Coffee, Car Parts and Front-Running

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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Coffee.

Yesterday's big merger news is that an investor group led by JAB Holding Company will buy Keurig Green Mountain for $13.9 billion in cash, or $92 per share, or about a 78 percent premium. You might know, or not know, JAB for such holdings as "Jacobs Douwe Egberts, Peet’s Coffee & Tea, Caribou Coffee, Einstein Noah Restaurant Group, Espresso House and Baresso Coffee": 

“JAB knows what they are doing and this is obviously part of a much, much bigger strategy,” Pablo Zuanic, an analyst at Susquehanna International Group, said on a conference call. “Just like you’ve seen Anheuser-Busch InBev consolidate beer, they want to consolidate coffee.”

Also Jimmy Choo for some reason. Anyway Keurig Green Mountain was a popular short, including twice for David Einhorn, and that 78 percent premium can't have been fun for the short sellers (though the sale price is still below Einhorn's most recent entry point of $102.08).

Also strangely caught out by the deal was Keurig Green Mountain's chief executive officer, Brian Kelley, who sold 24,464 shares at an average price of $53.28 last Friday. Those weren't "real" sales, exactly: Kelley received 50,912 shares as his previous restricted stock units vested, and the company withheld a portion of the shares to cover his taxes. But as pseudonymous financial blogger Kid Dynamite points out:

What’s fascinating here is that Kelley had to know that his company was in advanced talks to be sold. Another option for holders of vesting RSUs is to send in a check for the tax liability of the shares. Usually, since the recipient of RSUs has a significant portion of his wealth already tied to the company’s stock, it’s common to just sell a portion of the shares to pay the tax liability. Kelley presumably could have paid his $1.3 MM tax liability without selling these shares, and he would have realized an additional $900,000 in gains this morning on his position!

Of course, that would probably have looked terrible in hindsight, and probably would have been illegal?

I don't know? Insider trading is only illegal if you trade; insider abstaining-from-trading is more or less fine, though it occasions some grumbling. Electing to receive already-vested shares and pay the taxes by check seems to me more like "not trading" than "trading." But it certainly would look bad. Every merger attracts lawsuits, and this is not the sort of thing you want in that lawsuit. 

Elsewhere in M&A.

Otherwise yesterday was sort of an anti-merger Monday, as the Federal Trade Commission sued to block Staples' takeover of Office Depot and General Electric "abandoned a $3.3 billion agreement to sell its appliances business to Electrolux AB of Sweden, walking away from the deal in the middle of a courtroom fight with U.S. antitrust regulators." They are not alone:

Cheap debt and a slow-growth economy has helped fuel a record year for mergers and acquisitions—with $4.35 trillion in global volume and $2.12 trillion in U.S. deals, according to Dealogic. But it has also been a banner year for transactions that have fallen at the hands of antitrust police appointed by President Barack Obama.

Those two things go together, of course: The more and bigger the mergers are, the more likely they are to run into antitrust trouble. So you could have the ironic combination of apparently vigorous antitrust enforcement alongside an increasing concentration of corporate power.

Elsewhere in anti-mergers, Carl Icahn lobbed in a topping bid for Pep Boys, offering $15.50 per share, above the $15.00 deal that Pep Boys agreed with Bridgestone in October. The stock closed at $16.06, which I suppose is best interpreted as a sign that the market does not particularly expect Icahn's deal to happen, but that it does expect Icahn to force the price up, especially since he now owns 12 percent of the company. Pep Boys pointed out:

The “Background to the Offer” section of Pep Boys’ solicitation/recommendation statement on Schedule 14D-9 previously filed in connection with the merger agreement describes the Company’s prior discussions with Icahn (referred to as “Party H” therein). The Schedule 14D-9 discloses that such discussions took place over six months and did not result in Icahn’s presentation to the Company of a transaction with a value superior to Bridgestone’s $15.00 per share offer. Notably, on October 22, 2015, Icahn declined to increase its previously delivered $13.50 per share proposal for the Company and, since that date, Icahn has not presented the Company with any subsequent proposal.

"Bridgestone and Icahn are competing against one another for a company each may only want in part," points out Bloomberg Gadfly's Tara Lachapelle. 

The Investors' Exchange.

The comment letters criticizing IEX's plan to become a public stock exchange keep coming in, with a third letter from Citadel Securities and one from Hudson River Trading. The Hudson River letter is particularly effective, pointing out that IEX's "POP" (the "magic shoebox" that delays IEX orders by 350 microseconds) can't fully protect regular orders from being picked off by high-frequency traders. Since they're all subject to the same delay, getting there first is still valuable:

In this case, the POP simply slows down the trade execution process but does not alter the outcome. In other words, if IEX applied the POP equally to all order types and users, including itself, it would accomplish nothing with respect to members’ relative latency, but it would increase members’ absolute latency. In this regard, IEX is similar to other exchanges in that the closer a firm is located to the POP, the faster they are able to respond and trade on IEX.

