Leveraged Loans and Tweeting Doctors

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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Uber.

It is not particularly a mystery why Uber wants to borrow as much as $2 billion in the leveraged loan market. Uber constantly needs money, and leveraged loans are cheap:

Uber is hoping to price the loan with a yield of 4% to 4.5%, some of the people said, but it is unclear whether the company will achieve a rate that low, especially given that it is a first-time issuer. The average yield on new leveraged loans ranges from 3.9% to 5.5%, according to data from S&P Global Market Intelligence LCD.

Contrast that to the convertible bonds that Uber raised last January, which came with a step-up coupon and the right to buy stock at a 20 to 30 percent discount to Uber's eventual initial public offering price, for a possible double-digit yield depending on when the IPO comes. Or contrast it to Uber's stock, for that matter: It raised money at a valuation of about $50 billion last July, and then at about $62.5 billion last December, meaning that the stock returned about 25 percent in a few months. The return that investors expect on Uber stock, even now, is high. The return that they expect on weird equity-linked Uber instruments is also high. The return that investors expect on leveraged loans is, you know, in the mid single digits. For a startup, that's basically free.

Of course, unlike with the stock, Uber will have to pay back the leveraged loans, which you might think would be challenging given that Uber seems not to be profitable and is spending like mad to attract drivers in new markets. But if there is one thing we know about Uber, it is that it has unlimited ability to raise money in the private capital markets:

The move follows Uber’s sale of a $3.5 billion equity stake to the investment arm of Saudi Arabia—part of a $5 billion funding round that was the largest single injection into a venture-backed company—and underscores the cost of its quest for global market share. The new loan would bring to roughly $15 billion the amount raised in debt and equity by Uber, which has been valued at $68 billion.

So finding the money to pay back a dinky billion or two of leveraged loans shouldn't be a problem. 

I mean, no, probably Uber's plan is to pay back the leveraged loans with an IPO in the next few years. But there are other possibilities. "The company has said it is profitable in its most developed markets," so perhaps it could flip the switch from fast growth to profitability any time it wants, and service its loans without raising more money. My dream for Uber is that it will stay private long enough to become profitable, so profitable that it can replace this year's leveraged loans with just regular old investment-grade bank loans, and run a normal, large public-company capital structure without actually being a public company. Then my real dream for Uber is that someone will look around and say "hey we have too much equity," and mount a leveraged buyout of Uber's stock before the IPO ever happens. It's a bit of a challenge, LBO'ing a private company, but I bet Uber is up for it.

Hedge funds.

Of all the hedge-fund mysteries, Platinum Partners may be the most mysterious. Here are some stylized facts about Platinum:

  1. Its main hedge fund is one of the best-performing hedge funds around, year after year, returning about 17 percent a year since 2003 with no down years.
  2. It allegedly had trouble with outflows in that fund, which a Platinum co-founder solved by -- allegedly! -- bribing the head of a New York City correctional officers' union to invest union money in the fund.
  3. After the union official and the co-founder were arrested, Platinum is closing that fund.

If 1 was true, why was 2 necessary? And why is 3 necessary now? "New York-based Platinum told investors on a conference call on Tuesday that recent negative media attention and requests for the return of capital had forced it to begin the liquidation of its more than $700 million Platinum Partners Value Arbitrage Fund," but you don't shut down one of the best-performing hedge funds ever just because of some negative media attention. You might shut it down because you're getting lots of redemption requests, but why are investors redeeming? One element of Platinum's mystery is that it tended to attract mostly wealthy individual investors, not institutions, in part because institutions found ... the due diligence ... challenging. You could imagine institutions with reputational concerns redeeming out of Platinum despite its amazing track record, but those institutions were never investors in the first place. It's mostly individuals whom Platinum has made very rich. What are they worried about now?

Elsewhere, here is a paper about "The Optimal Size of Hedge Funds," which comes to pretty much the conclusions that you'd expect:

  1. "Like other investment vehicles, such as mutual funds, hedge funds are likely to suffer from diseconomies of scale."
  2. "Hedge fund managers’ compensation increases as fund assets grow, even when diseconomies of scale exist."

