Lucrative Bonds and Animated Toes

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Argentina.

From 2005 through 2014, Argentina's offer to holders of its defaulted bonds was to give them new bonds worth, initially, something like 30 cents on the dollar. That was the last offer that President Cristina Fernandez de Kirchner's government made to holdout bondholders in 2014. Now President Mauricio Macri's government has reached an agreement with its main holdouts (led by NML Capital, a unit of Paul Singer's Elliott Management) to pay them 75 cents on the dollar, which sounds like more -- but which is actually much, much more, because it's a different dollar:

Elliott will get back $2.28 billion, equal to about 369 percent of the firm’s $617 million in principal, under the terms of a settlement announced Monday, according to Finance Ministry data. Elliott’s total claims, including accrued interest, total $3.039 billion, according to data provided by Argentina’s undersecretary of finance Santiago Bausili in a Feb. 29 court filing.

Elliott got back 75 percent of its claims, but the claims include accrued interest, and the interest was very big. For instance, Elliott holds $132 million in principal amount of floating rate accrual notes, or FRANs, which accrued 101 percent interest for about a decade. (We talked about the FRANs a few weeks ago in a post that is -- disclosure-brag -- Exhibit 2 to Bausili's filing.) That $132 million of bonds, with interest, translated into almost $1.6 billion of claims, and Elliott will get paid almost $1.2 billion for it. Another holdout, Bracebridge Capital, did even better on its FRANs. From Exhibit 1 to Bausili's filing:

In addition to doing better on its FRANs, Bracebridge owned only FRANs, so its overall return was 952 percent; Elliott was averaged down by owning $485 million of other, less lucrative stuff. Still it's nothing to sneeze at. Bloomberg's Katia Porzecanski writes:

While Singer’s actual return can’t be calculated without knowing what he paid for his bonds -- which had plunged in price to pennies on the dollar as the nation defaulted on $95 billion in late 2001 -- the return on principal from the settlement is almost three times those an investor would’ve made accepting the terms of Argentina’s 2005 debt restructuring, according to Buenos Aires brokerage Puente. That swap, which Singer rejected, would be worth about 118 percent of face value as of Tuesday, said Alejo Costa, the firm’s head strategist.

For some rough dimensions, assume that Elliott bought its bonds in early 2002 at 37 percent of par. (Neither is likely to be true.) So it will get back 10 times its money over 14 years. That would be like an 18 percent annualized rate of return, and for a lot of work and risk and heartache.

All of this assumes the settlement will go forward, which I do. Yesterday Macri asked Argentina's Congress to pass the laws necessary to finalize the deal, and U.S. District Judge Thomas Griesa held a hearing to decide whether to lift his injunction on Argentina. Elliott, of course, opposed -- you don't put aside 15 years of fighting just like that! -- as did lawyers for small holdout bondholders who have not had an opportunity to negotiate directly with Argentina and who don't like Argentina's general take-it-or-leave it offer. I have to say that I am not that sympathetic: Forcing Argentina to negotiate individual deals with every retail bondholder before paying anyone would give those bondholders too much power to hold up the process and make a settlement basically impossible. (I suspect Judge Griesa agrees.) I have some sympathy -- one lawyer mentioned a partially paralyzed "90-year-old client who bought Argentine bonds in the 1990s for 'patriotic' reasons" -- but, honestly, take the money.

Valeant.

Poor Bill Ackman. He owns about 21.6 million shares of Valeant, which had a bad day on Monday, leaving him with a $321 million one-day loss on those shares. But he also has exposure to about 9.1 million more shares in the form of option combinations (short a put, long a call spread). My rough estimate (from the Bloomberg OV function) is that he lost maybe another $80 or $90 million on those options on Monday, turning them from an asset (he originally paid about $61.6 million for them) into a liability. I don't know Ackman's collateral arrangements with his dealers but, you know, he's probably not happy about this. Those options expire next January and include puts struck at $60; the stock closed yesterday at $65.45. (Ackman previously had another 3.4 million options that expired in February; he sold those just before they expired and got $2 million for them. He also bought 5 million shares in February in the mid-$90s just before closing out those options, but he had sold about 5 million shares for tax purposes in December in the $100s, so he's ahead on that one. All in all not as bad as it could be! But still bad.)

Elsewhere in Valeant news, it is just relentlessly bad. Hillary Clinton managed to take some time, on Super Tuesday, to launch an ad criticizing Valeant by name. Charley Grant at the Wall Street Journal writes about Valeant's communications problems, while Max Nisen at Bloomberg Gadfly writes that "its problems are much bigger than its communications strategy." Saddest of all, though, may be that Valeant is at risk of losing the animated mascot for its toenail fungus drug Jublia. (I don't know if the mascot has a name -- the article just refers to him as "the football-helmeted big toe with foot fungus" -- though I like to think of him as being named Jublius.) Apparently the Food and Drug Administration is skeptical of animated mascots for drugs:

“Personifying animated characters may interfere with message communication,” the FDA said in the document. “Whether personified characters lead to reduced comprehension of risk and benefit information in drug ads is an important and unanswered question.”

