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Stocks With “Too Much” Cash…and What They’re Doing With It

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They say that money can’t buy happiness. Well, that may or may not be true, but of one thing I am certain: Money buys you options.

When you’re looking for stocks to buy, one thing to examine is the so-called “war chest.” See, a company with a lot of cash on hand can expand its business without having to borrow funds or dilute shareholders by issuing new equity. And importantly, they can also reward their shareholders with big dividend hikes or share repurchases. Or, they can simply sit on the cash and save it for a rainy day. And it’s every bit as true for companies as it is for regular people.

But in any event, it’s just about impossible to have “too much” cash on the books.

Today, we’re going to look at four stocks sitting on a mountain of cash. Some have been better stewards of their cash hoards than others, but all have the options at their disposal that comes with being cash-rich.

Apple

Given the size of Apple’s (AAPL) cash stash, I feel obligated to mention Apple first.

Apple’s cash balance is the stuff of legend. If AAPL’s cash and marketable securities were a standalone company, they would be just bigger than Walt Disney (DIS) by market capitalization, and just smaller than Anheuser-Busch InBev (BUD). Even allowing for punishing tax rates on Apple’s cash held offshore, Apple has enough cash in the bank to sustain its dividend at current levels for years … without earning a single dime in additional profit.

As of this week’s earnings announcement, Apple had just under $203 billion in cash and securities. That’s about 28% of its gargantuan market cap. And the most amazing thing is that Apple’s cash hoard has continued to expand even while a disproportionate share of it gets dedicated to dividends and share repurchases.

Over the past year, Apple has raised its dividend by 11% and shrunk its shares outstanding by about 5%. And I expect plenty more to come.

Apple’s earnings release had disappointing guidance for the remainder of the year and sent shares sharply lower. I’d view any weakness here as a buying opportunity. While the iPhone 6 upgrade cycle was a one-off event not likely to be repeated, Apple shares are very reasonably priced, and its cash hoard gives it a wide margin of safety.

Google

Next up is Apple’s rival in the smartphone wars, search-engine giant Google (GOOGL).

While Apple’s cash stash gets more attention for the sheer size of the dollars involved, Google’s is nothing to sneeze at. As of June 30, Google had just shy of $70 billion in cash and marketable securities, which amounts to about 14% of its market cap.

Google could take a few lessons from Apple on how to reward its shareholders. Despite being an established tech company and one of the largest in the world by market cap, Google has yet to declare a dividend or commit to a share repurchase.

I want to like Google. I really do. But the company seems to have very little regard for its shareholders. The founders always had something of a stranglehold on the company via their control of supervoting B shares. But following Google’s reorganization last year, which resulted in the creation of non-voting C shares (GOOG), only cemented their control further.

There is a reason why Carl Icahn has focused his activism on Apple and not Google. Not even a billionaire corporate raider like Icahn can cajole an unwilling Google management to part with their cash. There aren’t enough voting shares for him to buy to make a difference.

That said, Google’s cash gives it options. Google is one of the few companies out there that could make a legitimate bid for Twitter (TWTR), for example. And Google, despite its lack of discipline, remains one of the most profitable companies in the world. It also has what Warren Buffett would call an “unassailable moat” in its control of Internet search. Virtually every site in the world, including this one, are built with the express intent of being optimized for Google search.

Google is a fine company and a seriously cash-rich stock.

Just don’t expect to see any of that cash returned to you as a dividend any time soon.

Microsoft

Rounding out cash-rich “Big Tech” companies, we come to Microsoft (MSFT). Like Apple, Microsoft had an earnings announcement this week that was something of a disappointment. While Microsoft actually beat expectations for the quarter, the outlook ahead was nothing to write home about.

The Nokia acquisition has proven to be a disaster and resulted in a massive write-off. And Windows sales remain weak due to continued sluggishness in PC sales. With the post-XP upgrade cycle now complete and Windows 10 not yet available for sale, the next quarter probably won’t be much to look forward to.

