Buffett dealmaking

I am surely not the only person who got into mergers-and-acquisitions law, and later investment banking, because I read “Barbarians at the Gate” at an impressionable age. There was just something about the high-stakes negotiations, the crack teams of experts mobilizing to work through the night to sign a big deal, the intensity coupled with quiet professionalism, that I found appealing. In my brief time as an M&A lawyer I once worked for a company that was selling itself, and at one point we really did have two different bidders in conference rooms on two different floors of our building, each unaware that the other was there, and I’d hurry between the bidders trying to remember who was where and hoping not to let anything slip and working frantically to get the deal done but also thinking somewhere in the back of my mind “man, this right here, this is the stuff.” I don’t know, I was a strange kid, it wore off pretty quickly.

On the other hand here is this!

The bathtub epiphany that led Warren Buffett to pump $5 billion into Bank of America Corp. after the financial crisis has been retold many times. Now, a new detail is emerging in the Wall Street fable.

In an interview with Bloomberg Television, Bank of America Chief Executive Officer Brian Moynihan recalled how Buffett initially tried to reach his company with a proposal eight years ago. The legendary investor called a public phone line and was rebuffed.

“He got into the call centers and asked to speak to me and of course they don’t transfer everybody who calls the call centers to the CEO’s line,” Moynihan said in an interview for broadcast on “The David Rubenstein Show: Peer to Peer Conversations.” 

I assume that what happened here (if this story is even true) is that whenever Buffett is going to make a big trade he does a few performatively folksy things first so he can have a good story later. Like probably he was following the news, keeping a close eye on Bank of America’s finances, talking a lot to his lieutenants and bankers and market participants, and as the idea of investing in Bank of America was just starting to crystallize in his mind he was like “oh hey hang on I’d better run a bath so that later I can tell everyone that the idea came to me in the tub.”

And then, you know, he toweled off and went into the office, where his assistant probably told him “the 30 best-connected financial-institutions bankers in the world have been calling here all morning, they are desperate to talk to you about putting money into banks at absurdly attractive terms, here are all of their numbers, they are hoping against hope that you will call them back,” and he was like “yes yes fine but all that can wait, right now, get me the public number on Bank of America’s website!” And then he called and a robot was like “press 1 for credit cards, press 2 for savings accounts, press 3 for mortgages ...” and he listened to the whole menu and pressed zero and waited patiently to speak to an operator and they finally answered and he was like “hello I live in Nebraska and would like to speak to your CEO about a business proposition” and the operator said “please hold” and then dropped his call and he turned to his assistant and was like “okay fine now I have my anecdote, get me one of those bankers.” I hope the call-center employee is getting royalties for this story.

Is there any greater inefficiency in financial markets than Warren Buffett’s time management? I mean no, I know, it’s fine, he reads a lot and learns a lot and seems to have a good time.  But people will pay millions of dollars to have lunch with him, and when he meets with corporate CEOs he can get incredibly lucrative deals for himself in 90 minutes, and at one of the very best moments in history for him to deploy his talents—a time when assets were cheap, he had lots of cash, the Buffett halo was in great demand, everyone was fearful and he was greedy—he was just sort of drumming his fingers on his desk while Bank of America’s hold music played. I kind of get it! He has all the money he’ll ever need, and this story is much funnier than an extra billion dollars would have been. Waiting on hold for customer service at a bank is not my idea of a good time, but perhaps if I were Warren Buffett it would be.

IPO underpricing

Here’s a theory about initial public offerings:

According to the theory, underwriters use the standard IPO contract to extract rents from the issuers that fail to foresee their vulnerability to underpricing under the traditional IPO process, while effectively bribing the more sophisticated issuers to keep using the inefficient contract. … 

First, underwriters offer the same firm commitment and book-building contract to all issuers. Second, underwriters maintain a strategy of underpricing the IPOs of naïve issuers. Third, in the IPOs of sophisticated issuers, underwriters pivot to a strategy of exploiting investors by overpricing IPOs. Finally, underwriters short sell (over-allot) these overpriced IPOs and make a trading gain when they repurchase shares at the lower market price.

It is often overlooked that IPO initial returns are extremely variable. While IPOs that pop in the after-market garner attention, almost a third of U.S. IPOs are overpriced. If investors bought at a $1.75 billion discount in Snapchat’s IPO, investors overpaid by $617 million after Uber’s IPO traded down on the first day. My behavioral theory of IPO pricing is the only theory that predicts both Snapchat-type and Uber-type IPOs.

Accurately pricing IPOs is not an objective of underwriters according to the model. A key result is that underwriters maximize their payoffs by deliberately over- or underpricing IPOs as much as possible. The kicker is that the traditional IPO transaction structure gives underwriters the capacity to manufacture mispricing by holding up IPOs on the sell side and, on the buy side, threatening to reward or punish investors in future IPOs. This result of the model accurately predicts the extreme variability of IPO initial returns and the correlation of mean underpricing and initial return variability over time.

