Mergers, Unicorns and Vampires

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.

The thing about the proposed Tesla/SolarCity merger is that it is good corporate governance. I mean, yes, Elon Musk is a co-founder and biggest shareholder and chief executive officer of Tesla, and yes, Elon Musk is the biggest shareholder and chairman of SolarCity (and his cousin is the CEO), and yes, he's the one who wants to merge them, and yes, they are both burning through lots of cash, and yes, he has done some unconventional things to keep them afloat, and yes, it's all very awkward. But the actual all-stock merger deal announced Monday has the best protections that minority shareholders could hope for. The deal is less generous to SolarCity than Musk had originally proposed, after independent directors of both companies negotiated and came to what they thought was a fair price. It requires the approval of both sets of independent shareholders, Tesla's and SolarCity's; Musk has essentially recused himself from voting. SolarCity has 45 days to shop itself and try to find a higher bidder, and while that go-shop is somewhat hampered by Musk's 22.5 percent stake in SolarCity, he's agreed to vote his shares for a higher offer if the board recommends it and other shareholders agree. The deal even cancels Musk's cousins' stock options for some reason. Given (1) two companies both more or less controlled by one guy, and (2) that guy's expressed belief that merging those companies is the right thing to do for both of them, you can't really expect a better process or outcome than this. 

Ah, but you say, one guy shouldn't be in charge of two different public companies. (Three, if you count SpaceX, which is not public and which Musk says will never be part of this roll-up.) I mean, maybe not. But think of Larry Page and Sergey Brin, who run a whole bunch of companies including an online advertising market, a thermostat company, a self-driving car business and a long-shot effort to extend human life. All of those businesses happen to sit under one corporate umbrella, Alphabet, so no one is too critical of them for having conflicts of interest or for shuffling money from one venture to another or for any perceived lack of industrial logic in combining all those businesses. Conglomeration and empire-building by personally venerated CEOs is just the norm in Silicon Valley. Musk started his different weird projects separately, so they have more transparency and shareholder accountability than they would if they'd all started as, like, divisions of PayPal. 

Elsewhere in governance, here is a claim that the recent Jamie Dimon/Warren Buffett/et al. corporate governance principles "serve as governance manna for the many corporate boards hungry for practical guidance on today’s leading boardroom issues." 

UberDidi.

Uber's negotiated surrender of its Chinese assets to Didi Chuxing has paved the way for an initial public offering:

While Uber Chief Executive Officer Travis Kalanick has said he plans to wait as long as possible before going public, throttling losses in China was one of the main things holding up a potential IPO, people familiar with the matter said last month. Uber had been spending at least $1 billion a year to fight market-leader Didi in the Beijing-based company’s home market, and has already lost $2 billion in China, separate people familiar with the details have said.

So it's the beginning of the end of an era: No company has defined the Age of the Unicorn like Uber, the Ubercorn, with its $68 billion-ish valuation, its sharing-economy buzzwordism and libertarianism, and its ability to raise limitless amounts of money without going public. Once Uber is public, staying private won't be quite as cool as it used to be. 

Also fares will probably go up. Felix Salmon:

Once Uber’s a public monopoly, with intense pressure to increase earnings every quarter, its shareholders will want it to raise fares for riders, while increasing its own share of the take, at the expense of drivers.

So long as Uber has been losing money, it’s essentially been subsidizing the transportation needs of everybody who uses it. But that won’t last forever. Indeed, it probably ended today.

You can read more post-mortems of Uber's attempts to compete with Didi here and here and here and here and here; don't miss Jean Liu's romantic characterization:

Uber, according to Didi president Jean Liu, “has done better than any Silicon Valley company in China” she said in a flowery internal email announcing the deal: “Uber has been a grand rival and we have had an epic battle … We raged an earth-shaking war, and when we join hands, our love will last till the end of time.”

Also there is this:

Mr. Kalanick helped Uber overcome the biggest obstacle in China: the Communist Party. By traveling frequently to China, meeting with officials and speaking in language often used by party cadres, Mr. Kalanick helped the company avoid the regulatory tripwire that has led many companies to stumble in the market.

It's odd that Uber's regulatory approach was more conciliatory and effective in Communist China than in, like, Texas, or the Hamptons

Tech vampirism.

Okay kids the time has come to have a serious conversation about a serious topic, which is that Silicon Valley appears to be a hotbed of vampirism

Speaking of weird and unsavory, if there's one thing that really excites Thiel, it's the prospect of having younger people's blood transfused into his own veins.

That is of course Peter Thiel, the billionaire tech investor and overdetermined movie villain. The practice is called "parabiosis," and is practiced in medical labs rather than in coffins, but still. "There are widespread rumors in Silicon Valley, where life-extension science is a popular obsession, that various wealthy individuals from the tech world have already begun practicing parabiosis, spending tens of thousands of dollars for the procedures and young-person-blood," though Thiel has said "that parabiosis was something he hadn't 'quite, quite, quite started yet.'" 

