Money Stuff

Unicorns and Superbonds

Also high-frequency trading, activism, M&A, Rule 105, and Treasury liquidity.


DealBook and the Wall Street Journal both have articles about the grim state of the initial public offering markets: Yesterday "First Data priced its offering at $16 a share — well below its expected price range of $18 to $20," and Albertsons, which had launched an IPO with a range of $23 to $26, lowered that range and then decided to postpone the deal; it "isn’t expected to try to price again in the near term." (Disclosure: As a young M&A lawyer, lo these many years ago, I worked on the Albertsons buyout, and actually I think I may have worked on First Data too for a minute, so I have some emotional or nostalgic or circle-of-life investment in these deals.) Part of this is just general market volatility, with Albertsons in particular "worried by the turmoil in the retailing sector after Walmart unexpectedly lowered its sales forecasts," but I suppose you could find a thematic explanation:

But the continuing concern for First Data and Albertsons, as well as for other private-equity backed companies looking to go public, is that investors are beginning to sour on shares of highly indebted companies. Investors had warmed to such deals in recent years, with near-zero interest rates and growing corporate earnings helping those firms refinance debts at lower rates and pay them down.

But with interest rates set to rise and corporate earnings expected to slow down or decline, high levels of debt is seen as riskier, as it will be more expensive to refinance.

If that's the concern, then it should be smooth sailing for venture-backed unicorns, right? Well, payments unicorn Square filed for an IPO yesterday, and "is braving the IPO market at a time when other tech IPOs have struggled." Here's Square's S-1 filing, which starts with photos of the smiling proprietors of Mr. Tod's Pie Factory and of Lavender & Honey standing next to their Square credit card readers, but which does not seem to feature a photo of Jack Dorsey, the Square chief executive officer who is also Twitter's chief executive officer. "This may at times adversely affect his ability to devote time, attention, and effort to Square," say the risk factors.


This is clever:

Puerto Rico and U.S. officials are discussing the issuance of a “superbond” possibly administered by the U.S. Treasury Department that would help restructure the commonwealth’s $72 billion of debt, people familiar with the plan said.

Under the plan, the Treasury or a designated third party would administer an account holding at least some of the island’s tax collections. Funds in the account would be used to pay holders of the superbond, which would be issued to existing Puerto Rico bondholders in exchange for outstanding debt at a negotiated ratio.

Investors would receive less debt, likely taking an effective “haircut” on the value of their holdings, but would have higher expectations for getting repaid.

So you have Puerto Rico, which suffers both from low capacity to pay and low levels of trust from creditors. You have the U.S. government, which has high capacity to pay and high levels of trust. The U.S. government can't just pay the debt (it "has said repeatedly that it has no plans to provide a bailout to Puerto Rico"), and it can't even substitute its own capacity to pay for Puerto Rico's, because a Treasury guarantee of new haircut bonds would look too much like a bailout. But it can, perhaps, substitute its own trustworthiness for Puerto Rico's, because a Treasury-administered "lockbox" doesn't look like a bailout. Treasury isn't risking any money; it's just lending Puerto Rico some administrative credibility. There are objections:

“Right now, Puerto Ricans don’t even like to pay taxes to their own government,” said one person with knowledge of the discussions. If the I.R.S. were to suddenly replace the local tax authorities and try to gather up the money for debt service, “people would say, ‘Go to hell. I’m not paying the U.S. government.’ ”


Wal-Mart put out a press release that tanked its stock a little after 10:30 a.m. yesterday, and I guess one obvious question is, why then? (The press release says 10:48, the Form 8-K was filed at 10:46, and the stock was crashing by 10:40, so the timing is perhaps a bit fuzzy.) Like, if you have news that is going to cause your "worst stock decline in more than 27 years," maybe get it together to put the news out before the stock market opens? 

The news itself concerns Wal-Mart's "strategic outlook," which is grim: "Coupled with its earlier decision to raise hourly wages by $1 to $10 and spend more on training, the investment in ecommerce means Walmart expects earnings per share to fall between 6-12 per cent in the year starting next February, whereas consensus forecasts had been for 4 per cent growth." Here is a collection of analyst reactions. Stifel says that "the market is reacting to meaningful evidence that Wal-Mart has substantially over-earned," which is a funny way to put it. Deutsche Bank says that "the combination of an improved store experience and lower prices could put a major cloud over the discount/dollar channel"; naively I would have said that better stores and lower prices would be ... nice? For customers? But I guess the upshot here is that Wal-Mart -- which last quarter made $3.5 billion of net income on $119.3 billion of net sales, for a net profit margin of about 3 percent, and which is, you know, a discount retailer -- was living too high off the hog, and will now have to adapt to a new world where it can't get the high prices and cushy margins that it's accustomed to. Wal-Mart! The Amazon effect is strong.

The company also announced a $20 billion stock buyback. That "implies significant margin contraction along with modest sales growth," says another analyst, but really the time to do a buyback is after your stock falls 10 percent. 

High-frequency trading.

One weird thing about critiques of the high-frequency trading "arms race" is that they boil down to a worry that people are overinvesting in building faster computers and better communications infrastructure. But those are ... good things, no? Like, if we find ways to make computers and telecommunications faster, then isn't that a positive externality of high-frequency trading? I suppose the theory is that the people who are busy building faster cables between Chicago and New York could be curing cancer instead; I don't know. Anyway here is an SMBC cartoon on the subject.

Elsewhere, and a bit counterintuitively, here is a Bank of England staff working paper:

Using trading patterns from execution algorithms as instrumental variables, I show that dark trading leads to improved liquidity on the primary exchange, both in absolute terms and relative to trading on the limit order book. Although these relationships differ across stocks of different sizes, dark trading does not lead to worse market quality at the intraday level for either small or large stocks during the sample period.