Yet the news is by no means all bad. Microsoft’s transition to a cloud-based business services company is progressing faster than expected, and the company is showing an innovative streak under CEO Satya Nadella that it rarely showed under former CEO Steve Ballmer.

And Microsoft’s cash position, at $97 billion, remains one of the largest in the world. It also represents a stunning 26% of Microsoft’s market cap.

Like Apple, Microsoft has come to be very generous with its shareholders. Microsoft has upped its dividend at a 17.5% clip over the past five years in addition to shrinking its share count by about 0.8% over the past three years. Expect more to come.

Berkshire Hathaway

 

Stepping away from the world of tech, we get to Warren Buffett’s Berkshire Hathaway (BRK.A).

Buffett is unlikely to ever “retire” from the investment business. He’s a lot more likely to die in the saddle with his boots on. But Buffett has indicated that he would like to hunt one last large elephant of a company before checking out to that big stock exchange in the sky, and accordingly, Berkshire Hathaway has been stockpiling cash.

As of its most recent filings. Berkshire had about $64 billion in cash, amounting to about 18% of the company’s market cap.

I have no special insight as to Mr. Buffett’s last big acquisition. But I can tell you that he has become a little more flexible with how his company’s cash is spent. Buffett has never paid a dividend, arguing (rightly) that it makes more sense to retain the cash for reinvestment. Considering that Buffett — arguably the world’s greatest investor — is the one doing the investing, I would have to agree.

That said, Buffett did authorize a share repurchase plan in 2011, something I never thought I would see. It makes one wonder: Might a dividend really be a possibility?

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. As of this writing, he was long AAPL and MSFT. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

This article first appeared on InvestorPlace.

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AAII Sentiment Survey: ‘Running of the Bulls’

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It’s that time of year again.

Tomorrow morning, thousands of adventurous (or phenomenally stupid) young men from around the world will run with the bulls in the streets of Pamplona.

I was one of those adventurous (let’s be honest — phenomenally stupid) young men once (see “¡Viva San Fermin!“). Though it was over a decade ago, I remember it like it was yesterday.

Lest I get teary-eyed, I’ll cut the nostalgia short. Today, we’re going to focus on a very different “running of the bulls.” Among individual investors, it seems there is nary a bull to be found these days. According to the latest American Association of Individual Investors (“AAII”) Sentiment Survey, there are fewer bulls today than at any time since the 2008 meltdown:

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The AAII survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months. To smooth out the noise a little, I used an 8-week moving average. And as you can see, bullishness is currently at lows you might normally associate with panic bottoms.

The weekly reading shows that just 22.6% of individual investors are bullish about the market over the next six months. To give a little long-term perspective, the long-term average bullishness reading is 38.8%.

While it has become cliche to call this “the most hated bull market in history,” at least by this metric it would seem like an accurate statement.

The AAII Sentiment Survey is viewed by many as a contrarian indicator. Like most measures that depend on investor psychology, it is noisy and doesn’t always give clear signals. But the takeaway here is that the bull market probably has a little longer to run. Yes, stocks are very expensive at these levels and probably won’t offer much in the way of returns over the next 8-10 years. But that doesn’t mean the market can’t continue to drift higher for the next several months.

 

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Google and Facebook Getting No Love from the Big Money

Big institutional money managers tend to be the conventional sort, though I’m not talking about their blue power suits or country club memberships. I’m talking about their stock holdings. Managers tend to pile into the same set of large, mega-cap stocks because deviating from the crowd comes with major career risk.

Let me explain. Running a mutual fund is a fantastic, high-paying job, but it is also a precarious one. The fund’s success — and thus the manager’s paycheck — is directly tied to its assets under management. This creates tremendous pressure to conform to a benchmark, which is often the S&P 500.

A manager’s thinking goes like this: If I bet big and beat the benchmark by going outside the mainstream, my investors are happy…for a day or two. But if I bet big and lose, I might be out of a job.

