Tech Earnings and Bank Meetings
My basic model for companies is that a company is good at a thing, and it spends a lot of money doing that thing, and eventually the thing reaches scale and becomes profitable, and the company makes a lot of money. And then demand for the thing plateaus, or even declines, because most people don't need an infinite amount of most things. And then the company is at a crossroads. It can just keep doing its thing profitably, make money, and give the money back to shareholders so they can go look for the next thing to invest in. Or it can reinvest the profits in its own bet on the next thing. In my simple dumb model, though, the company has a thing that it is good at, and there is no special reason to think that it would be good at finding the next, unrelated thing. On the other hand, it has desks and employees and computers and so forth, surely it should use them for something? Surely companies should be innovating, and if companies in general should be innovating, then why shouldn't each individual company try to innovate? It is a dilemma.
The tech industry prides itself on innovation, though, so you'd hope it might escape this trap. You can read Google's restructuring and rebranding into Alphabet as a formal attempt to do that. Google's Google business -- the one that makes it all the money -- is basically a business of selling online advertising. It is hugely lucrative, but there's only so much more market share it can gain, and the demand for online advertising is pretty obviously finite. Google does not want to be an online advertising business forever. So it reorganized itself to wall off its boring lucrative business from all the weird moonshot businesses that have nothing to do with online advertising but that might provide its next thing. (Like maybe: building a city?)
Apple has a thing: It is really, really good at designing computer hardware. It has a long history of designing lovely desktop and laptop computers, and then it found a way to shrink those computers into an astonishingly lovely phone, and it sold massive quantities of the iPhone at huge margins and was amazingly profitable. And then it was like ... what if we made the phone a bit bigger? And that was the iPad, and it sold millions of those. And then it was like ... smaller? And that was the Apple Watch, and it was kind of meh. Maybe there will be a television. "The car is the ultimate mobile device." There are still hardware worlds to conquer.
Still it is not inconceivable that Apple's long period of rapid growth is coming to an end, or that the demand for beautiful design in computer hardware is finite. (Apple now touts its recurring revenue from services, which in my experience are a bit less designed than its hardware, but never mind that.) As Timothy B. Lee says: "The issue is simply that the iPhone has been one of the most successful consumer products in world history. It's an almost impossible act to follow."
Anyway Apple announced earnings yesterday. They were bad: Apple's "streak of 51 consecutive quarters of uninterrupted sales growth is over," the forecast is negative, iPhone sales were down year-over-year, and sales in China were disappointing. Here's a transcript of the call. "We've hit an innovation plateau," says an analyst. If you subscribe to my basic model of companies, it may not surprise you to learn that Apple also increased its dividend (from 52 to 57 cents per share per quarter), and its stock buyback program (from $140 billion to $175 billion).
Oh elsewhere Twitter's earnings were terrible but what else is new.
It is bank annual meeting season, and bank shareholders seem to be a perpetually disgruntled group these days. For instance, "shareholders in Citigroup staged a significant rebellion over its executive pay scheme," though only in the boring world of U.S. shareholder democracy could you consider it a significant rebellion. Citigroup held a non-binding vote to ask shareholders if they approved its executive compensation scheme, and they did: A majority of votes were in favor of the plan. But 36.4 percent were against, well above the average of 8.8 percent, which is practically like losing. A non-binding vote. Devastating.
Besides its pay scheme, Citi is constantly defending its bigness:
At Citi’s annual meeting in Miami on Tuesday, Mr Corbat defended Citi’s structure. He pointed to the benefits of keeping the retail and investment business together, including cross-selling, sharing of technology and lower funding costs across the bank.
Together such benefits generated “operational efficiencies” worth $8bn-$12bn a year, he estimated.
“Large global institutions like the one I lead perform a vital and irreplaceable function,” he told investors. “We don’t aspire to be a monolithic entity intent on being big for big’s sake or crowding out smaller banks. We define ourselves as being appropriately scaled.”
Obviously some people disagree, either from a regulatory perspective or because they think the biggest banks might be worth more to shareholders in smaller pieces with, perhaps, less onerous regulation. On the other hand, some shareholders of Comerica -- already the 31st-biggest bank in the U.S. and a "systemically important financial institution" -- think it would be better off as part of an even too-bigger-to-fail bank, with both an activist investor (Hudson Executive Capital) and an activist analyst (Mike Mayo of CLSA) pushing it to sell itself. You can see why shareholders of the big universal banks might find them unwieldy, but you can also see why shareholders of mid-sized commercial banks might find them, you know, boring.
