Mergers, Clawbacks and Unicorns

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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M&A.

The big news is that ACE is buying Chubb as part of a wave of insurance deals; "M&A fever has seized the industry," says an analyst. And Wall Street is in its usual mode -- "cautious optimism" -- as mergers-and-acquisitions activity is "on pace to catch up with 2007, the last year of unbridled merger optimism before the financial crisis quieted Wall Street." Deal volumes are up, pipelines are strong, risk appetite is up, industries (insurance, telecoms, health care) are consolidating, and things look good. 

Industry consolidation raises antitrust risk, and yesterday the Justice Department sued to block General Electric's sale of its home appliances division to Electrolux, which would leave the stove market "dominated by Electrolux — which makes products under its own brands like Frigidaire and for customers like Sears — and Whirlpool." Elsewhere in antitrust, remember when we talked about a proposal to ban index funds because their cross-ownership of all the companies in an industry makes those companies less competitive? That proposal was based on empirical research into airline prices and cross-holdings, and one objection that people raised was, come on, if airlines are so anticompetitive why do they keep going bankrupt? Anyway now the Justice Department "has started a civil antitrust investigation into several yet-unnamed airlines." So there you go.

Meanwhile in appraisal arbitrage, LongPath Capital, which sued for appraisal seeking $4.96 a share for its stake in Ramtron International after Cypress Semiconductor acquired it for $3.10 a share, will get only $3.07

The judge found Cypress had built into its bid expected synergies of 3 cents a share. Under appraisal rules, investors are entitled only to the fair value of their stock, not any such cost savings or revenue enhancements a buyer is counting on.

With 5.75 percent statutory interest, LongPath will still do better than it would have if it had just taken the $3.10 merger price, which is maybe a reason to revisit the appraisal interest rules. You shouldn't have an incentive to bring a losing lawsuit!

Clawbacks.

The word "clawback" has pretty wide applicability; broadly it means that if someone gets a bonus, and later you're mad at her, she should have to give up her bonus. That is pretty subjective, and there are controversies about how mad you have to be, how much of her bonus (or how many years of bonuses) she should have to give up, etc. But there's a mechanical simple subset of clawbacks that are just, like, if the chief executive officer of a company gets a bonus of $1 for every widget sold, and the company sells 20 million widgets and she gets a $20 million bonus, and then later an investigation reveals that the books were cooked and the company actually only sold 15 million widgets, then she should have to give back $5 million. Seems fair! Even if it's not her fault that the books were cooked. The point is not that she's evil or that you're mad at her or that she should be punished, but only that she received compensation that she didn't earn and ought to give it back. Yesterday the Securities and Exchange Commission proposed new clawback rules requiring publicly listed companies to have and enforce clawback policies like that. The rules take up 198 pages and passed by a 3-2 vote, and obviously there's some nuance about who is covered (not just CEOs) and how you calculate, but, you know, in the abstract, seems fair. Though there is the issue of, how do you claw back a bonus if it's already been spent?

Steven Seelig, a senior regulatory adviser for Towers Watson & Co., a human-resources consultancy, said these kinds of rules could alter compensation practices, including the introduction of mandatory bonus deferrals. Deferring payments would make it easier for companies to recoup earnings from executives.

Bubbles and unicorns.

Steven Davidoff Solomon writes about venture capital firm Andreessen Horowitz's views on the situation in tech. The article, and the Andreessen Horowitz presentation, are very much worth reading. The basic thesis is that there's no tech bubble -- tech funding is much more reasonable, on most measures, than it was in 1999 -- but there is a "unicorn hunt": There are a lot of big private tech companies, and that's weird and different. But that's not about a bubble; it's about the vanishing tech IPO. Davidoff Solomon:

The Andreessen Horowitz partners argue that the gains that used to go to the public through initial stock offerings are now being transferred to private investors. For instance, Facebook went public with a valuation of more than $100 billion, and all of its gains went into private hands. For Facebook to match Microsoft’s public market returns, it would have to be worth $45 trillion, according to the presentation.

The unicorns are an extension of this and would have simply gone public earlier in a previous age. But now that the small I.P.O. has essentially vanished, it is the venture capitalists who profit by building a diversified portfolio and investing in these “quasi I.P.O.s,” which grab even more of the gains than Facebook.

This strikes me as pretty correct. Elsewhere, former Twitter CEO Dick Costolo thinks that going public "accelerates short-term thinking."

Greece

I kind of give up, but at least I can. I get the sense that the people negotiating this also want to give up, but what are they gonna do. "Eurozone officials said they were baffled by the mixed messages coming from Greece," with prime minister Alexis Tsipras telling the Greek people that "the sirens of destruction are blackmailing you to say yes to everything without any prospect of exiting the crisis" right after ... he said yes to almost everything in an effort to exit the crisis? "Tsipras has turned this country into North Korea," says an 83-year-old Athenian withdrawing the maximum 60 euros from a Greek ATM; even with withdrawal caps the ATMs may not make it to the referendum. Though at least the ECB voted to continue ELA for Greece. Tsipras's finance minister Yanis Varoufakis says he'll resign if Greeks vote yes in Sunday's referendum. Here's a story about Greek anarchists.

China.

