Car-Hailing Deals and Stress Tests

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 Didi.

How many car-hailing companies should there be? Network effects are pretty useful -- it is such a pain to have two apps on your phone -- but on the other hand competition is also nice. For users. Not so much for companies. Uber and Didi Chuxing have decided to forgo it in China:

Didi Chuxing, the dominant ride-hailing service in China, said it will acquire Uber Technologies Inc.’s operations in the country, ending a battle that has cost the two companies billions as they competed for customers and drivers.

"Getting to profitability is the only way to build a sustainable business that can best serve Chinese riders, drivers and cities over the long term," writes Uber's Travis Kalanick, which is ... probably true? Like, a system with two competitors, each of which loses billions of dollars, is not going to serve riders or drivers well over the long term. A system with one profitable incumbent is also perhaps not ideal? I feel like most industries end up in some other equilibrium. (Like: three profitable competitors?) Not, like, subways, though. Public transportation systems tend to be monopolies. I don't know what that tells you about Uber/Didi.

Anyway, the deal structure leaves Uber owning a chunk of Didi ("Uber Technologies will receive 5.89 percent of the combined company with preferred equity interest equal to 17.7 percent of the economic benefits") and Didi owning a chunk of Uber (Didi "will also invest $1 billion in Uber as part of the deal"). Didi already owns a chunk of Lyft, which means that Uber will own a chunk of a chunk of Lyft, in a big happy family of interlinked ride-sharing. (One that Uber investors had apparently been pitching to Didi investors for a while.) "Uber’s local operations will continue to operate as a separate brand under the Didi umbrella." So you'll still need to have two apps? But they'll be owned by the same company, with the express purpose of no longer losing money competing on price? The consumer benefits are perhaps not immediately obvious. 

Stress tests.

I like the European Banking Authority's system of doing bank stress tests without an official passing grade. The idea of a stress test is, you imagine a stress scenario, you calculate how much each bank would lose in that scenario, and then you calculate how much capital the bank would have left. There is a temptation -- somewhat encouraged by the Federal Reserve's stress tests in the U.S. -- to think that the bank should have left at least enough capital to satisfy its capital requirements. But that is circular. The point of capital is to cushion a bank against losses. Capital requirements should be set high enough that, if the bank had big losses, it would survive. Saying that a bank should meet those requirements after the big losses feels like double-counting.

So the European stress-test results announced on Friday just tell you how much capital each bank would have after its big losses, and then leave it up to you to decide how bad that would be. For instance: Negative capital is clearly bad! Banca Monte dei Paschi di Siena SpA surprised no one by getting a negative number in the stress tests, ending up with a negative 2.4 percent fully loaded Common Equity Tier 1 ratio in the stress scenario. It really shouldn't be surprising that a bank ended up below zero. After all, having capital below zero -- having losses that eat all the way through your equity -- is, colloquially, what it means for a bank to fail, and financial crises do tend to result in a bank failure or two. A stress test finding no bank failures might look unduly lenient. On the other hand, the broad purpose of the stress tests is to encourage banks to be well enough capitalized that they can weather any reasonable stress scenario, so it is awkward to find, this many years into the stress-test regime, a bank's capital still falling below zero. (Especially since "the tests ignored Greek and Portuguese banks, which were among the weakest last time.") 

Monte Paschi is trying to fix the problem, though it won't be easy:

Success depends in part on winning backing for a new fund that will buy the bank’s bad loans at prices that, according to at least one analyst, are higher than buyers have been willing to pay. Then Monte Paschi needs to find investors ready to provide 5 billion euros ($5.6 billion) of new equity to a lender worth less than 1 billion euros.

Meanwhile, various lesser forms of failure are still awkward:

Five banks in the test suffered a fall in their fully applied common equity capital ratio to below 7%, which is typically the level at which junior bonds convert into equity or get written down. These were mainly smaller banks, but there were also several big banks that got uncomfortably close to that 7% mark: Barclays, Deutsche Bank and UniCredit.

That's an advantage of the contingent convertible bonds: If the stress tests are credible, those bondholders should pester their banks to raise more capital to give them more cushion. The regulators don't have to decide the passing grade for the stress tests; the banks' investors can do it themselves. 

Mergers and governance.

Here's Steven Davidoff Solomon on the shareholder-vote mechanics for Yahoo's sale of its soul to Verizon:

The Yahoo deal, however, is not a sale of the public company. It is an asset sale, in which there is only a shareholder vote if there is a sale of “all” or “substantially all” of the assets of the company. Yahoo is not all of the assets or even “substantially all” – the Alibaba shares being left behind in Remain Co. are worth about $28 billion, or six times the value of the cash Verizon is paying for the Yahoo assets it is buying.

