Fake Unicorns and Amateur Algorithms

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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A Berkshire deal.

Berkshire Hathaway agreed to buy Precision Castparts Corp. for $235 per share in cash ($37.2 billion enterprise value), and here is the news release:

"We are very pleased to be joining forces with Berkshire Hathaway," said Mark Donegan, PCC’s chairman and chief executive officer. "We see a unique alignment between Warren’s management and investment philosophy and how we manage PCC for the long-term."

Do you think Berkshire is able to negotiate cheaper prices for public companies because it not only offers those companies' CEOs the chance to stay on to manage the acquired business, but also lets them refer to "Warren" by his first name in the deal announcement? People pay millions of dollars of their own money to have lunch with Warren Buffett; don't you think some CEOs might sacrifice some of their shareholders' money to work for him? Here is an analysis of Berkshire's changing emphasis, as symbolized by this deal, which will "push Berkshire further into heavy industry and cut reliance on insurance and stock picking, growth engines for most of Buffett’s 50 years in charge." Stock picking is a more or less anonymous activity; deal-making seems like a more efficient way to leverage the Buffett brand and charm. 

Unicorn substitutes.

Here's a story about how public market investors can't get a unicorn, so they get a goat and tape a stick to its forehead:

While other investors paid dearly to buy a piece of Airbnb — the start-up’s latest funding round valued it at $24 billion — Pier 88 did not invest directly in the privately held online home-rental company. Instead, Pier 88 put money into HomeAway, a publicly traded Internet company that competes with Airbnb, but has a market capitalization of just $2.95 billion.

I mean sure? You can quibble with some of the substitutes -- "ride-hailing start-up Uber was recently valued at around $51 billion, compared with $7.3 billion for the rental-car company Hertz," but I find Uber at least seven times as convenient as Hertz -- but the general thesis is that private valuations are so much higher than public ones that there ought to be a convergence trade:

Still, “the easy private financing environment has created an interesting trade opportunity,” said Kenneth J. Heinz, the president of Hedge Fund Research, which tracks hedge funds and their performance. “With such a disparity between public and private multiples, it’s a reasonable fundamental approach to believe that in this environment, the public company valuation will come up or the company will be acquired.”

If this is your thesis I suppose you need to have some explanation for why private market investors are so much bubblier than public ones. Like, are venture capitalists dumb? Does the absence of short selling in private markets hurt price discovery? Do private unicorns get high valuations by avoiding the full disclosure of public companies? Or is part of the private company premium that, you know, public markets are focused on quarterly profits and only private companies can still dream big?

The little guy.

I don't really know why retail algorithmic day-trading would work: Like, if you work on your algorithms "between 9 p.m. and midnight" when you get some time away from your day job, why would you be able to trade better than teams of professionals working full-time to build trading algorithms on faster computers? But it seems to be a thing, and this article contains one claim of profitability for an algorithmic day-trader who previously lost $6,000 on a typo in his program. Elsewhere: "Pain of Puerto Rico’s Debt Crisis Is Weighing on the Little Guy, Too," says this article about a math professor who put "more than 85 percent of his retirement savings in funds with large concentrations of Puerto Rico bonds." And "In Southern Europe, Bank Share Sales Can Hit Depositors Hard," says this article about how "it is a legal and long-standing practice for branch employees to sell stocks and bonds issued by the bank to people who have deposits and loans with the bank." Look, I am not going to say that individuals should only be allowed to invest in reputable, low-fee, broadly diversified mutual funds. I am just going to say (as I have before) that if they invest in anything else and lose all their money, it should be a felony to complain about it.

People are worried about stock buybacks.

But not Larry Summers:

Corporations that are hoarding cash earning nothing in the bank or in Treasury bills would be cheered, not jeered, by the market if they could be persuaded to put those funds to productive use. Most corporations are in this situation. The challenges are usually that companies do not have productive uses available for the cash or that they do but can’t convince investors of those projects’ validity. Pushing corporations to invest without having projects that are good candidates for investment is wasteful. And stopping or discouraging them from distributing funds to shareholders is dangerous if it results in mindless takeovers.

His piece is more or less a response to Hillary Clinton's concerns about "quarterly capitalism," and presumably means that he is not applying for the job of Treasury secretary in her administration. Meanwhile Donald Trump's potential Treasury secretary, Carl Icahn, has accepted the job, so if, as polls suggest, the 2016 election ends up being Clinton vs. Trump, it may well come down to a fight over stock buybacks and shareholder activism. I am pretty excited for that.