Never tweet.

Here is a bizarre story:

In New Orleans Monday, a major medical organization attempted a feat perhaps as hard as treating the disease doctors were there to discuss. They asked a packed convention hall of attendees not to tweet the confidential, market-moving data they had flown in to see.

It didn’t work.

I mean, why would it, but never mind that. This would be a good final exam problem for a law school course on insider trading. Let us assume that the information was material. (It was about relatively disappointing results in a study of a Novo Nordisk drug, and "on Tuesday, Novo’s shares fell 5.6 percent to 343 kroner, for their biggest one-day drop since February -- confirmation of how important the information was to the market.") If a doctor in the room tweeted the information, does that make it public? What if an investor then "retweeted the images to his more than 18,000 followers"? If you read it on Twitter and it's public, then you can probably trade on it. (Right?) But if you read it on Twitter and it's not public -- because it has only gone out to a relatively few Twitter followers -- can you trade on it? 

It seems to me -- and this is of course not legal advice, just some guidance on how I'd go about writing the exam answer -- but it seems to me that the answer would depend on (1) whether the doctors who tweeted the information breached a duty of confidentiality and (2) whether they received any "personal benefit" for doing so. Both are challenging. On (1), they were told the information was embargoed and that they should keep it secret, but on the other hand I am not sure that just being told that a public presentation is embargoed creates a duty of confidentiality. On (2), I mean, it's not like anyone is paying them to tweet the information. On the other hand, is there any more visceral form of personal benefit than being retweeted? I for one would love to see the government argue that social-media likes and retweets are the sort of "personal benefit" "of some consequence" required by the Newman decision.

Anyway it seems like all of this happened after trading hours, and the information was quickly put out in a press release, so no harm no foul.

Regulation.

Here is a weird story about Senator Elizabeth Warren's continuing animosity for Securities and Exchange Commission Chair Mary Jo White:

In a testy exchange before the U.S. Senate Banking Committee, Warren demanded that White provide evidence to justify a corporate disclosure review sparked by a concern that investors were suffering "information overload."

"Your job is to look out for investors, but you have put the interests of the Chamber of Commerce and their big business members at the top of your priority list," the Massachusetts Democrat said.

"A year ago, I called your leadership ... extremely disappointing. Today, I am more disappointed than ever."

“I’m disappointed in your disappointment,” replied White. Warren's complaint seems to be that the review of disclosure effectiveness is "a waste of the SEC’s limited resources when the SEC still must complete some 20 postcrisis regulations." I tend to be suspicious of arguments of the form "X is a bad use of resources when you could be focused on Y." Should the SEC be prioritizing, say, new political-contribution disclosure rules over a review of the effectiveness of existing disclosure rules? I mean, Elizabeth Warren thinks so; others might disagree. But one can always zoom out. Should the Senate be prioritizing scolding the SEC about disclosure instead of, say, confirming judges or passing legislation? Should I be prioritizing writing about this fight instead of writing about Brexit? All of us have a finite amount of time on this earth, and all of us pretty much waste it, and it seems a bit silly to pick on one person or agency for wasting theirs.

Elsewhere, the Commodity Futures Trading Commission's plan to get everyone's high-frequency trading code without a subpoena is controversial, mostly because deep down everyone assumes the CFTC would lose the code. (Also because the CFTC has no particularly compelling case for what it would do with the code.) And here is a new paper on the history of the Trust Indenture Act, which is relevant given the recent court decision finding that the TIA might prevent out-of-court debt restructurings:

Debt Restructurings and the Trust Indenture Act, a new paper recently posted on SSRN, uses thorough historical analysis to make three main points about the application of the TIA to debt restructurings. First, it demonstrates that Congress cannot have intended the TIA to prohibit transactions like the one in Marblegate. Second, it shows that “impairing” a bondholder’s right to payment had a well-understood meaning at the time. Third, the paper explains how the TIA’s non-impairment provision, despite its seemingly narrow focus, fit with the SEC’s broader policy objectives regarding debt restructurings. It concludes that debt restructurings that do not change payment terms do not implicate the TIA.