Still, there will be a shareholder vote -- both because selling "qualitatively vital" assets triggers the voting requirement, and because Yahoo agreed to hold a shareholder vote when it reached a settlement with disgruntled shareholder Starboard Value. "Shareholders are desperate to sell at this point," notes Davidoff Solomon, though on the other hand there are no appraisal rights, "so anyone who votes against the deal and thinks this is a bum price is out of luck." Are there people who think $4.8 billion is a bum price for Yahoo's internet assets? I suppose you could make the case that, what with Yahoo's foot-dragging and ambivalence on selling itself, management did not do all it could do to maximize price. But, you know, the market-implied price was zero-ish, so $4.8 billion seems like a good get.

In any case, for disinterested observers, the real appeal of Yahoo's shareholder vote is that it will have to file a proxy statement, which will presumably be filled with fun stuff like a "Background of the Transaction," explaining exactly how the auction went and who dropped out when, as well as financial-adviser opinions about how much Yahoo's core business was actually worth. 

Elsewhere, Bloomberg Gadfly's Chris Hughes is not impressed by Anheuser-Busch InBev's offer for SABMiller, which "will be a victory for the forces of big money and speculation, and set a worrying precedent for U.K. takeovers," because its structure is "designed to succeed by catering to the unique circumstances of certain big shareholders."

Door revolves.

I mean obviously:

Mervyn King, former governor of the Bank of England, has quietly taken up a role as a senior adviser to Citigroup, surprising friends and former colleagues who assumed his disdain for bankers would stop him following peers through the “revolving door” connecting policymaking and finance.

Look, one, if you are an official with a reputation for being tough on banks, that makes you a more attractive hire for a bank. If Mervyn King advises Citi that it can do something, it will be confident that it really can do that thing, because King has a reputation for not pulling his punches about banks. And, two, why would you become a banker late in your career if not out of "disdain for bankers"? Disdain is a great motivator, and the more disdainful you are for bankers -- King "has described bankers as 'incompetent and greedy'" -- the more excited you should be about competing with them.

But while these revolving-door considerations are all very straightforward and obvious, they remain a little embarrassing for some reason. "Lord King has consistently kept a low profile since he left the Bank of England and deliberately sought no publicity of his role at Citigroup."

Elsewhere in career changes:

Three decades in Tokyo’s finance scene led Robert Hirst to this: opening a theme park starring Nordic hippo-like characters known as Moomins.

The veteran British financier who helped pioneer yen-dollar swaps at the height of Japan’s bubble economy has turned his back on hedge funds and is knee-deep in sketches of the mouthless, round-bellied adventurers created by Finland’s Tove Jansson in the 1930s. He plans to open his venue in the hills outside Tokyo next year.

Happy Blood Unicorn Pitch Day!

Well this is exciting:

This is pretty much the scenario Theranos CEO and founder Elizabeth Holmes is going to face on Monday in Philadelphia, at the American Association for Clinical Chemistry’s 68th Annual Scientific Meeting & Clinical Lab Expo.

Holmes will present, for the first time and in front of hundreds of lab experts, “reproducibility and correlation data” for the blood-testing technology her company claims to have developed but has never proven to the satisfaction of the scientific community. Holmes will also “share data to demonstrate the precision and accuracy” of its tests.

"Weʼre not endorsing her in any way," says the doctor who invited her. "Weʼre just providing a room to show us what she has." The article is full of skeptical-to-angry quotes from doctors. "If it turns out to be a highly staged presentation with sanitized, prescreened questions, it might produce an opposite effect of loss of credibility to both Holmes and AACC leadership," says one. Still, what if this is the beginning of Theranos's comeback tour? What if the failed tests, regulatory ban, etc., were all just a big misunderstanding, and the technology actually works great? It seems a little incredible at this point, but on the other hand, if Holmes is still bluffing, why do this presentation? It does not sound like a particularly fun crowd.

People are worried about unicorns.

Here's a fact: As of Friday morning, "for at least a short time, the five largest companies in the world by market cap were all technology companies." (By the end of the day Exxon Mobil had moved back up above Facebook and Amazon.) I sometimes hear that there's a unicorn bubble, in which the private market gives technology startups valuations that are disconnected from what they could fetch in the public market. But the public market is not notably un-welcoming to technology companies generally, even if specific unicorns sometimes go public at below their private-market prices.

On the other hand, it's becoming increasingly popular for private companies to sell themselves to other companies rather than go public: "Lately, bankers and investors say, the downtrodden IPO market just can’t compete with buyers who are willing to pay big to take potential listings off the board."