So, the result is that most managers become closet indexers who overweight a handful of stocks and hope to beat the market by a percent or two.

Imagine how surprised I was when I saw the following chart in the Financial Times, which tracks institutional ownership of nine major tech companies. (Google makes the list twice, so it’s ten stocks but just nine companies.)

Percent Over- or Under-Weighted Relative to S&P 500

The large overweightings in Expedia (EXPE) and Trip Advisor (TRIP) aren’t that surprising. Expedia and Trip Advisor account for just 0.059% and 0.054% of the S&P 500, respectively, so even a small amount of institutional buying will put these stocks out of proportion to the rest. And the overweighting of Netflix (NFLX) is also pretty understandable given that it is one of the best performing stocks in the S&P 500 this year. It’s near the tail end of the chart that the numbers get interesting.

Two of the biggest names in tech — Facebook (FB) and Google (GOOGL) — are massively underowned by institutional investors relative to what their weightings in the S&P 500. And where it gets even stranger, institutional ownership of the less favorable of Google’s two traded share classes — the non-voting Class C shares (GOOG) — is “where it should be” relative to its weighting in the S&P 500. It’s the A shares (GOOGL), which actually have voting rights, that are underowned.

What’s going on here? Why are big money investors shunning Facebook and Google?

Let’s look at Google first. There are two issues: The discrepancy between the share classes and the overall underweighting of Google stock by institutional investors. The latter is the easier of the two to explain. Managers don’t care about the lack of voting rights because they know their votes don’t matter. For would be activists or corporate raiders, Google is an unassailable company. It’s founders hold non-traded “super voting” class B shares that make any sort of proxy battle a virtual impossibility. GOOG’s consistent discount to GOOGL, which has actually widened recently, really makes no sense in this context, so it’s perfectly logical for an institutional manager to overweight the cheaper GOOG relative to GOOGL.

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As for the issue of Google being underweighted overall… well, it might come back to that point I made about Google being unassailable. Google is not known for being particularly friendly to its shareholders (see “Hey Google, Stop Being Such a Baby and Pay a Dividend“). Google is a profitable company that mints money, yet it’s developed a reputation for being the plaything of its founders rather than a profit-maximizing business.

And the same goes for Facebook. Zuckerberg is a ruthless competitor and one of the few people that seems to know how to actually make money in social media. Yet Facebook has also burned through shareholder money on expensive acquisitions of dubious economic value (Oculus, Whatsapp, etc.) and expenses grew at twice the rate of revenues last quarter.

Is there a trade here?

Maybe. While I don’t see an immediate catalyst to change big money minds (neither Google nor Facebook will be paying a dividend anytime soon… sigh…), you could view the underownership as a contrarian value signal.

The safest move, however, might be a pair trade. Short GOOGL and go long GOOG and eke out an arbitrage profit as the discount closes.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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CAPE and Expected Returns by Country

Back in February, I used data from Swiss consultancy firm Wellershoff & Partners Ltd to compare stock values across all major world markets and forecast returns over the next five years. (See “Global Stock Values: Where to Park Your Cash for the Next Five Years.”)

Wellershoff used the standard cyclically-adjusted price/earnings ratio (“CAPE”) for each country and adjusted it for macroeconomic variables such as interest rates and economic growth. They then forecast returns going forward by seeing how the markets performed over subsequent five-year periods  when priced at similar CAPE valuations in the past. (For the quants in the room, Wellershoff runs a regression analysis. If you want to dig into the numbers, they explain their methodology here.)

Today, we’re going to look at updated CAPE data from Wellershoff to see what it might suggest for future returns. As always, past performance is no guarantee of future results, but this at least gives us precedent.

