Saturday, November 22, 2014

The American and Foreign Power Company

The American and Foreign Power Company was a publicly-traded utility that became a speculative favorite during the late 1920s. Benjamin Graham wrote about it in Security Analysis, using it as an example of the financial innovation and speculative excess that characterized that period.

AFPC issued a range of securities during the 1920s: bonds, common stock, two kinds of preferred stock, and "stock-option warrants." Stock-option warrants were essentially what we call warrants today: instruments created by the issuer that allowed investors to buy newly-issued stock at a certain price.

Graham wrote that warrants evolved from a niche instrument to a prominent security during the 1920s: they were originally attached to bonds and preferred stock as a way of giving them convertability into common stock. In this form, "the warrants themselves had little significance in relation to the company’s capitalization structure." But by the late '20s they had become widely-issued and widely-traded as discrete securities and were used as a popular way to speculate.

AFPC was at the vanguard of this change. In 1929 its common stock was worth $300 million, which by itself would have qualified the company as a major securities issuer, but its warrants were worth several times more:

The option warrants issued by a single company—American and Foreign Power Company—attained in 1929 an aggregate market value of more than a billion dollars, a figure exceeding our national debt in 1914.

AFPC's market capitalization was impressive not only compared to what preceded it but what followed:

It is an amazing fact that the option warrants created by one company, American and Foreign Power, reached an indicated market value in 1929 of over a billion dollars, a figure that exceeded the market value of all the railroad common stocks of the United States listed on the New York Stock Exchange in July 1932, less than three years later.

APFC itself wasn't immune to the Great Depression. At its nadir, the company "trembled on the brink of receivership, as shown by a price of only 15 1/4 for its 5% bonds."

Outside the Roaring Twenties

Graham used AFPC to illustrate financial trends during a specific period of time. In doing so, he gave only a small cross-section of the company's interesting history. Fortunately an article on, "The Rise and Fall of The American & Foreign Power Company," offers a more detailed description of the company and its experiences.

AFPC began life as part of a holding company called Electric Bond & Share, which itself began life as a subsidiary of Thomson-Houston, one of General Electric's predecessor companies.

Thomson-Houston sold electric equipment to utilities. In the late 1800s, when electrical transmission was still a recent invention, most utilities were small and thinly capitalized. Thomson-Houston provided them with a form of vendor financing, taking the utilities' debt and equity securities as partial payment for its equipment.

In 1905, it organized Electric Bond & Share as a subsidiary for the specific purpose of holding these securities. While EB&S was officially a utility holding company, in practice it was a financial intermediary, aggregating the securities of a number of tiny issuers into a holding company that could finance itself at better rates.

EB&S made its first foreign investment in 1917, buying electrical systems in two Panamanian cities. Investments in Guatemala, Brazil, and Cuba soon followed. In 1924, EB&S created AFPC as a subsidiary for holding these foreign investments. The following year, General Electric spun off EB&S and it became a separate publicly-traded company.

AFPC soon followed as a public company, and it pursued the same business model as EB&S, namely being a financial intermediary that operated as a utility. The United States ran large trade surpluses with the rest of the world during the 1920s, and AFPC, as a major international investor, helped to recycle those surpluses.

AFPC stepped up the pace of its investments as a public company, buying utilities in Argentina, Brazil, Chile, China, Costa Rica, Ecuador, and India. It also bought minority stakes in utilities in Canada, Italy, Japan and elsewhere. In 1929 it acquired Shanghai's municipal utility, making what at the time was the single largest American investment in China.

The Depression ensued, and AFPC nearly went bankrupt. It suspended dividends on its preferred stock in 1932 and didn't begin to pay them again until 1939. The unpaid dividends that accumulated during the interim were significant relative to AFPC's (admittedly diminished) market capitalization.

AFPC's problems during the Depression were political as well as financial. Mexico and Cuba forced it to reduce electricity prices, and many other countries prevented it from repatriating its subsidiaries' profits. It had to write off the Shanghai utility during World War II, and Argentina nationalized several of its utilities.

The company's fortunes seemed to improve during the 1950s, but that was a false dawn. Fidel Castro confiscated AFPC's Cuban properties in 1960, at which time they were its largest holdings. Brazil also expropriated one of its properties, and Mexico forced it to sell its utilities to the Mexican government at a cut-rate price. Exacerbating this theft, the government then refused to let AFPC repatriate the sale's proceeds.

AFPC responded to these misfortunes by gradually liquidating. It sold its foreign utilities throughout the 1960s and early 1970s and merged with Boise Cascade. The last remaining utility, a property in Ecuador, was sold in 1976.

Emerging markets

AFPC illustrates a big-- and in my opinion, under-appreciated-- risk of investing in emerging markets. Namely, that many of these countries have an opportunistic and predatory attitude toward foreign investors. In a period of globalization when foreign direct investment is increasing, they'll respect foreign investors' property rights because they know that doing so is necessary to receive foreign investment and its attendant benefits.

But if a depression or financial crisis shuts off the foreign-investment spigot, these countries will see no further reason to respect foreigners' rights. If their investments aren't confiscated, they'll be subject to actions that drastically limit their return on investment.

As the article notes, "[F]oreign adventures don't always work out as anticipated. In addition to the normal risks of business, including fluctuating exchange rates, there are unforeseen political risks that can seriously affect rates of return on investment."

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