Pipes, Content and Mutual Funds

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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Happy Merger Monday, AT&T/Time Warner Division.

"The future of video is mobile and the future of mobile is video," says this press release about AT&T Inc.'s proposed acquisition of Time Warner Inc., and everyone does seem to think that. I guess it must be true. The inevitable future of television, of movies, of sports, of news, of all entertainment, of all human activities really, is that you will watch them on your phone. Your phone is smaller than your television, never mind an IMAX screen, never mind reality, and the sound isn't great. But you will always have it with you, and you will always be looking at it, and you will always be entertained. Everything will be worse, but ubiquitous. Actually that would be a good slogan for a mobile/video conglomerate.

Anyway! The deal is for $107.50 in a 50/50 mix of cash and stock, implying a Time Warner equity price of $85.4 billion and enterprise value of $108.7 billion. Here's the merger agreement. The breakup fee (if Time Warner accepts a better deal, etc.) is $1.75 billion; if the deal is killed by antitrust authorities, AT&T will reimburse Time Warner for up to $500 million of expenses. The agreement seems relatively untroubled by antitrust concerns -- Time Warner can't force AT&T to divest more than a de minimis amount of its businesses to get the deal done -- which may be because there is not much antitrust overlap here. AT&T owns mostly phone networks, Time Warner owns mostly cable channels and production studios, and those businesses do not compete with each other in any particularly obvious way.

But that doesn't mean there won't be a lot of antitrust trouble. The main worry is that if you combine the content with the pipes, then you can restrict your content to your pipes, and your pipes to your content:

AT&T could make it difficult for competitors to get Time Warner programming, hoping to drive customers to its own platforms, while DirecTV could decline to carry rival programming, he said.

“If you’re just a video distributor that doesn’t own programming, you just want the best programming. But if you own programming, the thumb is going to be on the scale for your stuff as opposed to that of competitors because it’s cheaper for you and you make more money off of it from ads,” Bergmayer said.

But there are other, vaguer worries. For instance, combining two big companies into one big company just makes for a pretty big company, which is a folk antitrust problem even if it's not strictly speaking a legal issue. Certainly doing it two weeks before a presidential election gives the candidates something to talk about. "The Democratic Party is moving left, and if Clinton wins, this could become an early test for her ‘tougher on business’ rhetoric," says an analyst. And Donald Trump more or less announced that he would block the deal to wreak vengeance on CNN for criticizing him.

The way regulators typically deal with pipe/content exclusivity worries is by demanding neutrality: You make Time Warner give its content to non-AT&T distributors, and AT&T distribute non-Time Warner content, in reasonably fair ways. (There are limits to what regulators can do here. Andrew Ross Sorkin says: "While AT&T probably won’t be able to use Time Warner’s current crop of channels to bludgeon its competitors, it will be able to use Time Warner’s creative team to devise all sorts of new programming options, many of which could become exclusive to AT&T.") If the regulators can do that -- if they can prevent Time Warner from getting any distribution advantage by joining with AT&T, and AT&T from getting any content advantage by joining with Time Warner -- then why do the deal? The official reason seems to be, like, advertising data mining? ("Customer insights across TV, mobile and broadband will allow new company to: offer more relevant and valuable addressable advertising; innovate with ad-supported content models; better inform content creation; and make OTT and TV Everywhere products smarter and more personalized," says the press release, which also touts "a mobile-first experience that's personal and social.") I enjoyed Matt Yglesias's take: Running a telecom company is profitable but boring, while running HBO and Warner Bros. is fun (you "get to hang out with A-list celebrities and star athletes," plus media executives are paid really well), so you might as well use your shareholders' telecom money to make yourself into a media executive

AT&T will take on a lot of debt to do the deal, and the $40 billion of bridge loan commitments from JPMorgan and Bank of America seem a bit risky, given that the "deal could be hung up in antitrust wranglings for a long time." And of course there will be a lot of fees: "Freeman & Company, a merger advisory and consulting firm, estimates that there will be $80 million to $120 million in advisory fees for each side," while "the lending commitment alone would bring about $110 million to $130 million in fees for JPMorgan and Bank of America."

