Cars, Batteries and Dual-Class Stock

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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TeslaCity.

I mean look I guess this is a rationale for a merger:

In a conference call, Musk sketched out some examples of what this new all-in-one clean energy company might entail: "You could go into a store, or go online, and with a few clicks you can have everything from solar panels to batteries to electric cars."

Imagine the equivalent fossil-fuel energy merger, like, Ford buying Cabela's and Con Edison: "You could go into a store, or go online, and with a few clicks you can have everything from gas heat to kerosene stoves to gasoline-powered cars." Both combinations seem arbitrary. When last we talked about Elon Musk's web of companies, I said:

It would make sense that a company that makes space rockets would be separate from a company that makes electric cars and from a company that sells solar panels. Those are just pretty different businesses; it would be weird to combine them. It just so happens that the founder of each of those companies, Elon Musk, transcends the usual bounds of human competence, and has some ideas about how to do all of those projects. But he quite sensibly offered investors three separate companies, so that investors who like electric cars can buy Tesla, investors who like solar power can buy SolarCity, and investors who like space rockets (and are accredited) can buy SpaceX.

The counterargument would be that, deep down, both Tesla and SolarCity are essentially in the battery business, and combining forces might make them better at engineering and selling batteries. In any case yesterday Tesla offered to acquire SolarCity, for the one-click-shopping and the engineering synergies and probably also to simplify Musk's financing operation, though as a big shareholder and board member of both companies he will mostly recuse himself from consideration of the deal. As Bloomberg Gadfly's Liam Denning points out, "there's none of the usual talk of accretion -- how could there be when both companies are solid loss-makers?" It's an all-stock deal at an exchange ratio still subject to due diligence. Pro forma, "a combination of Tesla and SolarCity would have burned nearly $5 billion last year." SolarCity investors are happy, and its (many) short sellers are sad; Tesla shareholders and analysts do not seem thrilled:

Oppenheimer & Co. analysts including Colin Rusch downgraded Tesla, saying investors will probably view the deal as “a bailout” for SolarCity and “a distraction” to Tesla’s own production issues. “We do not view this acquisition as the best and highest use” of Tesla’s capital, Rusch said in the company’s research note Tuesday.

Gatekeeping.

People complain all the time about public companies with dual-class share structures that allow one person to keep voting control even without majority economic ownership, and I mostly shrug. (I shrugged as recently as yesterday, about Facebook.) Those companies generally went public that way. The founder-controller went out to investors and said, look, here is the deal: You will give me money, and I will do stuff with it, and you won't get much of a say, but I'm a great guy, aren't I? And the investors said, sure, sounds good. So what is the problem? Willing buyers, willing sellers, full disclosure, negotiated deals. Sure we have many years of experience with the default rule that public companies should be run along one-share-one-vote lines, and that mostly works pretty well, but in this modern world of financial innovation there is no reason to force every company into the old defaults.

But here is Ronald Barusch on the nonsense at Viacom:

Underwriting banks have for many years tolerated the use of dual classes of stock in certain initial public offerings, particularly for technology and media companies. The banks in a sense hold the keys to the dual-class structure because, as a practical matter, it needs to be in place by the time an IPO is completed. But as the Viacom control battle rages, it’s hard to see how responsible investment banks can continue to sanction a governance structure that could result in such bitter infighting.

There are two basic ways to think about the role of the investment bank underwriting an initial public offering. One is, the bank is an intermediary between the seller (the company going public) and the buyers (the investors buying the shares). Its job is to help the two sides reach an agreement on price and structure, to find the right deal that will clear the market while making sure that all of the important issues about the company are fully and fairly disclosed. The bank's role in corporate governance is just to represent what the market wants. If Mark Zuckerberg had come to his investment banks and said "I want to go public but I want shareholders to have to send me their firstborn children to live in my fairyland under the sea," his banks would have pushed back and said, you know, those aren't really market terms, we might have trouble selling that. But instead he went to his banks and said that he wanted to keep control over Facebook despite having a minority economic interest, and they were like, sure, fine, the market will probably live with that. After all, there were lots of precedents. (Like Google. Or Viacom!)

But the other view is that the bank serves a gatekeeper role based on its own judgment and experience of what is right and good. In negotiations with the issuer, it represents not what the market wants but rather what the market should want, what it deserves, what it ought to have. On this view, if investment banks decide that dual-class share structures are bad for the world, they shouldn't do IPOs with dual-class share structures, even if investors would buy them. The banks represent the collective memory and conscience of the market, and should work to perfect it.

This is in some sense an old-fashioned view. (There used to be a view that banks shouldn't IPO a company without a track record of profits; this went away when everyone realized that investors would cheerfully buy those IPOs.) But as a former underwriter of weird securities, I sympathize with it. I often negotiated terms in convertible bond documents that no investor would read or care about; the issuer would ask for something investor-unfriendly, and I would push back, not because the investor-unfriendly terms would make the deal hard to sell -- no one would care -- but because the investor-unfriendly terms were wrong. If, years later, the company ended up using those terms in a way that unfairly harmed bond investors, I would feel bad about it. Part of my job was to make capital markets work correctly, and if I didn't do it no one else would. Certainly the investors wouldn't.

