Download Revenue Recognition Certificates

Is Debt Really an appropriate
st
Financial Instrument for the 21
Century?
Evan Schulman
Tykye, LLC
Summer 2012
Proposal

US Government Sells:

“x”% of GDP for, say, 20 or 30 years

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With no guarantee, Certificates are not debt

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“x”% is the amount raised / Present Value of GDP
Certificates expire worthless
There is no guarantee of principal
Gilbert v Comm’r (2d Cir. 1969)
For tax purposes Certificates are annuities
Beneficiaries
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Legislators:
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Debt ceiling goes away - temporarily
Voters:
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Certificates are self-liquidating
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Treasury:
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No rollover requirement
Decreases debt service burden in recession
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We pay our own way; no longer saddling our progeny with our debts
The debt service relief can be used for tax decreases or stimulus projects
Investors:

A marketable, no-load, no fee term annuity with growth, inflation protection,
low volatility (vs equity) and no counter-party risk - that covers the economy

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Buy America (GDP = f(inflation, productivity, population]) vs TIPS
Intermediaries may disaggregate, allowing tailored sector exposure
Spreadsheet
Spreadsheet Results
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Retire 10% of Treasury Debt:
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Assume: 3% nominal growth, 30 year maturity
Given today’s Treasury rates of 2%, Govt needs to pay
0.3% of GDP of which principal is some $20 billion
Adjust for “equity” risk
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($1.6 Trillion)
Equity risk Premium = 4%, beta = 0.1
Investors’ required rate goes from approx 2 to some 2.5%
Value Inflation Premium
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“Unexpected inflation” starts in year 5 at 1.5%
Premium approximates 13% or some $180 billion
Corporate Debt: Limitations

Saddles Issuer with Fixed Costs
Exposes Investor to the risks of Inflation
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Low Placement Agent Fees
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Net of customization expenses
Illiquid Secondary Market

Transaction costs are large relative to the
small changes in credit and the value of
imbedded options & seller may have
information
Sales Certificate
A contract like a bond, but ….
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Payout = a function of gross revenues (sales)
Expires worthless at maturity
Standardized terms
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Terms are reset in case of merger or acquisition
This instrument is currently in use
Consequences: risk shifts for issuer &
investor
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Tax on crime, non-usurious,
Issuer Benefit

Fixed cost becomes a variable cost

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The “interest” equivalent is tax deductible
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Self Adjusting costs make these a Premium Product
Ernst & Young letter
Smaller liquidity premium
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Changes in revenue prospects will swamp
transactions costs versus the small changes in credit
ratings and valuations of imbedded options of bonds
Sales are transparent
Investor Benefits

In periods of inflation stocks & bonds are
highly correlated
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High Cash Flow Vehicle
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Certificates are hooked to sales & behave differently
Inflation insurance is important for both defined benefit &
defined contribution plans & NOW is the time.
No-load, no-fee, marketable Term Annuity with inflation
protection
More liquidity

More transparent; higher probability of informed participation
Percent of Sales to Service Issue
7
Growth
Rate
6
5
10 Year Maturity
0% Growth
0%
5%
4
5% Growth
3
Percent
of Sales
3.4%
2.8%
15 Year Maturity
0%
5%
2
1
0
Years to Maturity
5
6
7
8
9
10
11
12
13
14
% of Sales = $ Raised/PV Sales
Capital raised = ¼ Current Sales
6% Discount Rate Std Dev of growth rates = 8%
15
2.6%
1.8%
Potential Purchasers

Those who need an Inflation Adjusted Annuity

High Cash Flow Vehicle with inflation insurance
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New Asset Class
Investors such as
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Endowments, Casualty Insurers, Pension Funds
Institutions with 401(k) clients
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Tailored protection
Fidelity, Vanguard, Schwab
Entities under Shari’ah Law
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Sovereign Wealth Funds
Potential Issuers

Money Managers
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Other Professional Organizations
Auditors (WSJ, Mar 12th 2007 pg A8), lawyers, software firms,
consultants: firms with few assets but high margins, Co-operatives
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Private Firms, LBOs, Insurance Cos (AIG), Airlines
Firms under Shari’ah law
Firms financing stock repurchase programs
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Chevron – Market Value / Sales = 1. So, 0.75% of sales redeems
10%+ of equity: - Self-liquidating equity
1/3rd of listed firms have a Market Value / Sales ratio =< 1.0
Inflation Alphas
Cohn, Polk, Vuolteenaho: NBER Working Paper 11018 2005
Plus term-structure steepness
Issuer Games
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Move sales to out years
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Indenture statement & IRS rules
Concentrate on profitability
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Indenture statement as to use of funds
 Buy

less profitable firms?
Over-estimate sales growth of acquisitions
(Under-estimate sales growth of a division sold)

Statement “…these are the material facts as we
know them…” plus fair value opinion
Problems Mitigated: - Corporate Debt

Mitigation:
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Saddles Issuer with Fixed Costs

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Exposes Investor to the risks of Inflation

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Certificates offer self adjusting cost
Portfolios of Certificates allow tailored
coverage
Illiquid Secondary Market
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Duration changes, need to trade or ladder: like bonds

Speculators attracted by sales volatility
Low Underwriter Fees
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Premium product
Summary

Modigliani-Miller still holds
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Risks are reallocated more appropriately
Premium product, broader appeal
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New asset class, new types of issuers
Helps to complete the market
Liquidity:

More transparent; trades on revenue prospects, higher
probability of informed participation
The unfamiliar need not be implausible…