Elsewhere, here is Bloomberg News on how the negotiations developed, including the relevant code names. ("AT&T referred to the deal by the code name, 'Lily,' after an AT&T ad campaign with a sales rep named Lily. Time Warner’s choice was 'Rabbit,' a nod to the iconic Warner Bros. character Bugs Bunny.") Here is some praise for Jeffrey Bewkes, the chief executive officer of Time Warner, who turned down $85 per share for Time Warner in 2014 and got $107.50 per share in 2016. Here is an article comparing and contrasting the AT&T/Time Warner deal with the famously disastrous AOL/Time Warner deal, and here is article comparing and contrasting Verizon (which bought AOL) with AT&T (which is buying Time Warner). 

Happy Merger Monday, Other Division.

Imagine working all weekend to announce a merger this morning and it's Rockwell Collins buying B/E Aerospace for $6.4 billion. Or there is the deal by TD Ameritrade and Toronto-Dominion Bank to buy and carve up Scottrade for $4 billion. Or there's China Oceanwide buying Genworth Financial for $2.7 billion. All worthy, impressive, complex multibillion-dollar deals, which I am sure involved round-the-clock work by armies of bankers and lawyers this weekend. "Want to get brunch on Sunday," their long-suffering loved ones asked. "Nah, I can't, it's all hands on deck for this big deal I am working on." "Ooh," said the loved ones, who read the business section, "is it AT&T/Time Warner?" No it was not. Congratulations everyone; sorry you were a bit upstaged.

Active management.

Here is a story about Will Danoff, who runs Fidelity Investments' Contrafund, and who is pretty good at investing. He's beaten the S&P 500 index by 2.9 points per year since 1990, making him a rare bright spot in the world of actively managed mutual funds. Here's how he does it:

In September, Mr. Danoff says, he spoke with managers from roughly 100 companies, mostly face-to-face. This past week, he says, he met with three billionaire chief executives (no, he won’t name them). “I learn from shrewd executives about their businesses every day,” he says, “and this knowledge will help us make the right long-term investments for our shareholders.”

In his four or five daily meetings with managers, he sponges up insights about their companies and their suppliers, competitors and customers, as well as coming technological changes that could hurt or help a business.

This is a bit of an obsession of mine, but:

  1. A main activity of many active mutual-fund and hedge-fund managers is talking to companies.
  2. A main activity of regulators, prosecutors and judges in insider trading cases is pretending that doesn't happen.

We have talked about the Supreme Court arguments in the Salman insider trading case, in which Justice Sonia Sotomayor said: "There's regulations that stop that, talking to analysts." Nope! Danoff talks to companies four or five times a day. We have talked about the Securities and Exchange Commission's insider trading case against Leon Cooperman, which grumbles that "One strategy Cooperman employed was to accumulate large positions in publicly-traded companies and develop close relationships with those companies' senior executives." Danoff's relationships and private conversations are key to his investing decisions, and he is a throwback hero of big active mutual fund management. Any theory of insider trading needs to deal with the fact that the main way that most investment managers make investment decisions is by talking to people at the companies that they invest in.

Elsewhere in active managers, more and more of their performance can be explained by factors, which I guess means it doesn't count. (Danoff himself beats the S&P by 2.9 percentage points a year, but that's only 1.9 points of alpha once you adjust for risk, size, valuation and momentum factors. Which is still not bad?) Here is a story about closed-end funds trading at huge premiums to their asset values. And here is Cliff Asness on excuses for poor hedge fund performance

Blockchain blockchain blockchain.