I still pretty much shrug at the dual-class thing. That's a big-ticket item; shareholders notice it. If companies want to sell dual-class shares, and if fully informed investors want to buy them, it seems hopeless for investment banks to stop them. But I appreciate the aesthetic impulse that might make them want to try.

Insider trading.

Look, I joke around a lot about insider trading, but I mean it when I say that the First Law of Insider Trading is, don't insider trade. It is not worth it, particularly for successful financial professionals. You rarely see cases where a hedge-fund employee or banker or lawyer gets a life-changing amount of money from insider trading; it's usually a little extra money, a better bonus, a gambling addiction. And then the consequences are life-changing, but in a bad way. There are gray areas, sure, and it can be hard for professional investors to steer entirely clear of them. And recent years have seen more enforcement actions targeting gray areas that used to be fine. But in general it is a good idea to organize your life so that no one could plausibly accuse you of insider trading.

Anyway poor Sanjay Valvani, the Visium portfolio manager who was recently accused of insider trading, died this week, apparently of suicide, leaving a wife and two children. Over some tips about generic drug approvals. It is sad stuff. "We hope for the sake of his family and his memory that it will not be forgotten that the charges against him were only unproven accusations and he had always maintained his innocence," says his lawyer; I thought he had a decent case on the law alone. "He was an investor that had a high moral standard and moral code," says a former analyst who knew him. As for Preet Bharara, the U.S. Attorney who went after Valvani, "I don’t think he’s going to lose sleep over it because it comes with the territory," says a lawyer. 

40 Wall.

I don't spend a lot of time wandering around Wall Street, the physical street, so I was somehow not aware that Donald Trump owns 40 Wall. (Even though it is fronted by "golden capital letters proclaiming that this is THE TRUMP BUILDING.") But here are Bloomberg's Zeke Faux and Max Abelson with a tour of 40 Wall and the "frauds, thieves, boiler rooms and penny-stock schemers" who work there, or did, until they went to prison:

Since Donald Trump took over 40 Wall St. in 1995, prosecutors have filed criminal charges against at least 29 people connected to 12 alleged scams tied to the building. Nine other firms have faced serious regulatory claims. Authorities prevailed in most but not all of the cases.

And what 40 Wall is to Wall Street, the 28th floor is to 40 Wall:

A cheap way to get a 40 Wall St. address is to grab space on the 28th floor, which is broken up into small offices. The firms listed in the lobby directory for that floor include Your Trading Room, a foreign-exchange operation ordered shut by an Australian court in 2012; Asian AIM Incubator Co., which Malaysian regulators put on a list of possible scams; Stilas International Law, whose founder was banned from practicing law in Virginia; and Ero Capital Corp., run by a man convicted of credit-card fraud.

And that's not including former tenants like Mark Malik of Wolf Hedge, who "pretended to have died from a heart attack when investors tried to withdraw money from his fake hedge fund" and who is "currently serving 5-15 years" in a New York prison. Other notable current and former tenants of the building include Lynn Tilton's Patriarch Partners (on 25) and Trump University (on 32).

Elsewhere in alleged scams, "former New York Jets quarterback Mark Sanchez and other professional athletes said they were cheated out of millions of dollars in a Ponzi-like scheme orchestrated by an investment adviser who appealed to their Christian faith," according to a Securities and Exchange Commission lawsuit.

Hard work.

Hi kids, do you have investment banking interviews coming up? Consider memorizing this paragraph and just screaming it at your interviewer:

“Most people would say full-time is 40 hours, but every waking hour for me is a workday. So I’m at XenoTherapeutics full-time, at Dartmouth full-time and, on the side, I’ve got another way to pay the bills—since being a student and running a small nonprofit aren’t very lucrative. The Wright Brothers built bikes; I build spreadsheets.”

It's from Dan Primack's story about some weird Trump thing, but regardless of context, that quote is just sublime. Maybe substitute in your own school and sports team for "Dartmouth" and "XenoTherapeutics," but otherwise you should be good to go.

Culture. 

In a victory for casual culture in the financial industry, now you can wear jeans at BlackRock. Changzhi Zhangze Rural Commercial Bank, meanwhile, is kind of going the opposite way:

A motivational trainer in China beat eight rural bank employees with a stick, shaved the heads of the men and cut the hair of the women after they performed poorly on a training weekend.

Elsewhere in bank culture, here is "How Wall Street gets all Big Brother on emails." And here is Gawker's description of its restructuring bankers:

Houlihan Lokey isn’t best known for run-of-the-mill assignments. They’re most noted for being specialists in complicated situations, often involving financially distressed companies. To prove just how good they are at it, here is a picture they made of a banker hugging a puppy on a sinking boat surrounded by sharks.

Blockchains.

When news of the DAO hack first came out, I mentioned how odd it is that "the blockchain is almost universally touted as the future of finance," while so many actually existing blockchain projects have ended in massive thefts. So I was pleased to see that the Financial Stability Oversight Council is worried about the blockchain:

It noted: “Market participants have limited experience working with distributed ledger systems, and it is possible that operational vulnerabilities associated with such systems may not become apparent until they are deployed at scale.”

