• Investing in “Bond IPOs”
  • The dynamics behind Adobe’s acquisition…
  • Nuclear-powered ships…

Dear Reader,

Welcome to our weekly mailbag edition of The Bleeding Edge. All week, you submitted your questions about the biggest trends in technology. Today, I’ll do my best to answer them.

If you have a question you’d like answered next week, be sure you submit it right here.

Now, let’s turn to the mailbag.

Investing in “Bond IPOs”

Hi, Jeff. Unfortunately, as I am about to turn 70, the chance I will be alive when the 2040 bond matures is less than even, so holding to maturity is not very attractive for me. 

Also, in an era of rising interest rates, wouldn’t it be better to buy these later, as competing interest rates rise and the bond purchase price drops?

Finally, a question for clarification – is just the interest on the bonds tax-free, or is the capital gain at redemption or sale also tax-free? Thanks for your research. 

– Michael L.

Hi, Michael. Thanks for writing in with these questions, I think the answers will be useful to many other subscribers.

Challenging markets like the one we’re all faced with today require different kinds of investing strategies. I’ve been doing a lot of work with tax-free municipal bonds this year and am happy to say that I recently published a specific recommendation for a primary offering of a tax-free municipal bond. Primary offerings of these municipal bonds are what I like to think of as “Bond IPOs.” They really are the equivalent of an equity IPO in the world of bonds.

I published this research to my Brownstone Unlimited advisory, which is my highest level of membership. My Unlimited subscribers always get to see my new research first, and it allows me to explore unique opportunities and investment strategies that don’t yet have a “home” within Brownstone Research. My work in this space has required not just research and analysis, but also a lot of development work to make this asset class available to my subscribers.

Normal investors simply can’t purchase these primary offerings from their online broker. They aren’t available. It is an opaque world that institutional capital tries to keep to themselves, so it has been a fun project for me to crack that market open for my subscribers.

Municipal bonds aren’t for everyone, although they would fit nicely into anyone’s asset allocation. But my goal is to make sure that I have interesting and actionable investment research for all my subscribers, irrespective of where they are in life.

The smartest strategy with tax-free municipal bonds is to hold the bonds until maturity. Doing so eliminates any risk of selling the bond before maturity at a loss, if interest rates are higher at the time we sell compared to when we purchased them.

This is an important question as we are in an environment where the interest rates are rising.

The inverse is also true. As interest rates fall, the value of our bonds will increase, and it enables us to sell our bonds before maturity at a profit if we wanted to. To answer your question, if we sell the bond for a price that is more than our cost basis for our original bond purchase, we do have to pay a capital gains tax on that sale.

With that said, it is usually not much as the profits from tax-free municipal bonds tend to not be large. For example, if we purchase a bond at a slight discount of $950 a bond, and we receive par value at maturity – $1,000 – we are only taxed on the $50 gain.

There are always secondary markets for high-quality municipal bonds, so it is possible to sell them before maturity; but again, there is the risk of where interest rates are at the time of the sale.

I like the liquidity of the tax-free municipal bond markets. We can have the best intentions in the world, and plan to hold until maturity, but sometimes things happen in life… and we may need to raise cash for an unforeseen and undesired expense.

As we all know, it is impossible to know exactly when our day will come, so for conservative investors at your age who wouldn’t want to take any risk with interest rates and don’t want to hold until maturity, long-maturity municipal bonds may not be the best strategy.

A strong alternative with much shorter maturities would be high-quality corporate bonds in financially stable, high-growth companies. I cover these kinds of “X-bonds” in Exponential Tech Investor. The maturities tend to be just a few years out. Our strategy is to buy and hold these bonds until the markets return to health and valuations of the underlying companies expand. When that happens, and it will (I believe by next year), investors will have the option of holding on until maturity or selling their bonds for a profit and reallocating back into high-growth equities.

And one final point. Yes, in a perfect world, investors would be best-served investing in bonds at the absolute peak in interest rates. There’s no way for us to know when that will happen right now. But the reality is that interest rates are going to come back down again. The pain will be simply too much in the economy that the Federal Reserve is eventually going to have to pause, pivot, and ultimately reduce interest rates. When we see that happen, it’ll be great timing for those interested in bonds – to establish positions ahead of declining rates.

A monster acquisition

Hi, Jeff. I am writing to you from Mexico. I enjoy reading your Friday pieces and follow eagerly your monthly notes and portfolio updates.

I have a question for you. What are your thoughts about the recently announced acquisition of Figma by Adobe?

– Antonio T.

Hi, Antonio. Thanks for your question. This is a very interesting acquisition and a great case study on product strategy and valuation. I dug in a bit on this topic in this Monday’s Bleeding Edge and I’m happy to review it again.

For any subscribers who missed the news, Adobe – the company behind popular products like Photoshop and Illustrator – recently acquired a private company called Figma for $20 billion.

Figma is a web-based software that helps teams collaborate to create software applications for the web and for smart phones. And considering that Adobe provides tools – like Adobe XD and Dreamweaver – to develop websites, the acquisition does make sense.

