loan markets. Our findings indicate that a tightening of capital requirements may have significant real effects, in part because of the lack of substitutes for bank loans.

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