Elsewhere in activism, here is another story about how big mutual funds frequently support activist campaigns, this one focused mostly on ValueAct's campaign for a Microsoft board seat. "There are no 'management friendly' investors," says JPMorgan.

And elsewhere in presidential politics, here is a story about how Hillary Clinton plans on "bending the cost curve" in higher education by further subsidizing student loans, and I have to say that I don't think it works that way.

People are worried about bond market liquidity.

But not this guy:

Warnings of a liquidity crisis in the bond market are a myth created by Wall Street in hopes of repealing regulation, said Krishna Memani, the chief investment officer of OppenheimerFunds.

Memani argues that declining dealer inventories aren't a big deal "because trades that were reported in them weren’t available for client trading anyway." And here's Brian Reid of the Investment Company Institute on declining trading:

If there has been a decrease in willingness to trade, it may be tied to the shrinking compensation investors get for owning bonds -- they can less afford to shell out for Wall Street’s trading fees, according to ICI’s Reid.

That is, when yields are low and stable, yield variance is low, and opportunities for trading profits are too low to justify the costs of trading. As yields go back up, there will be more to do, and liquidity will improve. It is always worth distinguishing between "there's not much trading now," which is meh, and "there will be a liquidity crisis when yields go up," which is scary. This is an argument that the former does not imply the latter.

Elsewhere "The U.S. Securities and Exchange Commission and the Federal Reserve have been asking money managers about their ability to meet daily redemption requests from investors," which seems sensible enough. And here's a post on the topic "Are asset managers systemically important?"

CEO pay.

Last week the Securities and Exchange Commission finalized the rule "that requires a public company to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees," apparently with a view toward shaming companies into paying their CEOs less or, hey, you never know, paying their employees more. I have been skeptical, in part because of my belief in the first meta-rule of executive pay, which is: "All executive-pay rules have the effect of increasing executive pay." If your competitors pay their CEOs 4,000 times what their workers get, how can you justify paying less? But here is Gretchen Morgenson on the theory behind the rule: "Because the rule will generate an easily graspable and often decidedly shocking number, it may energize a cadre of new combatants in the executive pay fight." (And: "'The pay ratio was designed to inflame the employees,' said Charles Elson.") I suppose that is possible. The rule is so purely symbolic -- it doesn't limit pay, just requires disclosure of one apparently meaningless number -- that the symbolism must be important. If people were mad enough about pay ratios to demand this rule, then seeing the pay ratios might make them mad enough to demand something else.

What's coming next from the SEC?

I love that the Securities and Exchange Commissions leaks its investigations into illegal leaks:

In one case, the S.E.C., in tandem with other authorities, is poised to file charges soon in an unusual investigation that combines insider trading with cybersecurity, according to people briefed on the investigation but not authorized to speak publicly.

I hope someone is trading on advance knowledge of that investigation. Anyway, though, sounds fun. You'd sort of expect to see more of this, right? As far as I can tell hackers are constantly breaking into highly secure corporate computer systems to, like, steal social security numbers, which strikes me as a pretty laborious way to make a buck. Doesn't it seem better to hack into the secure computer system, find the draft of the earnings release or merger agreement, and go trade on it? Also on the SEC's agenda: the Pimco ETF valuation thing, "a major investigation into Wall Street’s hiring of the children of China’s elite," and "another insider trading case that involves trading activity in the shares of Dean Foods by the golfer Phil Mickelson and the professional sports gambler William T. Walters." The thrust of the article is about how the SEC, facing criticism for focusing too much on minor cases, "is quietly pursuing some high-profile cases that could enable it to redefine its regulatory role and reclaim some momentum," but notice that the SEC still can't quite tear itself away from its core competency, golf-related insider trading.

Midnight Madness. 

Congratulations to Pine River Capital Management, which won "Midnight Madness, Wall Street’s most elaborate charity scavenger hunt," this weekend. "Bloomberg LP, the parent of Bloomberg News, also fielded a team, which placed second," though it was docked points in my heart for not including me. People who think that the financial industry is full of evil corporate drones never, in my experience, fully reckon with its love for puzzle hunts.

Things happen.

"The Greek government is seeking to conclude talks on a rescue program by Tuesday." Norway is suffering from the oil bust. "The Petrobras scandal would read as pure tragedy were it not filled with a cast of Hollywood-ready characters and their lavish props." "Senior rates staff at US and European banks are on course to receive average rises in total pay this year of about 10 per cent." Men's studiesMetropolitan is 25. New York Pizza Styles: A Complete Guide. If You Work Hard, You’re More Likely to Drink Hard. Did Shakespeare smoke pot? "The person the Islanders hire will join a Zamboni community of sorts." 

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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 on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net