Blockchains, Unicorns and MacGyver

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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Blockchains.

Bloomberg's Tracy Alloway bought 24 cents worth of crude oil in a glass bottle, named it "Williston," then sold it forward to Izabella Kaminska of the Financial Times. "Kaminska insists on paying me by blockchain," which means that it is just possible that this is the first physical commodity derivative ever to be settled via blockchain? Let me know if you have earlier examples. Otherwise, congratulations all around! "In the meantime however, I am happy with my pint-size pet oil," says Alloway. "I keep it in the dark, away from open flames. I shake it every once in a while to prevent it from settling."

Other corners of the financial world are also blockchainifying: "The derivatives markets? Oh, they’re all going OBC," a banker tells Euromoney, meaning "on blockchain," a claim that seems to be borne out by Alloway's experience, and maybe no one else's. Still this Euromoney article is maybe the most comprehensive bull case for blockchain-in-banking that I've read so far:

The potential for the blockchain to transform payments, clearing and settlement, seems obvious. Instead of each bank having its own ledger and devoting vast resources to maintaining it while checking its records against those of other banks – managing confirmations, breaks and errors – the whole market having one shared ledger, immutable due to embedded encryption and uncontested, would be a game changer. 

This is still not so unlike DTC for stocks, but sure. The Economist is also bullish. Elsewhere in blockchains, "Bitcoin Is Suddenly Surging Again." A company surveyed "leading bitcoin companies" and "found a consensus view that bitcoin will become the sixth largest global reserve currency within 15 years," okay. And what's Charlie Shrem up to in prison?

“All the inmates know about Bitcoin! I'm even teaching them about Sidechains, Ripple and others so they understand what the industry look like. Many people here even owned Bitcoin before they came in. We have a lot of programmers here, finance guys, doctors, and economists. Just the other day, someone asked me to schedule an hour with him so he can pick my brain.”

I assume not in the Trotsky sense.

Valeant.

I feel like if you are early to point out problems at a company, and you point out the wrong problems, and the stock crashes, and then people find other, correct, problems, and the stock remains crashed, you ought to get a "no harm no foul" defense to any subsequent claims of securities fraud or market manipulation. This is of course not legal advice -- it's more of a personal aesthetic preference -- though I suppose you could make some arguments about loss causation. I get the sense that Andrew Left of Citron Research, who helped crash Valeant's stock with some now fairly well discredited allegations about its accounting, shares that aesthetic preference. Fortunately his lawyers gave him legal advice:

“They said if you get too deep into this thing, which you already are, let the other guys do the heavy lifting,” Left said. “It’s not my job to be judge, jury and executioner on this. People think I’m going to take a company that’s been financially engineered by the best minds in the pharmaceutical business and I’m supposed to take it apart in 2 1/2 weeks? What am I, the short-selling MacGyver?”

I sympathize? And yet, yes, if you sell Valeant's stock short and then publish reports intended to drive down the price, you actually are supposed to get those reports right. If getting the report right requires the skills of MacGyver, and you lack those skills, maybe don't publish the report? It is harsh, but life as a short seller is harsh. If you are long a stock and say vague nice things about it that turn out to be wrong, people rarely complain. Valeant is complaining:

Valeant said in a statement Monday that Citron “admits in its latest report that it has no substantiation for further allegations against Valeant” and that it was “not surprised, even as Citron continues to mislead investors in an attempt to profit by driving down our stock.”

Here is Citron's latest Valeant report, which says "For those of you expecting a 'kill shot,' you can stop reading here," one paragraph after it says "Citron Research stands by our Enron analogy." 

Unicorns.

Remember King Digital Entertainment, the maker of Candy Crush Saga? It went public all the way back in early 2014, when "unicorn" was a slightly less ubiquitous designator for a big private tech company. Now it is being acquired by Activision Blizzard in what I guess you would have to call a down round:

The Activision bid price of $18 is 20 percent below the $22.50 paid by investors in King’s 2014 initial public offering.

At least King Digital managed to get its peak valuation in the public market. The worry for today's tech unicorns is that they may peak while still private:

In one study, Battery Ventures compared valuations of venture-backed tech companies that have gone public in the past few years with their final valuations as private companies. Returns were consistent — until 2014.

Companies that raised their final private rounds between 2010 and 2013 have returned between 35% and 63% per year, through September 2015, as public companies, the study found.

By contrast, those that raised their final private round in 2014 and have since gone public have returned 8% on average.

That's in part because "The median final private valuation in the class of 2014 was $1.0 billion," emphasis added because you know how the "unicorn" designator comes from its rarity? Being a unicorn is now completely average.

Elsewhere here is I guess a story about how those valuations happen?