And: "In fact, trades on dark venues lead to a significant improvement in depth (shares available) at the best bid and offer on the primary exchange without significantly impacting the inside spread or volatility."


Here is a report of a study of activist hedge funds that finds "that the best way, bar none, for the activists to make money for their funds is to get the company sold off or substantial assets spun-off"; otherwise they don't seem to have much systematic effect one way or the other. That seems about right; activism may now be too big a category to draw useful aggregate conclusions. Some activists are good, some aren't. But the tone of the report is funny:

The evidence is pretty clear that the much vaunted “improvements” in operating performance (ROA, ROE, Tobin’s Q) result mainly from some basic financial manoeuvres (selling assets, cutting capital expenditures, buying back shares, etc.).

However, there is no evidence of deterioration in performance over a three-year period. That is not a result that owes much to the forbearance of activists. Business firms tend to be resilient and their management adaptive to the new reality of activists’ requirements. If the targeted firm can survive the holding period of the activist (more than a third will not), then, and only then, will they be able to start managing again for the longer term.

In general, the stock’s performance of targeted companies over a three-year span barely matches the performance of a random sample of companies.

I love the idea that activism is bad, but you can't see it in the data, because managers are good at ignoring it.

How to be good at M&A.

Here's a McKinsey report on the things that companies that are good at acquisitions (that is, tend to achieve synergy targets) do differently from companies that are bad at acquisitions. The report is enjoyable both as practical advice and as a pleasing bath of consultant-y jargon. "High-performing M&A companies are most differentiated from low performers in their integration capabilities." (Also they evaluate opportunities more often and tend to complete deals faster.) "When it comes to sourcing M&A targets proactively, companies get many internal tasks right but then fall behind on the external outreach." 

Rule 105.

You're not supposed to buy stock in a public offering if you sold that stock short in the five days before the offering. This is not, you know, the most critical rule to the continued functioning of our capital markets, but it is a rule, and people keep breaking it, mostly by accident. Who can remember what happened five days ago? Here are six more Securities and Exchange Commission settlements with firms who broke the rule, some of whom you've heard of and some of whom you haven't. 

People are worried about bond market liquidity.

One narrative about bond market liquidity is that banks have reduced their Treasury trading, pushed out by capital and leverage regulation and by competition from electronic market makers. (And perhaps, obscurely, by the Volcker Rule, though that rule prohibits neither market-making generally nor proprietary trading in Treasuries.) But in fact, bank Treasury trading is fine:

Despite the global financial crisis and the slew of new regulations that followed, dealers have been able to maintain their grip on most of the Treasury market. Rate-trading revenue at the 10 biggest banks climbed in the first half of the year, according to data from financial research firm Coalition Ltd. That marks a contrast with the proceeds from their corporate bond businesses, which continued to drop.

And, just as in the equities market, people are starting to worry about internalization, in which banks match client buy and sell orders against each other without sending them to public markets:

The shift in trading means more of the action in the market is happening without accessible data detailing which Treasury securities are trading, and at what price. It also means the data that five government agencies spent months collecting in an effort to figure out what happened on Oct. 15, 2014 -- when Treasuries suddenly went haywire in the bond market’s version of the “flash crash” -- was missing part of the picture. They were only able to obtain records from the interdealer platforms like BrokerTec and eSpeed, and missed the roughly $300 billion that is traded elsewhere each day, according to the Federal Reserve Bank of New York’s own measure.

Banks’ internalization, or "risk warehousing," may actually have made the swing on Oct. 15 more extreme, the International Monetary Fund said in a paper this week. 

Meanwhile, here is a blog post from the New York Fed about Treasury dealer positioning and Treasury auctions, which again finds that the big banks are still intermediating Treasury trading, or at least intermediating the auctions:

Dealers continue to be the leading underwriters of Treasury auctions despite their declining share of purchases in recent years. We find that such purchases leave a distinct mark on their holdings of the benchmark coupon securities, with positions increasing in the week of issuance and decreasing in subsequent weeks. The results suggest that dealers continue to play an important role in the intertemporal intermediation of Treasury supply, buying securities at auction and selling them off to investors in subsequent weeks. 

I wrote a while back about lawsuits complaining that the banks make excessive profits in those Treasury auctions. One thing that I thought then was that the banks provide an intermediation service,  and so should properly expect to get paid for it. You could push back on that thesis: Treasuries are super liquid and in high demand, and it's not that hard to move them from the seller (Treasury) to the ultimate buyers (investors) without much work or risk at the intermediaries (dealers). But the Fed itself concludes that the dealers "continue to play an important role" in the auction.

On the other hand: "U.S. Has Sold Over $1 Trillion of 0%-Interest Treasury Bills."

Me yesterday.

I wrote about structured notes.

Things happen.

Goldman announced earnings. So did Citigroup. Bank of America, Wells Fargo Earnings: You Really Can’t Fight the Fed. Ukraine Readies for Russia Court Battle After Debt Vote Passes. Corporate America's Epic Debt Binge Leaves $119 Billion Hangover. Libor-Rigging Trial Begins for 2 Former Rabobank Traders. Companies are increasing automatic 401(k) contribution rates. U.K. ring-fencing proposals. HSBC Cuts Pay 10% for Hundreds of Investment Bank Contractors. Valeant Pharmaceuticals Under Investigation by Federal Prosecutors. Fantasy Sports Said to Attract F.B.I. Scrutiny. BuzzFeed finds mergers boring. "If you look at how many times a person says ‘wasted’ in their profile, it has some value in predicting whether they’re going to repay their debt." Lazy ‘Gen Z’ loves mobile bankingDanny Meyer will eliminate tipping. Bees on a plane.

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