That, I think, accurately captures what happened with the DAO. Elsewhere, here's a Slock.it post about a counterattack on the DAO hacker; I don't know if it should make you feel better or worse about the blockchain as the future of finance.

People are worried about non-GAAP accounting.

As an accounting postmodernist, I am pleased that this recurring section has become almost entirely "people are worried about GAAP accounting." The latest is this Wall Street Journal excerpt from a new book called "The End of Accounting"

The problem with reported earnings, and financial statements in general, is that they no longer reflect the realities of businesses. Instead, they follow an arcane set of accounting rules and regulations. An alternate reality which fails to illuminate essential factors that make an enterprise rise or fall, where, for example:

—The most important, value-creating investments in patents, brands, IT and other intangibles are considered regular expenses, like salaries or rent, without future benefits.

—Reported earnings are a mixed bag of long-term items (indicating sustained growth) and one-time, transitory gains/losses (restructuring costs, for example), having negligible effect on corporate value. 

Etc. That last one -- distinguishing recurring earnings from one-time items -- is a perennial focus for people who worry about non-GAAP accounting. If you believe that U.S. generally accepted accounting principals are the highest and best way to represent economic reality, then when a company tries to exclude non-recurring costs, you might say things like "Fantasy Math Is Helping Companies Spin Losses Into Profits." But if you believe that GAAP is just "an arcane set of accounting rules and regulations" with no privileged connection to economic reality, and if you are trying to value a business based on its future earnings potential, then finding a way to distinguish recurring and one-time costs really is important. Not that companies' non-GAAP financial metrics are necessarily a good way to do it, but still.

People are worried about unicorns.

I am worried about Palantir, the Spy Unicorn, which seems to be mostly a big-data brand consulting company but which has enough NSA and CIA connections that I like to think that it is staffed by spies. But it is hard to imagine 007 getting injured this way:

Cohen describes how he was injured when he was slammed by a door as an apparently drunk coworker rushed to make his shot in a game of office beer pong. He also says he suffered from hives after an apparent office prank in which another (also apparently drunk) coworker placed dog hair around Cohen’s work station, scattered vinyl gloves across the room, and stole snacks out of his filing cabinet.

Cohen, Bernie Cohen, is a former Palantir technical writer who has threatened to sue the company. I wonder if actual spy agencies have similarly bitter fights over intra-office snack thieving. Or if they have office beer pong, for that matter.

Elsewhere in worrying unicorn things, here is an article titled "Banks Wary of 'Toxic' Fintech Unicorns" that I point you to not so much for the unicorn worries as for the illustration of a toxic unicorn, which is a sight to behold. It is a sort of pale-purple unicorn skeleton with a ridged back and neon green eyes glowing from its cavernous sockets. You would not want to run into it in a dark alley of the Enchanted Forest. 

People are worried about bond market liquidity.

There's a new bond index:

Wilshire Associates Inc. introduced a new U.S. bond index Tuesday that’s calculated based on where investment managers are putting their money. That’s a different tactic than other providers, notably the heavyweight Barclays Aggregate Bond index, which calculate their indexes based on the universe of outstanding debt.

It is funny to imagine how the universe of debt that is sold can be different from the universe of debt that is bought, though the actual answer is pretty prosaic. (The Wilshire index measures the holdings of "U.S. institutional plans like pension funds," so, for instance, heavy non-U.S. demand for Treasuries will lead to a higher Treasury allocation in the Barclays index than the Wilshire one.) If you are an active U.S. bond manager, do you want an index that more closely tracks the portfolio of active U.S. bond managers? On the one hand, it probably reduces your tracking error. On the other hand, it's possible for everyone to outperform (or underperform) an index that doesn't represent their aggregate holdings; if the index does represent the industry's aggregate holdings, then just as a matter of arithmetic some managers will underperform.

I guess this isn't really a liquidity worry but, you know, bonds in indexes are more liquid, etc. Elsewhere here is a speech by Gary Barnett of the SEC's Division of Trading and Markets that spends some time discussing single-name credit-default-swap liquidity.

Things happen.

Brexit Polls and Markets Disagree as Campaign Enters Final Hours. Jose Canseco is worried about Brexit. Puerto Rico, Bondholders Remain at Odds. A $541 Million Loss Haunts Deutsche Bank And Former Trader Dixon. SEC Readies Case Against Merrill Lynch Over Notes That Lost 95%. Energy Transfer Shares Surge During Merger Trial With Williams. A meeting about money markets that’s kind of a big deal. A Surprise Twist in the Fannie and Freddie Appeal. VW Seeks to Quell Investor Uprising Over Emissions Damages. Warren Buffett: "The big problem with Donald Trump was he never went right." "Waste-to-energy plants, like so many infrastructure projects in this country, deserve bipartisan support." Were You Aware of This 'Are You There God? It's Me, Margaret' Cover, In Which God Is Texting? Firefighters 'rescue' Alabama teen girl from giant Barney head. Cheetos Museum offering prizes for Cheetos that resemble other objects.

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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