Perhaps the answer is that these “investments” aren’t really equity—they’re much more like debt. I saw terms recently that had a 2x liquidation preference (i.e. the investors got the first 2x their money out of the company when it exited) and a 3x liquidation cap (i.e. after they made 3x their money, they didn’t get any more of the proceeds). 

I am naive about unicorn physiology, but that 2x liquidation preference -- that is, a debt-like return of 100 percent on the investor's money -- seems pretty high, no? Even for capped upside? There are cheaper ways to borrow money. (Here is a story about WeWork, which "has raised $1 billion, achieving a valuation of $10 billion," and which is "getting ready to close a credit facility this week" for $750 million.) But I suppose you pay a little extra to get to call it equity and say that you raised equity at a unicorn-qualifying valuation.

And of course, "Enraged Unicorn Screams At Confused Clown For Taking Her Photo On The Subway." 

Banks.

"Has Elizabeth Warren defeated Wall Street?" asks Ben White at Politico, and his answer is, kind of, yes:

“Dodd-Frank, no matter what Bernie Sanders or anyone else says, has put a tax on the size of banks, you pay more if you are bigger and there is real change because of it,” said a senior executive at a large Wall Street bank who declined to be identified by name because he was not authorized to speak publicly on the issue. “Everyone wants to be more bank-like and less trading-like. People want to get more boring and smaller. No one is looking to bulk up.”

This seems right, doesn't it? Measured by profits, capital, risk, business lines, compensation, and general swagger and derring-do, there really does seem to have been a slow but epochal change in what the big banks do and how they do it. If you came out of the 2008 financial crisis thinking that we needed much safer, more boring, less government-supported, better-capitalized and better-behaved banks, guess what, we have that. But no system will satisfy everyone. "I'll believe that Wall Street has really gotten the message when we go a full 12 months without a major scandal of somebody breaking the law," says Senator Warren. 

In related news, Standard & Poor's has put eight big banks' unsecured debt on negative credit watch "on the prospect that the U.S. government is less likely to provide aid in a crisis." On the other hand, here is an argument that "the industry’s 'single point of entry' (SPOE) strategy for recapitalizing and reorganizing failed megabanks" will "provide full protection for Wall Street creditors of failed megabanks while imposing the costs of rescuing those banks on ordinary investors and/or taxpayers." Elsewhere: "American International Group Inc., the insurer facing pressure from activist shareholder Carl Icahn for a breakup, posted a third-quarter loss as investment results deteriorated." And in the U.K., Standard Chartered will cut 15,000 jobs, eliminate its dividend and raise $5.1 billion of capital in a rights offering. And there's a financial scandal in the Vatican.

People are worried about stock buybacks.

"Over the past several years, November has been the busiest month of the year for company share repurchases," for reasons that might be a bit window-dressy:

“If stocks are being bought back aggressively, it tends to make the year end up on a spike, like a sugar high for equities,” said Dave Lutz, head of exchange-traded-fund trading at JonesTrading.

People are worried about bond market liquidity.

"Declining Agency MBS Liquidity Is Not All about Financial Regulation," say Karan Kaul and Laurie Goodman of the Urban Institute. Another explanation is a shift in ownership to "buy-and-hold" investors, including most notably the Fed but also commercial banks. "Reduced tradable float in turn has a direct bearing on how easily transactions can be executed because market-makers now have to work longer and harder to match buyers with sellers."

Elsewhere, "Paul Singer, the billionaire founder of $27 billion hedge fund firm Elliott Management, said stock and bond markets are structurally 'unsound' as evidenced in recent market volatility." And here are some complaints about junk-bond exchange traded funds

“These ETFs have horrendous performance over time,” says Gershon Distenfeld, director of high yield at AllianceBernstein. “It’s awful. You’re better off pulling a fund randomly out of a hat than buying one of these ETFs. They just don’t track the market.”

Things happen.

Happy 25th birthday, Citadel! China's 'Hedge Fund Brother No. 1' Is Now Target of Insider Probe. Andrew Ceresney on the Securities and Exchange Commission's market-structure enforcement efforts. Soros Takes Back $490 Million From Bill Gross at Janus Capital. New Bill Gross Investment Outlook. Goldman Said to Seek New Recruits Among Peer-to-Peer Lenders. Basel Committee to Stop Banks Gaming Risk Models. Subprime auto loan securitization is booming. Amazon opens a bookstoreHoward Buffett Is Getting His Hands Dirty. Meet The 11-Year-Old Girl Hailed As Next Warren Buffett. Simpson Thacher Avoids Billion-Dollar Lawsuit Over Epic Mistake. Religious arbitration. "We find that additional days above 80° F cause a large decline in birth rates approximately 8 to 10 months later" (via). Things to do before breakfast. Guys are getting Botox to stop sweating in meetings.

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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:
Zara Kessler at zkessler@bloomberg.net