The shoebox does, however, give IEX an advantage in routing orders, since it knows about price changes on IEX before any of its customers do. So if a trader ("Member C" in the letter) has buy orders at $10.00 at multiple exchanges, and its $10.00 buy order on IEX executes against a large routable order, it may want to update its buy orders to $9.99 on other exchanges. But IEX knows about the execution before Member C does, and can route the order to other exchanges before Member C can update its prices:

Without the POP, if Member C were faster than IEX and could update its price to buy at 9.99 on the other exchange before the IEX BD Router could reach the other exchange, the IEX BD Router would not be able to execute against the buy order at 10.00. Because the IEX BD Router has privileged information about the execution, it is systematically advantaged to allow it to “pick off” Member C on the other exchange. This behavior is similar to what IEX describes as latency arbitrage.

Similar, but different. This router is, after all, the hero of "Flash Boys": IEX's Brad Katsuyama built a router, and then a dark pool, and now maybe a stock exchange, all to prevent high-frequency traders from seeing an execution on one exchange and racing to update their prices on other exchanges. That really is pretty much the point of IEX, and of "Flash Boys": the intuition that this updating of prices is "front-running." High-frequency traders, of course, have the intuition that this updating of prices is just market-making, that preventing it is "picking them off," and that IEX's proposal to become an exchange is about front-running them.

Elsewhere in market structure, "CME Defeats Suit Alleging It Favored High-Frequency Traders." And here's a Commodity Futures Trading Commission settlement with Total Gas & Power North America over some alleged natural gas index manipulation.

Pumps, dumps.

Honestly I don't understand pump and dumps:

Matthew Eldridge was on Manhattan’s A-train heading to a bar when he spotted the email on his phone.

“A major opportunity for you,” it read, touting a mining company called Mustang Alliances Inc. “I don’t think the investment community is aware of it yet.”

Before his first drink, the 29-year-old mechanical engineer had logged on to his broker’s website and bought the stock—in the process falling for one of the oldest securities frauds around, the “pump and dump.”

Why would some spam e-mail on his phone have information that "the investment community" doesn't? Why would he buy stock on his way to a bar? Why would it be a societal priority to protect him from that scam? He is going to find a way to be scammed. It's part of his fun night out. Come on.

People are worried about unicorns.

"The rise of billion-dollar European unicorns" is this CNBC headline, and don't miss the majestic unicorn art. But what do you actually call a venture-backed startup with a valuation of at least 1 billion euros? A eurocorn? A Royale with cheese? Do you just dispense with cutesy valuation-based naming conventions entirely? I guess we'll never know.

In the U.S., Fortune's Erin Griffith is worried about the unicorns: "Today’s information scarcity means each new shred of bad news makes us rightly wonder which other startups are hiding dysfunction." And here is "The Latham US IPO Guide – An Insider’s Guide to the IPO Process," which might come in handy if you have a unicorn that you want to take public. 

In China, on the other hand, if you have a unicorn that you want to take public you are out of luck, because "about 675 companies are awaiting government approval to sell a total of roughly $63 billion in stock." One company waiting to go public (and raise $150 million) makes "famous duck-neck snacks," and you could probably work "duck neck" into a cutesy valuation-based naming convention somehow.

People are worried about swap spreads.

I missed this yesterday, but the most recent BIS Quarterly Review includes a box on "Recent dislocations in fixed income derivatives markets," meaning, basically, weird swap spreads. The official explanation is sort of unsurprising:

In the swap markets, forces that can compress swap rates include credit enhancements in swaps, hedging demand from corporate bond issuers, and investors seeking to lock in longer durations (eg insurers and pension funds) by securing fixed rates via swaps. In cash markets, in turn, upward pressures on yields stemmed from the recent sales of US Treasury securities by EME reserve managers. The market impact of these Treasury bond sales may have been amplified by a second set of factors that curb arbitrage and impede smooth market functioning. First, the capacity of dealers' balance sheets to absorb rising inventory may have been overwhelmed by the amount of US Treasury bonds reaching the secondary market in the third quarter (Graph A, centre panel), causing dealers to bid market yields above the corresponding swap rates. Second, balance sheet constraints may have made it more costly for intermediaries to engage in the speculative arbitrage needed to restore a positive swap spread. Such arbitrage is sensitive to balance sheet costs because it requires leverage, with a long Treasury position funded in the repo market.

People are worried about bond market liquidity.

Here is Euromoney on "Providing liquidity to liquidity providers" in the fixed income markets. And John Carney writes: "Over the past year it has become increasingly clear that hopes for a trading revival on Wall Street this year were worse than premature."

Things happen.

SEC prepares new Credit Suisse charges. Gordon Brown and Ben Bernanke to Sit on Pimco Advisory Board. Hillary Clinton plans ‘exit tax’ to tackle inversions. Anglo Shares Tumble After Miner Suspends Dividends to Save Cash. Architect of Valeant’s Turnaround Is Under Fire. Investors Place Record Bets on Rising U.S. Interest Rates. Adam Levitin on proposed TIA amendments. Aswath Damodaran on Yahoo. Josh Barro on the Chan Zuckerberg Initiative. Ronald Barusch on the Rural/Metro decision. Law firm bonuses. What Happens When Nobody Wants to Be the Boss? The history of interest rates. Did the DEA invent narco-terrorism? Did Yale invent the Bluebook? Underwater drone. Lost-and-found airplanes. Bentonville cricket. Night milk. Zombie Nativity. Snake people.

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(Corrects spelling of Adam Levitin's name in last item.)

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