So with no more ado, let’s jump into the data:

Developed MarketsHistorical Avg CAPEMacroeconomically Adjusted CAPECurrent CAPEPredicted Real Return Next 5 YearsPredicted Annual Real Return
Australia17.9316.1015.5840.006.96
Austria25.6711.1110.4165.9710.66
Belgium15.718.4417.4027.384.95
Canada19.3521.2619.0823.254.26
Denmark23.0027.9432.8834.006.02
Finland30.9410.1317.1322.244.09
France20.0813.2715.3056.039.30
Germany18.1719.6018.1224.234.43
Hong Kong18.8218.8817.0857.829.55
Ireland14.9716.4123.62(27.46)(6.21)
Italy20.3910.3911.0547.608.09
Japan34.4229.0024.2629.965.38
Netherlands14.6815.5215.8330.125.40
New Zealand16.9618.6918.2418.633.47
Singapore21.5914.9316.8339.116.82
Spain16.838.189.9541.627.20
Sweden20.7218.6018.9157.009.44
Switzerland19.9027.0819.7831.625.64
UK12.7815.3712.9326.104.74
USA16.3517.7725.046.731.31
Developed Markets Avg22.2217.3532.835.84

Most global stock values suggest solid, if not quite spectacular returns, over the next five years. A few exceptions jump off the page, however. Ireland is priced to actually lose 6.2% per year over the next five years, and New Zealand is priced to deliver returns of only 3.5%. And by Wellershoff’s estimates, the U.S. is priced to deliver a skimpy 1.3% in annual returns. All estimates are real, after-inflation returns.

Taken as a whole, developed markets are priced to deliver returns of about 7% per year over the next five years. This is not a “back up the truck” opportunity, but it’s not bad either, particularly given how unappealing bonds and cash are at current yields.

So, what’s the takeaway here?

To the extent you can, you should underweight US stocks and overweight developed Europe. In particular, Austrian, French, Italian and Spanish stocks are priced to deliver very decent returns in excess of 8% per year. For direct access, you can consider the iShares MSCI Austria ETF (EWO), the iShares MSCI France ETF (EWQ), the iShares MSCI Italy ETF (EWI) and the iShares MSCI Spain ETF (EWP). Or for a convenient one-stop shop, you can try the Cambria Global Value ETF (GVAL), an actively-managed ETF run by Meb Faber. While the Cambria ETF does not rely exclusively on CAPE valuations in its country selection, CAPE is a major analytical factor.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long EWP and GVAL.

 

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Prospect Capital: A Deeper Look at the Most Hated Stock on Wall Street

chartProspect Capital Corporation (PSEC) may very well be the most hated stock on Wall Street.

And I say this as an investor with skin in the game. Not only am I long Prospect Capital both personally and in client accounts, I also have reputational capital at risk: I chose Prospect Capital as my entry in InvestorPlace’s Best Stocks for 2015 contest. As of this writing, I am suffering the humiliation of being in seventh place.

So, just how hated is Prospect Capital these days?

The stock is down 34% from its 52-week high and trades at a 30% discount to book value. To put that in perspective, the median business development company trades at a 6% discount to book value.

When a stock trades for just 70 cents on the dollar, it tells you that investors are questioning the reported book value. And there have been some well-publicized incidents in which Prospect Capital did indeed list identical assets at higher values than their peers, which partially explains investor hostility toward the company. Investors have also never forgiven Prospect Capital for slashing its dividend last year, even though the reduction was necessary given the de-risking of the company’s portfolio and the lower investment income that came with that de-risking.

My view has consistently been that, at the wide discounts to book value we’ve seen over the past six months, we have a wide margin of safety. According to Prospect Capital’s latest investor presentation, 75% of its portfolio is invested in secured first and second lien debt. The portion of the portfolio under the most scrutiny — the CLO equity tranches — makes up only 16% of the portfolio. If you were to write the entirety of the CLO equity to zero — which not even the most bearish of bears would do — Prospect Capital would still be trading at a deep discount to book value.