This is not the first time we have talked about the vampires of Silicon Valley. There is "Thanatos," Madeleine Schwartz's vampire fan fiction based on Theranos, the startup that takes people's blood for possibly nefarious purposes and which is run by a young-looking billionaire in a black turtleneck. (Okay, not a billionaire.) Once you start looking, you'll see signs of vampirism everywhere. Hoodies? Great for blocking out the sun. Soylent? Just a pulpier, more socially acceptable Tru Blood. Investment bankers? Werewolves. There are also Marxist interpretations.

Oh hey speaking of Theranos, the Blood Unicorn (Elasmotherium haimatos), what are they up to?

Founder Elizabeth Holmes, who is facing a two-year ban by U.S. regulators from running a clinical testing company, used the session at the American Association for Clinical Chemistry’s annual scientific meeting to introduce the “miniLab” testing device, a 95-pound diagnostic tool that can fit on a tabletop. The device isn’t yet for sale and hasn’t been approved by regulators, Theranos said in a statement.

Well that is nice, I guess, but "it was expected to be an academic presentation to show if Theranos Inc.’s controversial blood-testing technology worked," so the fact that she ignored Theranos's existing technology and instead introduced an entirely new product was ... um:

“It is a bait and switch,” said Geoffrey Baird, an associate professor of laboratory medicine at the University of Washington who has been a critic. “We were told we were going to hear about the science of Theranos. This is a new speculative prototype idea that they have,” he said in an interview shortly before the presentation.

"There will be an appropriate time and place to talk about the past," said Theranos; my guess is that the place might be court.

Should mutual funds be illegal?

We talk a lot about the idea that the increasing concentration of share ownership in the hands of a few giant institutional investors might be bad for competition, but here is an argument that it might create more volatility, too:

Our empirical results show that ownership by the largest institutional investors increases the volatility of the underlying securities. We use two distinct identification strategies to address potential endogeneity concerns. The first relies on “local bias,” that is, the prior finding that asset managers overweight firms that are located closer to the investor’s headquarters. Using this identification technique, we find that the economic magnitude is large: a 1% increase in stock ownership causes an increase in stock volatility of about 12 to 18 basis points, relative to a daily average of 3.5%. 

Wait, really, "asset managers overweight firms that are located closer to the investor's headquarters"? That is so quaint. They have computers! And indexes. 

Elsewhere, here is a story about how exchange-traded fund providers are setting up new ETFs with silly themes like obesity and cybersecurity and millennials, I guess because people find it flattering to think that they will be good at spotting long-term economic trends but want someone else to do the work of translating those trends into stocks. Also, apparently people over 70 years old have an average discount rate of 54 percent, which seems fair, honestly.

Drug companies.

I suppose drug companies, like, do research to find new drugs, but mostly I think of them as laboratories for principal-agent problems. So for instance insurance companies normally require co-payments on expensive drugs: The insurance company pays most of the cost, but the patient pays a little, to discourage the patient from getting the drug if she doesn't really need it. But this can lead to cruel results if the patient needs the drug and can't afford the co-pay. So there are lots of co-pay assistance programs. Which tend to be funded by drug companies. Because if the patient doesn't have to pay for the drug, she is more likely to use more of it. And since the insurance company's payment is usually much larger than the co-pay, the drug company has every incentive to eat the cost of the co-pay to sell more "free" drugs to patients and get paid by the insurance companies. (Also it is good public relations to say that patients aren't denied drugs because prices are too high.)

This is all so well known that there is apparently a complex regulatory apparatus covering how drug companies can interact with the co-pay assistance charities they fund:

Under a federal law known as the anti-kickback statute, drugmakers are banned from giving direct co-pay help to the country’s about 40 million Medicare patients with prescription drug coverage. But they can make contributions to charities that help patients -- provided the charities are independent and there’s no coordination or detailed information shared on how the drugmakers’ donations are spent.

And now there's a whistleblower case accusing Celgene of violating those rules. (Celgene denies it, and calls the case "a classic example of 'no good deed shall go unpunished.'") I am reminded of the Justice Department case against Salix Pharmaceuticals: Salix took doctors out for fancy meals to pitch drugs to them, but the meals were a bit too fancy, and the pitches were a bit too perfunctory, so it got fined millions of dollars. You need rules about charity coordination and meal fanciness and pitch seriousness, but the rules can't be too bright-line, and they never make that much sense. Some amount of principal-agent awkwardness is just inherent in the business model.

Do bailouts create moral hazard?

Here is John Carney on a paper by Urs Birchler purporting to find that bailouts of systemically important financial institutions don't create moral hazard:

Too big to fail banks create so much moral hazard just by their very existence that the prospects of a bailout don’t make much of a difference. Just by virtue of their size and the impact of their failure on the economy, they are already socializing potential losses while enjoying private gains.

