Ratchets and TruXedos

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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Yesterday we talked about Square's initial public offering. Square had a "ratchet" that guaranteed an IPO price of about $18.56 per share to investors in its last round of private fundraising (last October's Series E), and gave them extra shares when the IPO came below that price.  A couple of readers pointed out that the ratchet provides an incentive for investors in the ratchet round to price an initial public offering as low as possible: In the Square IPO, pricing at $9 per share (where it priced) instead of $13 (near where it closed yesterday) made the Series E investors an extra $83 million. Of course, this is usually just a theoretical incentive: The Series E investors don't decide on the IPO price, the company and the underwriters do.

Except that here JPMorgan, one of the three bookrunners leading the underwriting of the deal, was also a Series E investor. So it had good reason to push for a lower price to get a better deal on the ratchet. Of course everyone was aware of this conflict, and there are well-established mechanisms for dealing with it. There were two other bookrunners, and one of them (Morgan Stanley) was a "qualified independent underwriter" under Finra rules and had to sign off on the pricing. Still, JPMorgan seems to have done well by the apparent underpricing, which corrected itself pretty quickly, with Square closing yesterday at $13.07.

Did Square close the unicorn window? Meh, I dunno, maybe:

Private investors, who recently valued tech startups at $1 billion or more, in some cases may shy away from new deals, as investors grow more worried that the prices there no longer indicate levels in the public market.

“We are likely to see more IPOs but at lower valuations,” said Sean Madnani, technology investment banker and senior managing director at Guggenheim Securities LLC. “Private capital for some companies is expected to dry up” unless they are willing to raise money at lower values, he said.

Again, everyone who invested in Square, ever, has made money, even though in fact private prices really didn't indicate public-market levels. The Series E was done at a nominal valuation of $15.46 per share, well above yesterday's close. But that's what the ratchet is for.

Elsewhere in IPOs.

The IPO of Match Group, which owns Tinder, Match and OkCupid, was perhaps a bit slowed down by the "sodomy" incident, pricing at the bottom of the $12 to $14 marketing range. But it recovered to close at $14.74. You could even say that investors ... swiped right ... on Match. I mean, I wouldn't, but you could.

But yesterday's most interesting IPO might have been Truck Hero, a profitable, private-equity-owned, "fast-growing designer, manufacturer and marketer of branded consumer accessories for pickup trucks" under brands including Extang and TruXedo.  While Match priced at the bottom of its IPO range, and Square priced below the bottom of its range, Truck Hero priced nowhere, and "said late Thursday it will postpone its planned initial public offering because of 'unfavorable market conditions'":

"We have created significant value, and we are unwilling to sell shares at prices that do not reflect the value we have created," said Bill Reminder, Truck Hero president and chief executive, in a statement. 

Noble Midstream also delayed its IPO yesterday. What do these real-economy pulled IPOs tell you about frothy tech valuations? One assumes that unicorns do not drive pickup trucks, or deck them out with TruXedos. You could tell a few stories:

  • This was a rough week for IPOs generally, and the unicorns (well, the unicorn and Match) ended up looking a lot better than the real-economy companies. 
  • This would have been a fine week for IPOs generally, but investors were focused on how much they hated Square, which dragged down prices for everyone, so Truck Hero and Noble Midstream decided to get out of the way.
  • This was a rough week for IPOs generally, and Truck Hero and Noble Midstream decided to wait for a better week. But tech companies don't have that luxury, because the unicorn window is closing, and so Square was willing to do a deal way below the range because a bad deal this week is better than no deal forever.

I don't know! Still, it does seem like some IPOs this week went a lot worse than Square's.

Short selling is risky.

Yesterday we talked about the New York Stock Exchange's decision to get rid of stop orders because they keep blowing up retail investors and making the market less stable. There are those who object to that decision as an abrogation of personal responsibility and manly virtue, but, you know, it is 2015, we can try to build a safer stock market. There is no need to encourage small-time traders to do dumb things, or to expose them to the full consequences of those dumb things.

Anyway here is the story -- and the GoFundMe page -- of a guy who found himself in debt to Etrade by $106,445.56 because he shorted KaloBios Pharmaceuticals, which had announced that it was going out of business, only to find out that Martin Shkreli was stepping in to rescue it. I mean. Obviously don't put all your money on a small-cap short. And, like, what was his edge in this trade? The company announced it was going out of business and he was like, oh, cool, I bet that means the stock will go down? Come on. He had $37,000 in his account before this unfortunate incident, and says:

Never in my wildest dreams did I imagine that Etrade would NOT have some sort of stop or circuit breaker in place that would automatically cut a position if the account went to $0.....how could they ever let it get to -$144k loss on a account that small!

That is jump risk for you, and the sort of thinking that led the NYSE to ban stop orders. KaloBios didn't gently creep up from $2.07 to $19, giving ETrade plenty of time to close out all of its customers' dopey shorts to protect them from themselves. One minute it was a worthless company in liquidation; the next minute it was a takeover target. Stops couldn't solve that.

Now he knows! Maybe GoFundMe will shield him from some of the consequences. Be sure to read the comments.


The political economy of tax inversions is pretty weird:

  1. The tax code allows U.S. companies to move abroad by "inversion" mergers with big enough foreign companies, and thus avoid paying U.S. taxes on all of their global income.
  2. Companies do not like paying U.S. taxes on all of their global income.
  3. Republicans do not like that the tax code charges companies U.S. taxes on all of their global income.
  4. Democrats do not like inversions. 

But as long as the tax code allows inversions, inversions will happen, and Democrats who want to change the tax code can't, because Republicans want to change it the other way. Here is a story on Pfizer's "collision course" with Treasury over Pfizer's potential inversion merger with Allergan, on the one hand, and Treasury's new anti-inversion rules, on the other. Those rules can only do so much, since, again, the tax code allows inversions, but they "go after a technique known as 'stuffing,'" and another one known as "cherry-picking." But stopping those techniques "didn't appear to be a deal breaker for" Pfizer and Allergan. And because Republicans don't like the tax code, Pfizer has a certain amount of political cover to press ahead even though Treasury clearly doesn't like the deal. (Contrast Yahoo's proposed tax-free spinoff of its Alibaba shares, which also seems to be allowed by current law, but which no one likes, creating pressure on Yahoo not to go through with it.)

People are worried about bond market liquidity.

"European Union rules for companies raising funds on markets will be changed in a bid to increase liquidity in corporate bond markets," apparently by encouraging companies to issue bonds in smaller denominations? So that retail investors can buy them? I don't think that's quite how the bond market liquidity problem works but, sure, good effort.

Me recently.

I mentioned Square earlier, but also, on Wednesday I wrote about last look, and if you're interested in that here is a paper by Álvaro Cartea and Sebastian Jaimungal about "Foreign Exchange Markets with Last Look":

For a given rejection threshold the risk-neutral broker quotes a spread to the market so that her expected profits are zero. When there is only one venue, we find that the Last Look option reduces quoted spreads. However, if there are two venues we show that the market reaches an equilibrium where traders have no incentive to migrate. The equilibrium can be reached with both venues coexisting, or with only one venue surviving. Moreover, when one venue enforces Last Look and the other one does not, counterintuitively, it may be the case that the Last Look venue quotes larger spreads.

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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