That is from a blog post by Patrick Corrigan of Notre Dame Law School; here is the related article, “The Seller’s Curse and the Underwriter’s Pricing Pivot: A Behavioral Theory of IPO Pricing.” The idea is that most newly public companies are tricked by their bankers into underpricing their IPOs and selling shares for less than they’re worth, rewarding the banks’ investor customers with cheap stock, but a minority of newly public companies are smart and can demand that their bankers overprice their IPOs so they sell shares for more than they’re worth.

I want to say first of all that this is obviously not at all the lived experience of anyone involved in the IPO process. The idea that companies agree to underprice their IPOs because they are naïve does not seem to match the facts: Many companies with big first-day pops are backed by large sophisticated venture capitalists, and much of the recent controversy about IPO pops comes exactly from those repeat-player VCs complaining about how their IPOs keep popping. The idea that sophisticated issuers intentionally overprice their IPOs does not match their actual reactions: When SmileDirectClub Inc. priced its IPO and it promptly fell 28%, the company’s CEO called Jamie Dimon to complain. Just from my personal experience sitting on a capital markets banking floor, it seems clear that bankers try to price every IPO for a 10 to 20% pop, but sometimes miss very far in one direction or another just because pricing IPOs is hard.

Still I find myself drawn to the theory? It really is the case that part of the reason so many “hot” IPOs are underpriced, and trade up immediately in the aftermarket, is to win favor with investors in the long run and make it easier to sell the occasional difficult IPO. I think of this as sort of a risk-sharing mechanism for issuers—by making the IPO market generically attractive, you make it easier for every future IPO to get done—but, sure, you could imagine it being exploited. You could imagine a sophisticated and price-sensitive issuer saying “well okay if that’s how it works I want to be one of the difficult IPOs that doesn’t pop; I want you to take the goodwill that you accumulated in previous deals and spend it on me.” Again I don’t think that anyone explicitly says, or even thinks, that; I just think that it’s sort of a clever theory of investment-banker false consciousness. If you told an IPO banker “what you really do is try to fool a bunch of naïve issuers into underpricing their IPOs so that a few sophisticated issuers can overprice their IPOs and you can make money trading their greenshoes,” I think her immediate response would be “that’s ridiculous! I don’t do that,” but her second response might be “wait … do I?”

Also though what is the alternative theory? I mean, I know what the alternative theory is, and I think it’s true, but I don’t feel great about it. It has two parts. The first part is that an average pop of 10-20% is good both for individual issuers (they get goodwill from investors, their unsold stock goes up, everyone is happy, etc.) and particularly for repeat-player pre-IPO investors (if IPOs generally pop then a venture capitalist’s next IPO will have an easy time getting investor attention), so issuers and investors and banks are all happy with it. That part of the theory is reasonable and compelling and a little non-obvious and I feel smart typing it.

The second part is that there is huge variability around that average pop because it is really really really hard to price an IPO: A bunch of the top banks could all do due diligence and build financial models and have one-on-one meetings with sophisticated investors and take their orders and price the deal to meet their demand and then wake up the next day to find out that the right price was 100% higher, or 30% lower, than the price they came to after two weeks of surveying investors. There is nothing particularly smart about that. It’s probably true! But there is something appealing about a theory of cynical rent extraction by banks and investors, when the simple, probably correct, but embarrassing alternative is that banks and investors have no idea what companies are worth.

Selfie round

Well this is a little weird:

Oyo Hotels and Homes is raising $1.5 billion from founder Ritesh Agarwal, SoftBank Group Corp. and other investors as the India lodging startup expands into foreign markets such as the U.S. and Europe.

Agarwal, 25, will spend $700 million to buy new shares in the company as part of a previously reported $2 billion plan to triple his ownership stake. …

The young founder made headlines in July with plans to spend $2 billion to raise his stake in the company to 30% from about 10%. Japanese banks Mizuho Financial Group Inc. and Nomura Holdings Inc. are bankrolling Agarwal’s share acquisition, according to people familiar with the deal. He is buying some of those shares from Sequoia and Lightspeed, and will carry out the transaction through an entity called RA Hospitality Holdings, Oyo said.

On Twitter, Sumanth Raghavendra called it a “selfie round.” In general, if you are the founder of a company and own $1 billion worth of its stock, you can borrow some money against that stock and use it to buy more stock. It strikes me as a bit of a weird thing to do, but it happens—Adam Neumann did it at WeWork—and my resistance is probably just that I am not temperamentally suited to be a startup founder. If your entire life and career and net worth and every waking hour are wrapped up in your startup, why not leverage that a bit more? Why not devote, like, 300% of your net worth to the startup?