But it’s not the acquisition itself that caught my eye. It’s the price tag…

At $20 billion, it makes the deal the largest acquisition of a private software company in history.

And it’s not the sheer size of the number that is most interesting. It’s what Adobe paid for Figma in terms of valuation that’s so astonishing.

Adobe’s offer for Figma is about 50 times Figma’s estimated 2022 sales. Fifty times? That’s not the kind of multiple that we would expect in a bear market. Not even close.

For comparison, in December of 2020, Salesforce announced its acquisition of another collaborative software company, Slack, at a valuation of 26 times sales. That was a very “expensive” price.

My read on the situation is that Adobe was eager to take a competitor (in a certain segment of the market) “off the board.” Prior to the acquisition, Adobe already had a competing product, but it just couldn’t catch up with the progress that Figma was making.

Adobe basically bought market share through the acquisition of the number one software company targeting web and smartphone application design. Not only does this mean market dominance for Adobe now, it also means that another large software company won’t be able to buy Figma and compete directly with Adobe. Meta (formerly Facebook) has been using this strategy for years.

In 2014, Facebook paid $19 billion to acquire WhatsApp back in 2014. At the time, this was considered an outrageous sum. And valuation multiples weren’t even a consideration. WhatsApp had no revenue.

But at the time, WhatsApp was crushing Facebook’s Messenger in terms of adoption. The acquisition was a way to neutralize a competitor and bring it into the fold.

It was the same story with Facebook’s acquisition of Instagram in 2012. Back then, Facebook paid $1 billion for the company. While not as large as the WhatsApp acquisition, the price tag was still steep considering Instagram only had 30 million users and zero revenue at the time.

But again, Facebook saw a potential competitor in Instagram. And they wanted to own it before the company got too large.

And this single acquisition helped turn Facebook into the company it is today. In 2021, Instagram generated $47.6 billion in revenue for Facebook, almost half of the company’s total haul.

The market did not react well to the Adobe/Figma acquisition. But I suspect – in time – the decision will be vindicated, just like it was with Facebook.

We can’t have a “Captain Phillips situation”

Hi Jeff, I just read Friday’s question from Jeff D. about nuclear-powered commercial vessels and your response.

You are absolutely correct. The cost to build, operate, maintain, and repair each nuclear-powered submarine or aircraft carrier propulsion plant is enormous. As your contact mentioned, the Navy uses highly-enriched uranium. For national security reasons, I don’t think it is commercially available.

I am a retired Naval officer with 25 years’ experience in operation, maintenance, and repair of nuclear-powered ships and subs. It is worth that expense for the Navy because we gain significant strategic and tactical advantage over our adversaries. Not true in a commercial business.

– Michael P.

Another consideration is the physical security of the nuclear ship and the enriched fuel. Commercial ships are not armed (various reasons) and could be hijacked – the movie Captain Phillips comes to mind.

Additionally, there are countries in the world that do not allow nuclear-powered ships in their ports. Their view was either against nuclear power (totally), or they did not want a floating nuclear bomb in their harbor.

– Jan R.

Michael, Jan, thanks for your input on our recent mailbag edition. These are fantastic points that give even more perspective to the original question that was raised.

For readers who missed it, last week we discussed an interesting question: Why can’t commercial ships make use of nuclear power the way military vessels do?

To get an answer, we reached out to a contact in our network that gave us some insight. And the answer came down to essentially one factor: Cost. Readers can catch up on the topic right here.

Jan, you bring up another interesting point. Nuclear-powered commercial vessels could theoretically pose a security risk. If commercial vessels were nuclear-powered (with fission reactors), they would almost certainly need a security escort and be armed themselves.

Even in the best of times, that’s not realistic. But given the current backlog of marine traffic, it becomes a logistical nightmare.

And to give us an idea, let’s have a look at the below image. This is a publicly available map of all commercial marine traffic updated in real time. Each of those dots represents a commercial vessel. It really puts things into perspective. And we should keep in mind that this is just a small snapshot of global marine traffic.

The reality is, there’s no way to protect so many vessels, which would likely be required if they were nuclear-powered (fission). Again, the costs associated with building, operating, maintaining, repairing, and protecting these ships would simply be too high. And to Michael’s point, this assumes that commercial entities could purchase highly-enriched uranium – and I seriously doubt that. After all, the kind of highly-enriched uranium used by the Navy can be turned into nuclear weapons. That’s not the kind of material that the government would want trading freely on the open market… neither would I.

Commercial Marine Traffic

Source: marinetraffic.com

When I previously wrote about this topic, I did mention a possible solution. A company called Avalanche Energy is developing compact nuclear fusion reactors small enough to be carried by a single person. If the company is successful with its technological development, this is the kind of technology that could fuel planes, trains, and ships. Better yet, there would be no need for any dangerous materials like highly-enriched uranium.

This topic proved to be very popular with readers. And I wanted to thank you all for being so engaged and submitting your feedback and comments.

That’s all the time we have this week. Remember, if you’d like me to answer one of your questions, send me a note by writing to [email protected]. I’ll do my best to get to it in a future mailbag.


Jeff Brown
Editor, The Bleeding Edge