“A SIFI, unlike a normal bank, takes excess risk even under laissez-fare. By definition of a SIFI, its failure leads to a systemic damage borne by the rest of the economy rather than by the bank,” Mr. Birchler writes. “A profit maximizing bank will neglect such cost.”

It strikes me as a mistake to view banks as unitary entities that either internalize or externalize risk. A bank is not a group of managers and shareholders and creditors who get together and decide jointly and sensibly how much risk they each should take (and how much they can offload onto the rest of the economy). A bank is a system of different groups -- managers and employees and shareholders and creditors and regulators -- who sit around separately deciding how much risk they can offload onto each other, without the others noticing. "The rest of the economy" is just another outlet for that risk.

People are worried about callable debt.

"People are worried about duration" has popped up in Money Stuff a couple of times recently, so I suppose I should also mention an opposite risk: "With benchmark 10-year Treasury yields sinking to record lows last month, more debt is getting called away from investors," and "noncallable bond prices appreciated relative to callable bonds." If rates go up, people who are long lots of duration will lose lots of money; if rates go down, people with callable bonds won't get to enjoy them. Duration seems to be the more popular worry -- with rates near record lows, more people are worried about them going back up than about them going down even more -- but you never know. To some extent all of these "people are worried about whatever" sections are cheating. You can find someone, somewhere who is worried about anything, or its opposite. It's just a question of whether they write articles about it. (If it's bond market liquidity, they always do.) Elsewhere: "Microsoft sells $20bn of debt to fund LinkedIn deal."

People are worried about unicorns.

I mean, if I were you, I'd worry about vampire unicorns, but the traditional unicorn worries are more about whether large highly-valued private tech companies can go public at similar valuations, so this might be of some interest:

By studying the only mandatory pre-IPO market in the world—Taiwan’s Emerging Stock Market (ESM), we document that pre-market prices are very informative about post-market prices and that the informativeness increases with a stock’s liquidity. Since 2005, Taiwan has required firms going public to trade on the ESM for at least six months before the IPO. The ESM price-earnings ratio shortly before the initial public offering explains about 90% of the variation in the price-earnings ratio using the offer price. However, the average IPO underpricing level remained high during 2005-2011, at 55%, suggesting that agency problems between underwriters and issuers can lead to excessive underpricing even when there is little valuation uncertainty.

Elsewhere, "investors keep pouring money into mammoth new venture funds," including a new $2.5 billion fund at Technology Crossover Ventures.

People are worried about bond market liquidity.

Peter Hooper, Torsten Slok and Matthew Luzzetti of Deutsche Bank Markets Research put out a chart book titled "Bond market liquidity," which I am of course obligated to mention. Here's a chart of Treasury market liquidity:

There are also charts of corporate bond market liquidity. Trading volume is "down from peaks" (but still up from previous periods), "primary dealer inventories of corporate bonds have dropped as bond market volume has risen," that sort of thing.

Elsewhere, here is a National Bureau of Economic Research working paper about "Dealer Information Sharing in Treasury Markets":

We estimate that yearly auction revenues with full-information sharing (with clients and between dealers) would be $5 billion higher than in a "Chinese Wall" regime in which no information is shared. When information sharing enables collusion, the collusion costs revenue, but prohibiting information sharing costs more. For investors, the welfare effects of information sharing depend on how information is shared. Surprisingly, investors benefit when dealers share information with each other, not when they share more with clients.

Things happen.

U.S. Oil Prices Enter Bear Market. Aramco Buyer Beware: The Risky Track Record of Government Oil. Why White Collar Crime Is Here to Stay. UBS rogue trader: 'It could happen again.' Supreme Court Could Redefine Insider Trading Law. Financial repressionDeutsche Bank and Credit Suisse Shares Slump After Cut From STOXX Index. "Those who didn’t embrace the central banks and selling vol  — in all its various forms — are likely to have seen their capital and influence diminish." Argentina’s Fernandez Says She Deserves a Nobel Prize in Economics. The Puzzle of the PDVSA Bond Prices. ICAP founder Michael Spencer may not get to be a lord because of Libor. Elaine Ou on bitcoin, chargebacks and "sketchy people on the internet." Hedge fund tied to kickback probe used ‘checkered’ valuation firm. SEC Announces Agenda for August 2 Meeting of the Equity Market Structure Advisory Committee. FINRA Files Complaint Charging Broker With Fraudulently and Excessively Trading Accounts of Elderly, Blind Widow. The Ideal Office Floor Plan, According to Science. Why Corporate America Is Leaving the Suburbs for the City. "Ms. Adair was the coxswain for one of the crew boats; Mr. Ackman rowed on a different boat." New study finds that men are often their own favorite experts on any given subject. New York Is a Mecca for Top Frisbee Talent. Don't wear cargo shorts. Suit is onesie. Bacon critic. Tank biathlon. Anthrax Spewing Zombie Deer Are the Least of Your Warming Planet Worries. Newly crowned Miss Teen USA apologizes for racist tweets

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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