We have talked a couple of times about the voting mishaps in the Dell buyout, in which several funds opposed the deal and intended to vote against it but then ... somehow ... didn't. They just sort of hit the wrong button, or the right button at the wrong time, or something even weirder happened. And so they went to court and said, you know, come on, man. And the court said no, the rules are the rules, even though they are pretty dumb. And so their votes against the deal didn't count, and more importantly they missed out on appraisal rights that would have paid them more for their shares.

The court involved in those cases was the Delaware Chancery Court, and the judge was Vice Chancellor Travis Laster, and here is a very interesting speech that he gave last month about basically how dumb this was. And how the financial industry should get together to find a better system for keeping track of who can vote shares and how they voted. And how that system should be ... oh, just guess. (Hint: it's in the section heading.) 

The current system works poorly and harms stockholders. But the current plumbers—financial intermediaries—do not have an incentive to fix it. They are making healthy profits in a non-competitive market. They might play around the edges, but real change will have to come from the outside.

The good news is that you have a plunger that you can use to clean up the plumbing. That plunger is distributed ledger technologies, the technology that drives bitcoin.

The weird part here is that there is of course already a pretty functional system for keeping track of who owns stock and how they vote. It's the Depository Trust Company, which basically just keeps a list. And its procedures for keeping the list are a little complicated and archaic, so sometimes it gets messed up. And you might think, well, okay, maybe DTC -- or Delaware corporate law, for that matter -- should slightly modernize its procedures to make them easier to follow and harder to mess up. And Vice Chancellor Laster's answer is, no, burn everything to the ground and start over with a blockchain system. Which is really a lot more complicated than just having a trusted intermediary keep a list. But people don't trust their trusted intermediaries so much any more.

Meanwhile, here is my Bloomberg View colleague Elaine Ou with "Smart Contracts Don’t Have to Be Dumb." And here is a story about some cotton that's on the blockchain:

As port staff scan the bales, an update to an electronic contract will be triggered, transferring ownership of the goods and authorizing the release of payment. The deceptively-simple sounding process is only possible because digital-ledger technology encrypts and stores the parameters of the contract, ensuring all parties are working off the same synchronized version, which cannot be unilaterally altered or tampered with.

I mean, when my local supermarket's automatic checkout machine scans my groceries and my credit card, it transfers ownership of the groceries to me and authorizes the release of my payment, without any blockchain technology at all, but give it time I guess.

Market structure.

Here's a fun natural experiment:

Starting in 2010, high-frequency traders began using ultrafast microwave links to relay prices and other information between Chicago and New York. To begin with, only some traders had access to microwave networks. Until 2013, others had to rely on less speedy fiber-optic cable. 

But microwave transmissions are disrupted by water droplets and snowflakes, so during heavy storms traders using the networks switch to fiber.

It turns out that during storms, when the fastest HFTs were slowed down to the same networks as everyone else, researchers Andriy Shkilko and Konstantin Sokolov found that "adverse selection declines accompanied by improved liquidity and reduced volatility." As a market-structure result I guess that makes sense? The point here is not that speed is bad for liquidity, or that high-frequency trading is bad: It's that speed differentials are bad, and perhaps that the traders who will pay most for the fastest connections are more likely to be aggressive traders than liquidity providers. In any case I mention it to you not so much for the result as for the pun, which is that rain increases liquidity.

Insider trading.

Don't do this (emphasis added):

The Securities and Exchange Commission today charged a Tennessee-based lawyer who served on the executive committee of the board of directors at Nashville-based Pinnacle Financial Partners with insider trading based on nonpublic information he learned about an impending merger.

The SEC alleges that James C. Cope obtained more than $56,000 in ill-gotten gains by purchasing securities in Pinnacle’s acquisition target, Avenue Financial Holdings, prior to the banks’ joint public announcement later that month.  According to the SEC’s complaint, Cope learned confidential details about the planned merger during a board executive committee meeting on Jan. 5, 2016, and proceeded to place his first order to purchase Avenue Financial stock while that executive committee meeting was still in progress.  He allegedly placed four more orders within an hour after the meeting ended.