I spoke with Chief Operating Officer Grier Eliasek this week to get management’s take on Prospect’s recent share-price slide. Mr. Eliasek was very open with me and shared a set of slides that, until now, have not been released to the general public (see Prospect Capital Corporation Investor Presentation). Don’t worry, it’s ok to read them. They are based on public, reported numbers and are being reproduced with permission.

The usual caveats apply here. The data was prepared by Prospect Capital, and while I believe it to be factually accurate, I have not independently verified all of the data. And you should always assume that management has its own motives for sharing any data with the public.

So with that said, let’s jump into the presentation.

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Figure 1: Historical Returns

 

Figure 1 comes pretty close to stock touting, but it is instructive nonetheless. This chart shows the subsequent total returns (capital gains + dividends) that investors experienced the last time Prospect Capital traded at deep discounts to book value. On March 17, 2009, Prospect Capital traded at a 30% discount to book value, just as it does today. And over the 12 months that followed, the stock returned 94%.

Can we expect those kinds of returns over the next 12 months? Probably not. March 2009 marked the beginning of one of the greatest bull markets in history, and a rising tide lifts all boats. That’s not our situation today, although I do believe total returns of 40%-50% are possible and very likely.

The next two slides will be somewhat controversial to anyone sitting on large capital losses, but it is instructive nonetheless. It also happens to be very close to how Warren Buffett has traditionally measured his success at Berkshire Hathaway (BRK-A).

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Figure 2: Operating Returns

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Figure 3: Operating Returns

Figures 2 and 3 measure Prospect Capital’s “Operating Return,” defined here as change in book value plus dividends. The thinking here, as with Mr. Buffett, is that management has no direct control over the share price. That is the prerogative of Mr. Market. But management does have control over the underlying investments, which show up in the company’s book value.

In recent years, most of Prospect’s returns have come from its dividend, though its total operating return has outperformed its peers in the BDC sector.

I agree that these returns are distinctly not what investors have realized in the stock. But just as Warren Buffett has asked to be judged by his growth of Berkshire’s book value, I think the same logic applies here. This hinges on book value being reliable, of course. And I raised that question with Mr. Eliasek:

Sizemore: “A lot of investors seem to be questioning Prospect Capital’s accounting these days. How would you respond to those who say that your book value estimates are overly aggressive?”

Eliasek: “We actually consider our book value accounting to be a major source of strength. We don’t value the portfolio ourselves. Our third-party valuation firms start with a blank piece of paper every quarter and value our portfolio from scratch. And our auditors approve.”

Sizemore: “How does this compare to your peers?”

Eliasek: “We consider ourselves to be among the most conservative. Some BDCs ‘self value’ or ask a third-party valuation firm to simply confirm in-house company estimates. We were one of the first BDCs to insist on truly arms-length, third-party valuation.”

Can a valuation firm be “encouraged” by management to inflate asset values? Of course. There are natural conflicts of interest when the company whose portfolio is being reviewed is the one doing the paying. We saw the same conflicts of interest with bond ratings agencies in the aftermath of the 2008 mortgage meltdown. But I would still consider the third-party valuation firms to be more reliable than an in-house valuation, and I have no reason to believe that Prospect Capital’s asset values are systematically more inflated than their peers.

When a stock is doing well, investors tend to ignore executive compensation. But when a stock is lagging, investors look at it with a much more critical eye. A consistent criticism I read about Prospect Capital is that its management team is overcompensated.

Is this true? Well, let’s look at the numbers.

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Figure 4: PSEC Expenses

 

According to Figure 4, Prospect Capital’s expenses — the largest of which are the management and incentive fees used to compensate management — are almost exactly in line with their peers. Yes, I realize that depending on numbers provided by Prospect Capital itself is a little like allowing the fox to guard the hen house. And as an externally-managed BDC, Prospect does not disclose the compensation of its individual officers. But I see nothing here that would indicate that Prospect’s management team is uniquely overpaid by industry standards.