A-shares.

You could loosely describe the recent Chinese approach to stock-market regulation as being (1) encouraging buying and (2) discouraging selling. Ways to discourage selling include "restrictions on foreign investors redeeming their stock investments in China," as well as "the curious ability of Chinese companies to stop trading in their stock whenever it seemed to suit their own need." (Though last month regulators "introduced new guidelines aimed at limiting the frequency with which Chinese companies indefinitely suspend their shares from trading.") One important way to encourage buying would be to get MSCI Inc., the index provider, to include mainland Chinese stocks in its Emerging Markets index, which would more or less force index-tracking foreign investors to buy those stocks and support their value. But the two goals are in conflict, and MSCI has delayed including Chinese A-shares in the index:

In a statement accompanying its verdict—delivered as MSCI also said it would admit Pakistani stocks to the index for the first time—the index provider pointed to a key remaining issue for investors when it comes to Chinese markets: their ability to get money in and out of the country without limits.

Andrew Caspersen.

When Andrew Caspersen was charged with fraud for allegedly tricking people into investing with him and then putting most of the money into S&P 500 Index options, I called those trades "a last refuge of the desperate, the financial-markets equivalent of the roulette tables." So I am not surprised to see that Caspersen's lawyer "contended that his client, a former Wall Street executive with an Ivy League pedigree, was the victim of an uncontrollable gambling addiction that drove him for more than a decade." Obviously! Still I continue to object to the phrase "Wall Street greed":

Mr. Shechtman said news media reports have wrongly characterized his client as a man driven by greed and self-interest.

“This is not about Wall Street greed,” he said. “This is about addiction and mental illness.”

"Wall Street greed" has no explanatory power. Everyone -- well, everyone charged with financial crimes, anyway -- wants more money. Some people want more money to feed their families, some want more money to buy a yacht, some want more money to feed a gambling addiction. There is no clean dividing line, no way to separate "Wall Street greed" from the usual complex of human motivations and worries and failings. If you are looking to punish "Wall Street greed," while leaving normal self-interest and "addiction and mental illness" alone, you will always be disappointed.

People are worried about non-GAAP accounting.

No they aren't; they're worried about GAAP accounting. Here is a story called "Why Billions in Proven Shale Oil Reserves Suddenly Became Unproven," and the answer is not because better geological science discovered that the oil wasn't actually there.

The wells must be profitable to drill at a price set by an SEC formula. The companies got a temporary reprieve for 2014 because the SEC number was about $95 a barrel even though crude had plummeted to less than $50 by the time results were reported in early 2015.

That advantage has disappeared. When companies reported their 2015 reserves this year, the SEC price was about $50. Wells that vanished this year may return if prices rise.

"Proved reserves" is not a scientific or economic concept; it is not a direct translation of a fact in the world onto an oil company's balance sheet. It's a convention, a set of semi-arbitrary rules and formulas created by the oil industry and the Securities and Exchange Commission to make oil companies' financial statements comparable to each other. What is obvious here is also true, to some extent, of all generally accepted accounting principles. If an oil company said "our SEC proved reserves are a billion barrels, but at current prices only 300 million barrels are economic" -- well, that would be reporting a non-GAAP number. But it would be weird to call the non-GAAP number "fantasy math." The official number, in this case, is closer to fantasy.

People are worried about unicorns.

Marc Andreessen wants to show the herd of unicorns the path out of the Enchanted Forest:

Andreessen, the co-founder of venture capital firm Andreessen Horowitz, expects many more M&A deals this year and a stream of IPOs in 2017 and 2018. The pendulum has swung too far away from the public markets in recent years and closely held companies have remained private far longer than the historical norm, he said Tuesday at the Bloomberg Technology Conference in San Francisco.