Man, imagine if Chinese stocks had been added to major global indices in mid-June, and indexed investors had had to add Chinese exposure based on the then-market cap of those stocks, which everyone kind of thought were in a bubble. The bubble popped like a week later! Delightfully, China's securities regulator's latest response to the 20+ percent decline in the Shanghai and Shenzhen markets over the last few weeks will be to encourage more margin lending, lowering required equity ratios and doing this:

The regulator also opened up margin trading to more investors, allowing those with less than 500,000 yuan ($80,600) in their investment accounts to engage in the practice. In yet another step, brokerages will be able to securitize their margin loans, which would boost the amount they can lend without pressuring balance sheets.

Another fun thing to imagine is buying a securitized high-loan-to-value margin loan to a small retail Chinese investor in a bubbly and volatile stock market. That does not sound especially appealing.

Ponzi plus.

Here's an SEC (and criminal) case in which a former stockbroker is accused of  "conducting a Ponzi scheme and stealing investor money to purchase a condominium in Florida and afford his own vacations and other luxuries." The impressive thing is that when the Ponzi stopped working the guy allegedly moved on to other tactics:

The SEC further alleges that Segal eventually started stealing directly from his customers’ brokerage accounts in a last-ditch effort to keep funding the Ponzi payments.  He forged letters of authorization to facilitate the transfer of customer funds to accounts he controlled, notably forging the signature of one customer’s wife who had died before the date of the transfer. 

I feel like if you're stealing money to cover up your Ponzi you have probably made some bad life choices. Elsewhere, here is a private investigator who does due diligence for financial institutions. "I should be jaded by now, and yet I'm always surprised by the number of people who fudge their work and education history."

In other SEC enforcement, Deloitte & Touche got in trouble for violating auditor independence rules. And here's a case against a hedge fund firm and a broker accused of colluding to inflate the value of illiquid residential mortgage-backed securities. The way this works is, the hedge fund gets paid on assets under management and performance, so it needs to know how much its bonds are worth every month, and it wants them to be worth more rather than less. The bonds don't trade much, so it can't just get a market price. So it has to get an indicative price from brokers. If the brokers know that they don't have to trade on the prices they give the hedge fund, and if they're buddies with the hedge fund managers, then, sure, why not, maybe the hedge fund managers can persuade the brokers to give them unjustifiably high prices. Here allegedly the hedge fund managers (AlphaBridge) sent the broker (Evans) a list of holdings, "read aloud AlphaBridge’s prices to Evans over the telephone," and then Evans wrote them up and sent them back to AlphaBridge as his own prices. Probably don't do that. Though these SEC cases come out from time to time and I get the sense that it happens more than you'd think.

People are worried about bond market liquidity.

Here's a speech from Federal Reserve Governor Lael Brainard about bond market liquidity; honestly she seems more puzzled than worried:

Although anecdotes of diminished liquidity abound, statistical evidence is harder to come by. Indeed, there is relatively little evidence of any deterioration in day-to-day liquidity. Traditional measures of liquidity, such as bid-asked spreads, are generally no higher than they were pre-crisis. Turnover, an alternative measure of day-to-day liquidity, is lower, but it is unclear whether this reflects changes in liquidity or perhaps changes in the composition of investors. The share of bonds owned by entities that tend to hold securities until maturity, such as mutual funds and insurance companies, has increased in recent years, which would lead turnover to decline even with no change in market liquidity. 

She is also skeptical of claims that regulation has reduced liquidity, but adds that "it is important to recognize that those regulations were put in place to reduce the concentration of liquidity risk on the balance sheets of the large, highly interconnected institutions that proved to be a major amplifier of financial instability at the height of the crisis." Plausibly it's better to stick liquidity risks with bond funds than with banks. 

Don't lose your stock certificates!

Obviously I cannot resist a story about missing stock certificates. This one is by William Cohan and about shares in Franklin Resources worth about $150 million. There are a lot of Roman numerals after the names of the people involved. It's a good time. It's also a throwback to a time -- the 1970s -- when the way you gave someone stock was by handing them a fancy embossed piece of paper that says I Am 4,000 Shares of Stock. That's not really how it happens any more; now it is all electrons in a central computer. Those are much harder for you to lose, though if the central computer loses them we're all hosed.

What's Andrew Fastow up to?

Speaking at Camp Alphaville, which sounds fun

Clutching a trophy he won after being named CFO of the year in the early 2000s, Mr Fastow said he had won it for services to off-balance sheet financing, adding that people did not win awards for that any more.

In his other hand he held his US Federal prison ID — which he said he was given for exactly the same deals that won him the CFO award.

Arguably that is a problem with both the CFO trophy system (?) and the criminal justice system.

Things happen.

"As part of the deal, Kumar Palghat, a Kapstream founder and former Pimco executive, will join Mr. Gross’s Janus Global Unconstrained Bond fund as co-manager of the fund." Hedge Funds Fight to Save Puerto Rico Investments. RBS is cutting back on cash management. Expert network Gerson Lehrman is rebranding. Swiss banks will be more secret. Robot kills worker. Facebook changed its logo. Bobby Bonilla and Bernie Madoff. Rural Pennsylvania Fire Department Files for Bankruptcy to Save Bingo Night. Drink rosé. "One of the points I tried to make is that dog mess, like other forms of urban pollution, is profoundly historical." Ayn Rand Wrote A 135-Page Novel.

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This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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

To contact the editor on this story:
Philip Gray at philipgray@bloomberg.net