It is true that I was so amped to watch an animated toe tackle the words "TOENAIL FUNGUS" carrying a football (you kind of have to see it to understand) that I barely noticed that you are supposed to apply Jublia for 48 weeks (so many weeks!), or that "most common side effects include ingrown toenail, application-site redness, itching, swelling, burning or stinging, blisters and pain." Anyway "the FDA’s main study will enroll 1,500 participants to watch ads and then answer an online survey," so be sure to sign up for that if you can.

Deutsche Bank.

Euromoney asks: "Can Cryan halt Deutsche Bank's decline?" Here is I think a revealing passage:

Jain and his team had built the plain-vanilla flow-monster capability in rates and foreign exchange that might yet sustain it in future, but at its heart Deutsche Bank was a derivatives-focused, principal trading firm: a hedge fund in essence, which also had many other US and UK hedge funds as its core institutional client base.  

A senior executive at the firm tells Euromoney: "If a real-money client came to Deutsche Bank wanting to sell a block of shares, the typical Deutsche response would be to bid for those shares as principal, take them on balance sheet, hedge them, manage the delta and work the position out over a long period. It’s the derivatives and principal trading mentality, aiming for a big pay-off. Its instinct would not be to cross that block against countervailing customer orders and take a quick and easy agency commission. But that is what market businesses today are all about."

I actually don't think that being "derivatives-focused" and doing "principal trading" makes a bank "a hedge fund in essence." That senior executive's description of Deutsche Bank as a firm that would commit capital, take risk, and do complicated structuring and risk management in order to do trades for clients actually sounds like a standard description of the traditional model of client-focused, customer-servicey, universal banking circa 10 years ago. It is not crazily different from how Jamie Dimon describes the role of JPMorgan today. ("The best way to look at any business is from the standpoint of the clients," etc.) For the client, Deutsche Bank buying a block of shares from it directly at its own risk is better service than Deutsche Bank selling off the block in a slow drip as "countervailing customer orders" come in. The notion that big banks should take big balance-sheet risks, and do complicated things, to service clients used to be pretty common -- not (just) because bankers like taking risks and doing complicated things, but also because clients demanded it. 

That notion is much less popular today. Taking trading risk makes you look too much like a hedge fund, and no one wants banks to be hedge funds.

Asia hiring.

"Barclays PLC on Tuesday became the latest bank to disclose that U.S. authorities are investigating its hiring practices in Asia"; the list now includes about 10 U.S. and European banks who may or may not have hired relatives of Asian officials in order to win business. That's a no-no under the U.S. Foreign Corrupt Practices Act, which prohibits bribing foreign officials, but you get the sense that people just didn't think that giving a nephew an internship was really a bribe. It's not just banks, either. Yesterday Qualcomm agreed to pay $7.5 million to the Securities and Exchange Commission "to settle charges that it violated the Foreign Corrupt Practices Act (FCPA) by hiring relatives of Chinese government officials deciding whether to select the company’s mobile technology products amid increasing competition in the international telecommunications market," and reading the SEC order I am again struck by how difficult it is to know where salesmanship ends and bribery begins:

In fact, the initial interview decision was “No hire” because the son of the telecom company executive was not “a skills match,” didn’t “meet the minimum requirements for moving forward with an offer,” and among those who interviewed him, “there was an agreement that he would be a drain (not even neutral) on teams he would join.” Despite these assessments a director in Human Resources advocated for the son’s hire at the direction of EVP, summarizing, “I know this is a pain, but I think we’re operating under a different paradigm here than a normal “hire”/”no hire” decision tree. We’re telling this kid (and in effect, [the telecom company]) that we don’t want to waste time or extend any extra effort in this favor [the telecom company] has asked of Qualcomm, and then turn around and ask the same person we just rejected to do us a special favor.”

Right? It's a relationship business. Sometimes the relationship involves giving out jobs to people who are not quite a "skills match." Elsewhere: "Olympus Will Pay $646 Million to End Kickback, Bribe Probes."

Aubrey!

Antitrust is another of those areas in which it is sometimes hard to tell where rational self-interest ends and collusion begins. Yesterday entertaining shale-gas wildcatter Aubrey McClendon was charged with criminal antitrust violations:

The indictment says that Mr. McClendon, who led Chesapeake Energy before he was forced to step down three years ago, orchestrated a conspiracy in which two oil and gas companies colluded not to bid against each other for the purchase of several leases in northwestern Oklahoma from late 2007 to early 2012.

According to the Justice Department, the companies decided who would win the leases, with the winning bidder allotting an interest in the leases to the other company.

It is fairly common for oil and gas companies to own interests in each others' leases. Perhaps that drives down the price of leaseholds (less competition to buy them if you can just share them), or perhaps it drives it up (more capital and shared risk means you can pay a bit more for the lease). Obviously you cannot collude to say "I will win the auction for Lease A and you can win the auction for Lease B and we'll split them," but if two companies have a practice of allocating interests in their leases to each other, then they might implicitly come to a similar place. It is all a bit murky to me. The dynamics are similar to "club deals" in private equity, also a bit of an antitrust mystery. Might the bidders have paid more on their own? Maybe! Is it an antitrust violation? I don't know. "I have been singled out as the only person in the oil and gas industry in over 110 years since the Sherman Act became law to have been accused of this crime in relation to joint bidding on leasehold," complains McClendon.