Don't insider trade from the board meeting. I mean, that's not legal advice. My guess is that if you are on the acquirer's board, and you buy stock in the target before a merger is announced, the SEC is going to notice that, whether you buy the stock during the board meeting or afterwards. But logging into your online brokerage account to buy stock during the meeting is just rude. At least give the company your full attention. Save your insider trading for later.

Zimbabwean deflation.

Zimbabwe's currency reached a point where 100 trillion Zimbabwe dollars "was eventually worth something like 70 U.S. cents" before the country abandoned its own currency in 2009, but things have changed:

Ironically, any Zimbabweans who managed to snag one of the uncirculated 100 trillion Zimbabwe dollar notes that are no longer legal tender experienced something wholly unfamiliar. They are now worth close to $65 on eBay, appreciation of nearly 10,000%.

I feel like we have not fully explored the economics of running a small country's currency system on novelty value.

People are worried about unicorns.

People are apparently standing at the edge of the Enchanted Forest with delicious unicorn treats, trying to coax the unicorns out:

There have been only 14 tech initial public offerings this year compared with 371 in 1999 at the height of the bubble, and an annual average of 49 since 1980. The reason is simple: world changers like Uber and Airbnb — so-called unicorns valued at more than $1bn — have elected to stay private.

Several years into this tech boom, however, the IPO drought shows signs of breaking. The pressure from investors and employees to cash in is mounting; the need for a higher profile or more liquid stock to fund acquisitions is becoming more acute; it is harder to raise money privately; and there is pent-up demand from public market investors like Mr Price. The unicorns are finally trotting towards IPOs.

The unicorn treats are, of course, money. (Or acquisition firepower anyway.) Also this is not exactly a unicorn, but it is a California-based startup with a good origin story:

Because he’d ruined his credit during his years of drug use, his grubstake for the store consisted of $50,000 worth of gold coins he’d squirreled away. With a partner, Hayley Gorcey, his girlfriend at the time, he also found a backer, a professional gambler who wishes to remain anonymous. Finally, he sought advice from his friend Fred Segal, the retail clothing legend and a stickler for detail.

People are worried about duration. 

This could almost be "people are worried about bond market liquidity," but the headline "Most Crowded Trade in Bonds Is a Powder Keg Ready to Blow" is actually about duration -- that most crowded trade is "a headlong rush into higher-yielding, long-term bonds" -- so let's just put it here. It's ready to blow.

People are worried about bond market liquidity.

I mean, there's that powder keg ready to blow. Also "the Federal Reserve Board announced Friday that it plans to collect data from banks for secondary market transactions in U.S. Treasury securities and will enter into negotiations with the Financial Industry Regulatory Authority (FINRA) to potentially act as the Board's collection agent for the data." 

Things happen.

Short Sellers Shake Up Asia’s Clubby Investing Scene. "Banks will start moving operations out of the U.K. late this year and early next as they anticipate a hard Brexit." Prime Money Fund Outflows Slow After Reform. Ruling exposes Deutsche’s US arm to fresh legal battle. For a 46% Return, Bond Investors Go to Venezuela—If They Dare. Monte dei Paschi shares rallying again ahead of industrial plan. How Zombie Companies Are Killing the Oil Rally. Are Banks Being Roiled by Oil? A Bright Robot Future Awaits, Once This Downer Election Is Over. As Artificial Intelligence Evolves, So Does Its Criminal PotentialThe Fatal Mistake That Doomed Samsung’s Galaxy Note. Former Banker Jutting Pleads Not Guilty to Murder Charges. Trump's plan for his first 100 days in office includes suing the women accusing him of assault. Cursed images. Stop, Collaborate and Listen: Keys to Success in Business, by Vanilla Ice. Hairless hamster gets tiny sweater.

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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