One way to think about this is that Agarwal is effectively transforming his stake from stock into stock options. If he owns $1 billion of the company at a $10 billion valuation, he just owns 10% of the company: If it turns out to be worth $10 billion he’ll get $1 billion, if it turns out to be worth $5 billion he’ll get $500 million, 1  if it turns out to be worth $100 billion he’ll get $10 billion, etc. If he ends up owning, say, $3 billion at a $10 billion valuation, with $2 billion of that financed by borrowing, then his payoff is nonlinear. If the company turns out to be worth $5 billion, his 30% stake will be worth less than the amount of the loan, and he’ll get zero. 2  If it turns out to be worth $10 billion, his 30% stake will be worth $3 billion, but he’ll only get $1 billion of it after paying off the loan. If it turns out to be worth $100 billion, the loan will be a trivial inconvenience and he’ll keep $28 billion. The payoff of stock plus a (non-recourse) loan is essentially the same as the payoff of a stock option; the strike price of his option is essentially $2 billion for a 30% stake, or about a $6.7 billion valuation. 3

Why would you do this if you’re an entrepreneur? Well, you’re a confident bullish guy, you think your company is going to $100 billion, you want to make a more concentrated levered bet on it than just having all of your net worth in its stock would allow. It is not what I would do but, again, I am not a startup founder. Why would you allow this if you’re an investor in the company? Well, companies pay executives in stock options all the time, you want to incentivize risk-taking and bold ambition. Again it is not what I would do—there is such a thing as too much incentive to take risks—but I suppose it’s possible. Why would you do this if you’re Agarwal’s lenders? That I don’t know. 

Elon vs. the world

Here is a story about how, after Elon Musk slandered a British cave diver on Twitter, a committee of seasoned executives, lawyers and public relations experts ghostwrote a statement for Musk to send out in which he would apologize for tweeting so much and log off for a while:

Sam Teller, a director in the office of the CEO at Tesla, SpaceX, Boring Co. and Neuralink, sought feedback from a team of executives, lawyers and advisers inside and outside the companies on what Musk should do after baselessly calling the diver a pedophile in July 2018. The insult, lobbed after Musk’s attempt to help save Thai children trapped in a cave was rejected, sent Tesla’s stock tumbling and prompted the group to suggest that Musk take a break from Twitter. …

In the email sent to Musk in July of last year, Teller sent a draft outline of an apology for Musk to send out. Teller wrote that he had solicited feedback from almost a dozen people in crafting the proposed message, including Gwynne Shotwell, SpaceX’s COO; Antonio Gracias, a SpaceX and Tesla director; Deepak Ahuja, then Tesla’s CFO; two former Tesla communications executives; and Anthony Romero, the executive director of the ACLU.

Teller advised that Musk begin the message addressed to his employees: “I understand that my recent behavior has probably embarrassed you and I’m sorry.” Teller suggested that Musk say he understood people wouldn’t stop attacking him on Twitter, but that he would do his best to “tune them out.”

Imagine a world in which Elon Musk would cheerfully send out a committee-written apology for tweeting, promise not to tweet so much, and stick to that promise! Imagine being an executive at one (or more) of his companies and thinking that was a realistic plan! Oh sure sure sure if a normal public-company CEO baselessly tweeted that some complete stranger was a “pedo guy,” he would probably ask a team of professionals to draft an apology and then dutifully send it out, but in this hypothetical why was the normal CEO tweeting about “pedo guys”? No, no, if you are drafting a promise not to tweet for Elon Musk, you have to know that won’t work. It did not:

“After sleeping on this, I’m not happy about the suggested approach,” Musk wrote back to Teller, in an email included in the court documents released Monday. The CEO said “it would have been particularly foolish and craven” to apologize the night after Tesla’s shares declined, as it “would simply have been dismissed as a disingenuous and cowardly attempt to restore the stock price.”

“We need to stop panicking,” Musk wrote.

Oh yeah “court documents” because the diver is suing Musk for defamation, for the “pedo guy” tweet but also for emailing a BuzzFeed reporter with false claims about him in the hopes that BuzzFeed would look into them. “Musk’s lawyer in the defamation suit, Alex Spiro, said in an email that the case is ‘nothing but a money grab’ by Unsworth,” the cave diver, and my feeling on that is … just give him his money, you know? Like, Musk’s main hobby seems to be sending out tweets that cost him tens of millions of dollars, and this is clearly one of those eight-figure tweets, and just pay the man, come on. If you settle the case, it’s just another multimillion-dollar tweet for Musk; if you fight it, there are embarrassing revelations and distracting depositions and oh right also he’ll probably tweet some more about it and get in further trouble. Of course advising him to settle runs into the same problems as advising him to apologize and stay off Twitter; he’s the guy who did all this, why would he stop doing it and settle?