Meanwhile in universal banks, "Barclays said on Wednesday that its profit declined 7 percent year-on-year in the first quarter, but the lender’s core businesses had shown progress since it announced a shift in strategy this year." Here are the announcement, the presentation, and the management speech.
And elsewhere in bank governance:
Popolare di Vicenza, Italy's eighth largest bank, says managers who have since left were wrong to ask clients to buy shares using bank loans. It was a way of using the bank's own money to bolster a balance sheet weakened by mounting bad debts.
Yes that does seem wrong.
Here is the sad story of the decline of "a core group" of investors in real estate investment trusts -- at my old job we called them the "REIT Mafia" -- who "once could alter the path of initial public offerings and affect decisions about how companies should be run," but who are now losing influence given the rise of index funds. We talked yesterday about "closet indexing," a phenomenon that has become more controversial as it's gotten easier to track: Now that you can statistically measure the "active share" of a portfolio, you'd expect to see a decline in broadly diversified boring but non-indexed asset managers, as mangers bifurcate into pure indexers and concentrated active managers. The old model of a diversified mutual fund was, say, four parts index to one part active; the new model of investing is just to put the index parts in an index fund and the active part in a separate fund that is very active indeed.
You could imagine something similar happening in governance: The old, regular, active-but-not-too-active investors would have engaged, thoughtful, active-but-not-activist relationships with corporate managers. The new model might be: Checked-out index funds, plus occasional activist hedge fund interventions. Though you'll probably see less activism in REITs.
Elsewhere: "Brevan Howard Said to Get $1.4 Billion Redemption Requests." Here is Joseph Cotterill on the potential for Saudi Arabia's sovereign wealth fund. And here is Ben Walsh on Saudi Arabia's plan to transfer 95 percent of Aramco "into a sovereign wealth fund, where it will be classified as an investment" instead of as oil revenue:
“There is less to this than meets the eye,” Jason Tuvey, Middle East economist at Capital Economics wrote in a note to clients. “It reflects a shift of balance sheets rather than any new assets and doesn’t in itself reduce the government’s dependence on oil revenues. In short, we don’t buy into Mohammed bin Salman’s assertion that Saudi Arabia will no longer by dependent on oil by 2020.”
I, of course, have a fonder view of this; as I once said:
What I love there is the vision of the transformative power of finance. Owning an oil company is dirty and lame and old-fashioned. Owning shares in an oil company is the future. The very minimum of financial structuring can move you up the value chain.
Oh man, this Dune Lawrence story in Bloomberg Businessweek about LabMD's fight with the Federal Trade Commission is something else. LabMD was a small health-care company. A data-security consulting firm called Tiversa allegedly hacked into its patient files and ... well, sent "polite extortion notes" saying that the files had leaked and asking LabMD to pay for its consulting services to clean up the leak. LabMD didn't pay, and Tiversa reported LabMD to the FTC for violating patient-privacy rules. The FTC brought a case against LabMD. LabMD fought the case, at a high cost in money and lost business; the company shut down in 2014. But it eventually won in the FTC's administrative court, after a former Tiversa employee named Richard Wallace testified about the strange relationship between the FTC and Tiversa:
Wallace testified that Tiversa gave the FTC a list of more than 80 companies in 2009 that had suffered supposed breaches. The main criterion for inclusion was an order from Boback, he said, and the list was scrubbed of existing Tiversa clients. The FTC did little to verify any of the information Tiversa provided, according to Wallace.
That decision has been appealed. The House Oversight Committee has investigated, finding "that Tiversa had faked evidence of data leaks to promote its services." Everyone is suing everyone.
One thing to think generally about regulation is that it creates its own economy, its own sources of profit. If you make a rule that health-care companies have to secure their data, health-care-data-security consultants will spring up. That's generally a good thing (they're good at securing data!), but you have to be pretty careful about the incentives you create. You might get companies and consultants working together to secure their data, or you might get consultants stealing data to blackmail companies.
And of course enforcement authorities have their own incentives, which you can summarize as: (1) More enforcement is better, and (2) easier enforcement is better. A consultant with a list of violators and a pile of ready-made evidence will of course get a sympathetic hearing from enforcement staff.