Foxconn/Sharp.

The Foxconn/Sharp story -- in which Foxconn had almost agreed to buy Sharp, but then was given pause by newly disclosed information, but then Sharp disclosed the agreement anyway, and then everyone got mad -- is giving me terrible flashbacks to my brief time as a mergers and acquisitions lawyer. (I also once worked on a deal where one party accidentally put out a press release announcing the deal before it was final! That did not help.) This is particularly gruesome:

The information listed around 300 billion yen ($2.66 billion) in contingent liabilities at Sharp. The list was pulled together by working level officials at Sharp and forwarded, without top officials seeing it, to Foxconn as a goodwill gesture to make the buyer aware of worst-case scenario risks, sources said. They were not liabilities that required formal disclosure.

It didn't go down well on the Taiwan side.

"They felt violated," said a person briefed on the issue. Another person said Gou shouted at his team for not having discovered these liabilities in the first place.

Oh man. I feel like I have been the junior guy, working on the disclosure schedules, trying to be as inclusive as possible (more disclosure means more certainty, after the agreement has been signed), and also wanting to bother the senior people as little as possible. They are just disclosure schedules, surely no one important needs to review them. Whoops.

Elsewhere in M&A, I was pleased to learn that "London Stock Exchange Group Plc and Deutsche Boerse AG have gone on a hiring spree for banks in a so-called street sweep, as they try to fend off interlopers to their European exchange merger by hoarding advisers and financing." I realize that most bankers don't actually think this way, but I would think that the ideal banking job is to get hired on a deal, not to do any work on it, but just to prevent you from working for anyone else. I would have not worked for anyone else for free!

Krawchain.

Sallie Krawcheck is joining the board of Digital Asset Holdings, Blythe Masters's private-blockchain startup, and I must say that Digital Asset seems to have made good on its plan to mainstream the blockchain, or at least the idea of the blockchain, for big banks. Meanwhile here is Steven Davidoff Solomon on "tenure voting," that is, giving shareholders more votes the longer they hold their shares:

The beauty of tenure voting is that it is devised to address short-termism while rewarding all shareholders. Blockchain technology can make it easier to track ownership of everyone’s shares to ensure they are given the right number of votes. (Blockchain technology, which is used by Bitcoin, would create a public ledger of all transactions.)

Or you could just have a database, come on.

People are worried about unicorns.

It's actually a little quiet on the private tech startup front, but here, have "Delightful unicorn plushies poop rainbow scarves, will make you feel warm and magical." The tech angle is that there's a Kickstarter.

People are worried about bond market liquidity.

"Market illiquidity has created a fundamental mismatch between the liquidity that hedge-fund investors expect and the illiquidity of the underlying investment assets," said the manager of a $150 million credit hedge fund that Golub Capital is closing after it lost 20 percent in 2015. Is bond market liquidity so bad that a fund with a $150 million portfolio can't even trade any more? Or is that "fundamental mismatch" about small distressed credit funds promising investors inappropriately easy liquidity terms? I don't know. Here is Bloomberg Gadfly's Lisa Abramowicz with more. 

Elsewhere, Deutsche Bank research made a slide of headlines worrying about bond market liquidity and somehow my own extremely straightforward "People Are Worried About Bond Market Liquidity" did not make the list, so thanks for nothing, Deutsche Bank. I guess that's the opposite of a disclosure-brag. Elsewhere in Deutsche Bank: "The likelihood of low-liquidity events has risen substantially since the crisis." In the new-issue market, "there have been just 337 bond sales this year, the weakest start to a year in at least a decade by number of deals." And in non-liquidity bond worries: "The Party’s Over for Corporate Bonds, as Moody’s Warns of Rising Defaults."

Things happen.

China to lay off five to six million workers, earmarks at least $23 billion. China Credit Outlook Cut to Negative From Stable by Moody's. ‘Critical Mass’ of Oil-Producing Countries Agree to Freeze Production. Debt collection in Russia is intense. Lawmakers Urge Greater Care With Sales of Distressed Mortgages. DNC Chair Joins GOP Attack On Elizabeth Warren's Agency. 'Bond King' Gross: I did not quit Pimco. Congratulations Eric Hunsader! Stock Exchange Prices Grow So Convoluted Even Traders Are Confused, Study Finds. Rolls-Royce Names Activist Shareholder ValueAct to Board, Vows No Change to Strategy. U.K. Banker in Insider Trading Case Uncomfortable With Profits. "How can a baseball batter be described as a quant?" "The possible election of Donald Trump as President is the greatest present threat to the prosperity and security of the United States." "Donald Trump embodies how great republics meet their end." Subway Foot-Long Sandwich Settlement Approved. Sixth grade economics. Tennis dogs. Baseball horse.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net