Mergers, Spinoffs and CDS

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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Mergers.

Here is a story about how Dow Chemical's chief executive officer, Andrew Liveris, has been trying to buy DuPont "for much of his 11-year tenure at Dow." He offered a deal as far back as 2006, and when DuPont's new CEO started this October, "he hadn’t even had a chance to find the bathrooms at DuPont when Mr. Liveris came calling." I like this story both because, how long does it take to find the bathrooms, and because it undermines one popular view of a potential Dow/DuPont deal, which is that it would be a soulless surrender to shareholder-value activists that will cut jobs and achieve efficiencies with no broader strategic purpose. John Cassidy is typical:

In reality, this looks like a defensive merger designed to cut costs, enhance monopoly power in particular markets, and yield a quick buck to the likes of Nelson Peltz’s Trian Fund Management, which has built up a big stake in DuPont, and Daniel Loeb’s Third Point fund, which has been busy agitating at Dow Chemical.

But, no, it turns out this deal may not be driven by a desire to increase efficiency and enhance shareholder value, which would be Bad, but rather by the old-fashioned motive of CEO empire-building, which would be Good. I confess that I find many critiques of the ideology of shareholder value puzzling -- like, why should you do mergers? -- but I pass it along.

Elsewhere, Bloomberg Gadfly's David Fickling and Brooke Sutherland argue that the conglomerate discount is not all it's cracked up to be. And "Pep Boys gave Bridgestone Corp. three days to top Carl Icahn’s $863 million takeover offer, saying its board had determined that the billionaire investor’s bid is superior to their earlier agreement."

Yahoo?!?

I said yesterday that Yahoo's new plan to spin itself off and leave its Alibaba stake behind is not especially different from its old plan to spin the Alibaba stake off and leave itself behind. In either case, the idea is to achieve a tax-free separation of the actual business from the Alibaba shares, which can then live on as an Alibaba tracking stock (or, ultimately, an Alibaba subsidiary). Both plans rely on the same somewhat aggressive view of the tax-free spinoff rules. So why is the new plan better? Mainly because, if the Internal Revenue Service objects to this plan, it can do less damage. Here's Ronald Barusch:

Yahoo has reduced the magnitude of the risk. Under the old plan, the amount of the potential tax payable would have been based on the value of the Alibaba shares held by the spun-off company if the tax treatment went off the rails. Because the operating business of Yahoo is worth so much less than the Alibaba shares, the potential tax payable in the new deal is a fraction of what could be owed in a spinoff of the Alibaba shares.

And Stephen Gandel reports: "Independent tax expert Robert Willens says Yahoo’s new deal could have a tax bill of around $3 billion, which is $7 billion less than what it would have to pay if it stuck to its original plan." Of course this is assuming that the IRS challenges the new plan; it's conceivable that defeating the old plan is enough of a victory for the IRS, and it won't bother coming after that $3 billion.

The downside of the new plan is that it will apparently take another year to complete, but that does give Marissa Mayer "another chance to increase a price tag on the once-great Internet company." "I have no intention of stepping down," says Mayer, and it might help that she is paid partly in sort-of-backdated stock options. Here is Leslie Picker on core Yahoo valuation, and here are some comments from Wall Street analysts. And elsewhere in tax structuring, "Clinton Targets 'Earnings Stripping' by Corporate Tax Avoiders."

CDS is great.

Last month Abengoa SA announced that it was "filing for preliminary creditor protection" under Spanish law. If you owned credit default swaps on Abengoa, you might have thought that that filing would trigger a payment under the terms of the CDS. And you might have been right. Or you might have been wrong. It depends on where the word "similar" appears in your CDS contract:

ISDA’s credit determinations committee has confirmed that a one-word change in new credit default swap definitions led to a surprise split decision on Abengoa that will trigger payouts on credit default swap contracts issued under the 2003 definitions, but not on those under 2014 definitions.

If your CDS contract references the 2003 ISDA Credit Derivatives Definitions, you get paid, because the ISDA committee voted that Abengoa's filing was "a proceeding seeking a judgement of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights." But in the 2014 Credit Derivatives Definitions, as the International Financing Review reports, "the word 'similar' has been moved to refer to relief rather than law. It now reads as 'a proceeding seeking a judgement of insolvency or bankruptcy or any other similar relief under any bankruptcy or insolvency law or other law affecting creditors’ rights.'" Abengoa's "pre-concurso" filing for "preliminary creditor protection" doesn't seek a judgment of bankruptcy or similar relief, so it doesn't count under the 2014 definitions, but it is a filing for some sort of relief under bankruptcy law (or similar law), so it counts under the 2003 definitions.

I don't know that there's a "right" answer exactly -- offhand, I'd think CDS should trigger on an impairment, not preliminary negotiations for impairment, so the 2014 answer seems a bit more "right" -- but, man, call your lawyers tonight, and thank them for all that they do. Someone dreamed a thing that pays off when a company defaults on its debt, and then that thing came into being, but that general intuition required hundreds of specific individual decisions about things like where to put the word "similar." Sometimes those decisions have consequences, and isn't it nice that someone is thinking about them?

Banks and technology.

How annoying is blockchain for banks? So annoying that one of its proponents went looking for a simile and came up with this:

“Blockchain is a bit like gluten,” says Tim Swanson, head of research at R3CEV, a New York start-up backed by 30 banks. “Everyone is talking about it but no one knows what it is in great detail.”