Elsewhere, Barclays is fighting its $488 million fine from the Federal Energy Regulatory Commission for allegedly manipulating electricity prices, saying that "its trades were motivated by legitimate business purposes, and that no fraud can exist with open market transactions 'based solely on transparent bids and offers.'" I mean ... I don't think I'd agree with that last part? Plenty of market manipulation is based solely on transparent bids and offers. But Barclays's more general point is probably right: FERC's standards for market manipulation are rather famously nonexistent, and its case against Barclays is pretty puzzling. FERC has no theory of market manipulation; it just goes after stuff that kind of looks unfair. "It’s a stance that critics say feeds uncertainty over what is acceptable and risks chilling legitimate trading." This is exacerbated by the fact that rules in the electricity market are often pretty dumb and invite gaming: If a trader takes up the invitation and plays the game, is that manipulation? Or is it just the intended outcome of the rules?
Also here is the story of an art forgery scandal.
I appreciate Bloomberg's new mini-series of articles checking in on whether SunEdison executives are still employed there. On Monday there was "SunEdison's Chatila Still CEO of Complicated Clean-Energy Giant," and then yesterday there was "SunEdison's Exiting CFO, Brian Wuebbels, Has Yet to Leave Post." That one is kind of weird: Wuebbels's replacement was scheduled to start "no later than April 4," according to SunEdison's announcement of his appointment in March. It is conceivable that events since March -- particularly SunEdison's bankruptcy filing last week -- would make it a less appealing place to work. You might also remember Wuebbels from the time that SunEdison tried to sell some assets to TerraForm Global, an affiliated public-company "yieldco," and TerraForm Global's independent directors rejected the deal. SunEdison got rid of those directors, fired TerraForm's chief executive officer and chief financial officer, and installed Wuebbels -- SunEdison's CFO -- as TerraForm's CEO. He is no longer the CEO there, at least.
People are worried about unicorns.
Oh sure Theranos, the Blood Unicorn (Elasmotherium haimatos), raised hundreds of millions of dollars at a $9 billion valuation from venture-capital investors. But not from the right venture capital investors:
Part of the company’s appeal was the familiar origin myth of Theranos’s founder, Elizabeth Holmes, who, like Bill Gates and Mark Zuckerberg before her, dropped out of college in order to found her company.
That might impress some social media investors, but in life sciences, everyone puts in years of formal study just to earn a seat at the table.
Yowzers. That's from Randall Stross, in an op-ed titled "Don't Blame Silicon Valley for Theranos" that is filled to the brim with burns like that:
Theranos approached GV twice and was turned down twice because of what one partner called “so much hand-waving.” People I have talked to at other investment firms said they turned down Theranos for similar reasons, unsatisfied with Theranos’s attempt to substitute its intangible “coolness” in place of technical details needed to validate its diagnostic technology.
Luke Evnin, a co-founder at MPM Capital, said he had never met with Theranos or Ms. Holmes, but he found the makeup of the board puzzling: “It is pretty weird that if you look at her board, there’s not a single person who knows what they’re doing in the business.”
The first million dollars that the company received was from Tim Draper, a venture capitalist who became a venture capitalist through a very un-Silicon Valley-like route: His father was one (as was his grandfather).
Ahhhhhh! Those burns are so fiery that everyone involved will need a blood transfusion. Good thing they have a blood lab.
Elsewhere, we have debated whether Ant Financial, the Ant Unicorn (Formica elasmotheriosa), actually qualifies as a unicorn, but it says here in the New York Times that it's a "Different Breed of Unicorn," so ... wait is that a yes or a no? I think it counts. In any case, here is a Wall Street Journal story about how Ant Financial used to antagonize big Chinese banks ("What determines success in the market shouldn’t be the monopolies and those with power, but the consumers," said Jack Ma; "I said to Jack Ma, ‘Give up your reform efforts. You don’t have the ability,’" said the head of a Chinese bank), but its latest funding round included some of the biggest banks.
People are worried about bond market liquidity.
Here is the story of why Wells Fargo became a primary dealer in the Treasury market. (Basically: "The world's central banks, a growing force in bond markets everywhere, prefer to trade with" primary dealers, and Wells Fargo wanted to go after that business.) But this cuts against a more usual set of worries about, more or less, bond market liquidity:
Wells Fargo is making the move as other Wall Street banks balk at the responsibilities that come with the title. The dealer role isn’t as lucrative as it used to be, according to three current and former heads of trading desks. Wells Fargo is the first addition to the list in over two years, and the group is down from a high of 46 in 1988.
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