Elsewhere in Elon Musk, Zach Mider has an article in Bloomberg Businessweek titled “Tesla’s Autopilot Could Save the Lives of Millions, But It Will Kill Some People First.” I suppose that raises profound ethical questions, and I think I might be on Musk’s side about the answers, but in any case here’s an anecdote about Mider getting into a self-driving Tesla with Musk superfan Omar Qazi:

Tesla has legions of die-hard fans, many of them well-to-do, tech-obsessed, and male. Qazi is pretty close to the archetype. His Twitter handle, @tesla_truth, is a bottomless font of Muskolatry. Before we met in August, he’d emailed Musk to give him a heads-up and encourage him to speak with me. The billionaire CEO, who declined to be interviewed for this story, replied to his fan the same day. “Your Twitter is awesome!” he said, before adding a warning: “Please be wary of journalists. They will sweet talk you and then wack you with a baseball bat.” Musk cc’d me on the message. Tesla also declined to comment.

Remember Musk is being sued right now for, among other things, sending indiscreet emails to reporters! He really just can’t stop, I love him, he is so purely and constantly himself.

Man says things

Oh sure:

First Ken Fisher shocked his audience with sexist and off-color remarks. Then the billionaire said he didn’t understand why.

After stunning the crowd at a San Francisco conference Tuesday by talking about genitalia and likening winning money-management clients to "trying to get into a girl’s pants," Fisher said he was surprised by how people reacted. He said he’s spoken like that plenty of times in the past.

“I have given a lot of talks, a lot of times, in a lot of places and said stuff like this and never gotten that type of response,” Fisher, 68, said in an interview Wednesday with Bloomberg, adding he thought his comments were taken out of context. “Mostly the audience understands what I am saying.”

Yeah no, they understand what you’re saying!

“People are worried about custom keyboard market liquidity.”

I think it is fair to say that if you include that sentence in your blog post about Vickrey auctions for mechanical keyboard kits, you are going to get a link in Money Stuff, so, uh, congratulations to Kevin Lynagh. A Vickrey auction is a sealed-bid auction in which the highest bidder wins but pays the second-highest price, lessening the “winner’s curse” and encouraging bidders to bid their true value. Here, the maker of the kits auctioned 10 of them, “the highest 10 bidders won, and they all paid the same price — the 11th highest bid.” If you’re interested in custom keyboard kits, check it out.

But also we have been talking a lot recently (including up above) about the problem of IPO pricing, and about potential ways to fix that problem, and if you’re interested in running an auction-based IPO but like the idea of attracting investors by offering them a good deal on an IPO priced below what they’re willing to pay, perhaps you should consider running a Vickrey-auction-based IPO? “All buyers will likely all pay less than they were willing to pay, which makes ‘em feel like they got a good deal,” writes Lynagh.

Things happen

Silicon Valley Is Trying Out a New Mantra: Make a Profit. Even Greece Is Getting Paid to Borrow Money in Debt Markets. Money Managers Gain Sway Over Muni Market. Aramco’s Long-Delayed Mega-IPO Is Finally Set to Hit the Market. Levi Strauss bets moral mission can survive public markets. PG&E Bankruptcy Judge Gives Outside Group’s Plan a Chance. Bond-Trading Bots on Verge of Becoming Masters of the Universe. Repo Market Is Telling Washington That Deficits Still Do Matter. ECB’s Draghi ignored in-house advice on decision to restart QE. No Deal: Why Buying the London Stock Exchange Is Hard to Do. Facebook CEO to Testify at House Panel About Libra. Greek Shipowner Torched Tanker in $77 Million Fraud, Judge Says. Large Korean Hedge Fund Halts Investor Withdrawals Amid Probe. “Quantitative teasing.” ‘Consider Getting Arrested,’ Rich Clients of Private Bank Told. “There’s something almost Samuel Beckett about [‘But Not the Armadillo’].” “Just let everyone know that Kevin Durantelope is coming.”

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1. For simplicity I’m assuming that everyone owns common stock. If the entrepreneur owns common stock but the venture-capital investors own preferred stock, as is not uncommon, his common stock has some option-like aspects even without the borrowing.

2. Will he get less than zero? Ehh. He “will carry out the transaction through an entity called RA Hospitality Holdings,” which makes it sound non-recourse, but don’t worry about that. The point is that if you are a 25-year-old entrepreneur and you borrow $2 billion to buy stock and the stock ends up being worth less than $2 billion, that loan is non-recourse, no matter what it *says*. They can sue you for the rest of the money, but you don’t have it.

3. For simplicity I am just using the “plans to spend $2 billion to raise his stake in the company to 30% from about 10%” numbers, not the actual $700 million he’s putting in in this round. Also I’m assuming the $2 billion is all borrowed, and I am treating the whole position as a single option, rather than just the *incremental* 20% stake. None of this is precisely about his actual trades, it’s just about the general idea.

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