Good lord. And then there's this:

“The blockchain could disrupt everything,” wrote Goldman strategists last week in a note to clients called “Themes, Dreams and Flying Machines”.

Goldman Sachs is at least semi-committed to the blockchain, in the form of its non-bitcoin-blockchain patent application for "SETLcoins." (I remind you of Izabella Kaminska's views on "pseudo profound buzzword banking revolutions involving coins.") This is part of a broader Goldman interest in technology:

The SETLcoin project is among dozens that emerge each year from Goldman’s technology group, which, with about 9,000 engineers reporting to Marty Chavez, chief information officer, is easily the biggest of 11 divisions within the 36,000-strong bank. Another 3,000 or so “strats”, or tech strategists, are sprinkled across other divisions.

That tech focus is part of how Goldman went from having "600 traders in New York City making markets in US stocks" to having fewer than 10. (Disclosure: I used to work there, though I don't think I was supplanted by a robot.) Meanwhile, in another part of the blockchain, remember that every Satoshi Nakamoto is a hoax.

Marketing jargon.

A while back, I mentioned that the word "'sample,' in financial presentations, means 'not true.'" This week the U.S. Court of Appeals for the First Circuit reversed a Securities and Exchange Commission decision fining two former State Street employees who the SEC thought had misled investors about two crisis-era State Street bond funds (referred to collectively as the "LDBF," for "Limited Duration Bond Fund"). Here is how the First Circuit describes a slide that one of these employees presented to potential investors to describe the funds' "typical portfolio," which the SEC found misleading:

Importantly, the Typical Portfolio Slide portrayed percentages for both sector allocations and quality of investments. It is the sector allocations (going to diversification) which disturb the SEC. The typical sector allocation graph showed that the LDBF was 55% invested in ABS, 25% invested in commercial mortgage-backed securities ("CMBS"), and 10% invested in mortgage-backed securities ("MBS"). In 2006 and 2007, the LDBF's actual investment in ABS reached 80% to nearly 100%. 

Lying to investors about a bond fund's concentration in asset-backed securities, in 2006 and 2007, does seem misleading. But of course they weren't lying to investors. "The slide was clearly labeled 'Typical Portfolio Exposures and Characteristics -- Limited Duration Bond Strategy' and did not purport to show the actual exposures to each sector at any given time," says the First Circuit, concluding that even if it misrepresented the portfolio, it was not material to investors. "Typical," like "sample," apparently means "not true."

Other enforcement news.

Here's some happier news for the SEC: It finally won a civil case that it brought in 2004 against a former public-company chief executive officer for securities fraud. It took a while, but eventually the SEC got that Jeff Skilling guy.

Elsewhere, "a failed hedge fund, whose manager was jailed for fraud, sued Citigroup Inc. over allegations the bank undervalued assets when it closed out trades at the height of the 2008 financial crisis." The hedge fund's manager was previously sentenced to four years in prison for overvaluing the fund's assets, so I expect this to be a hard-fought battle.

Proved reserves.

People sometimes get exercised about companies that report financial numbers that don't follow generally accepted accounting principles, but it is worth remembering that even GAAP numbers create only an extremely stylized picture of the real world. Just because your financial statements say that you have assets or make money, that doesn't make it "true," for some value of "true." For instance, here is a story about how Chesapeake Energy will have 1.1 billion fewer barrels of oil reserves at the end of 2015, compared with 2014, not because the oil vanished but because of some price-based averaging formulas in GAAP. 

People are worried about unicorns.

Australian software company Atlassian priced an initial public offering on Nasdaq at $21 a share, above its $19 to $20 marketing range. That gives it a $4.38 billion valuation, well above the $3 billion valuation in its last private investment round. (Though that round was a secondary round, and Atlassian has never raised outside money for itself.) So unicorns are all better now, and the Square panic has passed? Maybe? Here is Aswath Damodaran on how tech companies "age in dog years."

People are worried about bond market liquidity.

"No One Knows How Messy the Fed Increase Could Get" is the headline here, and a control-F for "liquidity" gets two results, so I'll count it. Meanwhile Depository Trust & Clearing Corp. is "seeking $50 billion in commitments from banks and trading firms" for a credit backstop for its Fixed Income Clearing Corp. unit, "which facilitates trades in the $2.6 trillion repo market." Needless to say, "analysts warn that vulnerable repo markets could make it harder to buy and sell securities underlying the trades, a key concern at a time when the Fed is preparing to raise short-term interest rates for the first time since 2006."

Things happen.

Argentina’s Next Finance Chief Meets Debt Dispute Mediator. Trading Revenue Seen Rising at BofA, Citigroup in Quarter. Senate Republicans Introduce Bill for Puerto Rico Relief. Glencore Plans Bigger Debt Reduction as Commodity Prices Slide. Herbalife Attorney Lobs Threat at Ackman Team Over Research Tactics. The Investment Industry Regulatory Organization of Canada is cool with high-frequency trading. U.S. Said to Probe Possible Rigging in Agency Bond Market. The Litvak decision "by and large emboldens the broader potential wave of prosecutions by the government." Does Securitization Increase Risk: A Theory of Loan Securitization, Reputation, and Credit Screening. Resilience bonds. How A Magic Goldfish Might Short The Stock Market. Roddy Boyd on Insys Therapeutics. "'Netflix and chill' shouldn't ever mean leaving workers out in the cold when they most need to spend time with their families." How to overcome your attractiveness and bag that great job. New Serial. Fashion Santa. Darth Trump.

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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