“We have a team inside the firm focused on IPO preparedness,” said Andreessen, who in the past has promoted the benefits of startups staying private.

Look, that is probably right; my fantasies notwithstanding, it seems like even Uber is slowly gearing up to go public. Still I wonder if the pendulum is the right model for public versus private markets. It seems plausible that broad long-term trends, not just the vagaries of regulation and investor appetite, could be driving more investment into the private markets. Financial and communications technologies make it much easier than it used to be for private companies to raise money, provide information to investors, allow transferability of their private shares, etc., all while tailoring the entrepreneur/shareholder relationship in ways that are not possible in the relatively standardized public markets. There is more money in fewer hands -- due to wealth inequality but also due to the increasing concentration of most people's money in big asset managers -- which means that private companies have access to almost as much capital as public ones. There will probably be some reversion to the historical norm, but I'm not sure we're due for a return to the days where an IPO was a prerequisite for a billion-dollar valuation. Some unicorns may leave the Enchanted Forest, but the forest itself won't be chopped down to fuel the public markets.

Elsewhere, "Dropbox CEO Pushes Toward Profitability in a ‘Post-Unicorn Era’":

Drew Houston, Dropbox's chief executive officer, now declares that we're "entering the post-unicorn era." Unicorn startups, those valued at $1 billion or more, will need to focus on creating healthier businesses as venture capital and other sources of private-market funds dry up, he said Tuesday onstage at the Bloomberg Technology Conference in San Francisco.

"In these boom times, you get really disconnected from the fundamentals," he said. "Cash is oxygen, and if you keep having to go to investors to fill up your scuba tank, you can run out."

That is definitely good scuba diving advice.

People are worried about bond market liquidity.

I couldn't find any worries yesterday, but maybe it's just because everyone who's worried about bond market liquidity was at the ASIFMA-GFMA Market Liquidity Conference in Singapore? (Or at the "Fixed Income Conference (Fully Booked)" of the CFA Society of the United Kingdom in London?) Anyway here is the keynote speech from Julia Leung of the Hong Kong Securities and Futures Commission:

Now one way to look at this topic is from a macro perspective. Over the past eight years since the first quantitative easing, the talk has ranged from how the torrent of liquidity unleashed by highly accommodative monetary policies has inflated asset prices, to how it has led to a build-up of leverage and compression of risk premia.

But from a micro, market dynamic perspective, the concern is completely different. It is about the apparent decline in bond market liquidity resulting from dealers’ reduced market-making capabilities as well as the significant increase in stress incidents where market liquidity evaporates all of a sudden.

These macro and micro forces have combined to produce a rather odd phenomenon where more liquidity is actually less. And this is what market participants are living with today.

That nicely captures the exhaustingly paradoxical nature of bond market liquidity worries. I may rename this recurring section "More Liquidity Is Actually Less." Elsewhere: "Fund Managers Are Stockpiling Cash"; I assume you know why.

Things happen.

‘Brexit’ Vote: Investors Go From Denial to Fear. Osborne Warns of Brexit Tax Toll as ‘Leave’ Gains in Polls. Machines Beat Humans in Hedge Fund Quest to Time Market Bottom. Alibaba Tries to Shore Up Investors’ ConfidencePutin’s Once-Mighty Bank for Pet Projects Now on Chopping Block. Iceland’s selective default? The Global Stakes of a Saudi Aramco I.P.O. "We argue that this inefficiency calls for an industry-wide solution of creating standardized templates for merger agreements that could be used across firms." Convicted Ponzi schemer: I'll conduct $50 million marketing campaign for Trump. The End Of Apple Man. The FDA approved a weight-loss device that sucks food out of your stomach. "He designed a chart, maintained by his secretary, that tallies points based on how much time he spends with family." Frog mating positions. Newfoundland has too many moose"We work in the financial industry, where everybody likes Trump. Everybody’s walking around saying, ‘Hey Trump train! Trump train!’ I’m not making this up at all."

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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:
James Greiff at jgreiff@bloomberg.net