Elsewhere in tech news, "Silicon Valley (and Alley) moguls are landing the sort of megababes who once fancied rock stars, pro athletes, Hollywood hunks and Wall Street wolves." But there is a dark side:

But Hoffman says app developers can be just as loathsome as derivative traders.

“[Guys in tech] think they’re so cool after a big fund-raising round,” he says. “They’re doing their designer drugs, they’re partying [and] abusing their bodies, just like a successful guy on Wall Street.”

People are worried about stock buybacks.

Even Goldman Sachs is worried about stock buybacks. From a Portfolio Strategy Research note this weekend:

Buybacks have decelerated since the start of 2Q given reduced authorizations and high stock valuations. We expect further near-term deceleration. However, record buybacks in 1Q and remaining capacity suggest full-year repurchases will rise by 7% to $600 billion. Investors have rewarded buybacks for many years but the pattern has reversed in 2016. Our Buyback basket (GSTHREPO) has lagged the S&P 500 YTD (5% vs. 7%). Managers should focus on firms returning cash to shareholders via dividends.

"So far in 2016 investors have penalized firms that executed buybacks while rewarding firms with high dividends and high capex." And: "During periods of low growth and low interest rates, firms with the highest buybacks fail to provide investors with either the consistent yield of bond-like assets or the prospect of future growth." If your worry is that buybacks are a sign that investors only reward short-term financial engineering rather than long-term growth, what do you make of that data point? Has the market abandoned its short-termism and re-focused on fundamentals? Or was that story never quite right?

Meanwhile, "Herbalife Ltd. is considering bringing back stock purchases after this month’s settlement with U.S. regulators." If your theory of stock buybacks is that they are mostly about getting a company's capital structure to the right size to match its business opportunity, and if your theory of Herbalife is that the terms of its regulatory settlement will make it much harder to grow its business in the U.S., then the buyback sort of explains itself. Other theories are of course possible. Perhaps the buyback is an expression of confidence that the settlement won't impact the U.S. business. Or perhaps it's an effort to squeeze Bill Ackman's short position.

Elsewhere: "Tech Stocks’ New Attraction: Dividends."

People are worried about bond market liquidity.

People are worried about bill market liquidity, as new money-market fund regulations are pushing money out of prime money-market funds and into Treasury-only funds:

Estimates suggest between now and mid-October, the influx may produce an extra $400 billion or more in demand for short-term government securities and put a squeeze on a sizable chunk of the $1.51 trillion bill market.

“There may be just enough bills out there to be handling this now,” said Gennadiy Goldberg, an interest-rate strategist at TD Securities. “But if there is another $400 billion inflow into government funds that could put more pressure” on bill supply, he said.

A central problem of bank regulation, which is also a central problem of shadow-bank regulation, is how to satisfy the demand for risk-free information-insensitive assets (like bank deposits or money-market funds) without encouraging or subsidizing risky behavior by the banks or shadow banks. The new rules require money-market funds that invest in non-government securities to have a floating net asset value, instead of pretending that their value never changes. But investors want something whose value never changes, and if you take prime money-market funds away from them, you have to give them a replacement. Here, that seems to be: more bills.

Elsewhere, people are worried about Treasury market settlement, as JPMorgan is getting out of the business and leaving it to Bank of New York Mellon:

Having just one firm in the business of making sure traders deliver cash and securities as expected will pose a fresh test for a sprawling market whose functioning has come under scrutiny since the financial crisis. Many analysts already worry that liquidity, the capacity to trade quickly without moving prices, has been falling when markets come under stress.

Things happen.

The U.S. Economic Outlook and the Implications for Monetary Policy. 1MDB: The inside story of the world’s biggest financial scandal. Goldman Sachs Subpoenaed by U.S. Agencies for Documents Related to 1MDB. How Valeant Cashed In Twice on Higher Drug Prices. Short Sellers Pile Into Mexico After It Lands in U.S. Crossfire. Startups Shake Up 401(k) Arena. The Value of Creditor Control in Corporate Bonds. Multi-manager hedge funds suffer losses in first-half 2016. An Ex-Goldman Banker Has Big Plans for Alibaba Finance Affiliate. Back-Stabbing and Threats of a ‘Suicide Parachute’ at Hershey. At Black Hat, the ‘Internet of Things’ Gets Put Through Its Paces. Pokémon Go is the future of paymentsLawsuit filed in New York over handling of dachshund's $100,000 trust fund. Hammocks. Mistress dispellers. The Harambe Variations. What is the roundest country?

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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:
Brooke Sample at bsample1@bloomberg.net