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Figure 5: Insider Buying

And finally, it is only fair to note that Prospect Capital’s directors and officers eat their own cooking. The insiders are very aggressive buyers of the stock on the open market. And to clarify, these are real, open-market purchases that the executives are making with their own money. These are not executive stock option grants or other forms of stock-based compensation. Since 2010, six company officers have been responsible for buying a cumulative $43.6 million in Prospect Capital stock.

Let’s take a look at some of the more recent purchases, courtesy of GuruFocus:

InsiderPositionDateBuy/SellSharesTrade PriceCostShares Owned Following This
Brian H OswaldCFO6/9/2015Buy65,000$7.27$472,550440,000
M Grier EliasekCOO6/9/2015Buy20,000$7.23$144,600322,196
John F BarryCEO6/5/2015Buy131,060$7.58$993,4345,300,786
M Grier Eliasek COO5/8/2015Buy30,000$8.00$240,000302,196
Eugene S Stark Director5/8/2015Buy2,000$8.00$16,00028,000
Eugene S Stark Director2/11/2015Buy1,000$8.50$8,50026,000
Eugene S Stark Director12/12/2014Buy4,000$8.20$32,800250,00
M Grier Eliasek COO12/9/2014Buy25,000$8.31$207,750272,196
Brian H OswaldCFO12/9/2014Buy63,500$8.35$530,225375,000
John F BarryCEO12/8/2014Buy132,200$8.46$1,118,4124,833,410
M Grier Eliasek COO12/2/2014Buy50,000$9.10$455,000247,196
Brian H OswaldCFO12/2/2014Buy162,500$9.12$1,482,000311,500
John F BarryCEO12/1/2014Buy115,000$9.08$1,044,2004,701,210
John F BarryCEO11/10/2014Buy110,000$9.57$1,052,7004,535,544
Eugene S Stark Director11/10/2014Buy1,512$9.40$14,21221,000
M Grier Eliasek COO11/10/2014Buy5,000$9.56$47,800197,196
John F BarryCEO9/16/2014Buy100,000$10.17$1,017,0004,329,941
M Grier Eliasek COO9/16/2014Buy5,000$10.10$50,500192,196
M Grier Eliasek COO8/29/2014Buy20,000$10.26$205,200187,196
Eugene S Stark Director8/28/2014Buy4,000$10.32$41,28019,488
Brian H OswaldCFO8/27/2014Buy27,300$10.40$283,920149,000
John F BarryCEO6/13/2014Buy100,000$10.37$1,037,0004,110,959
Brian H OswaldCFO6/12/2014Buy30,000$10.25$307,500121,700
Eugene S Stark Director6/12/2014Buy1,000$10.27$10,27015,488
John F BarryCEO6/12/2014Buy100,000$10.33$1,033,0004,010,959
M Grier Eliasek COO6/12/2014Buy24,000$10.28$246,720167,196
John F BarryCEO3/20/2014Buy100,000$10.86$1,086,0003,793,385
Eugene S Stark Director2/6/2014Buy1,000$11.10$11,10014,488

Through June 9, CEO John Barry owned 5.3 million shares worth over $38 million. And most of these shares were purchased at prices far higher than today’s. CFO Brian Oswald owned 440,000 shares, and COO Grier Eliasek owned 322,196. All three men have made major new purchases in the past six months.

Given the amount of money they have personally invested in the stock, the picture in the financial press of a greedy management team looting the company for its own gain doesn’t quite hold water.

So, with all of this said, is Prospect Capital a buy?

As a value investor, I would answer that question with an emphatic yes. We have a wide margin of safety in the large discount to book value, and a management team that, while taking criticism from investors these days, has a lot of skin in the game. We’re also being paid generously to wait for the market’s mood to shift, as Prospect sports a current dividend yield of almost 14%.

Additional dividend cuts may be in the cards if the company continues to de-risk or if there is an uptick in non-performing loans. But I consider the current dividend safe for at least the next 9-12 months.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long PSEC.

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.