Money Stuff

Merger Goofs and Disgruntled Quants

Also doughnuts, book value, corporate speech, day-drinking and Cards Against Silicon Valley.

CVR Energy.

This Securities and Exchange Commission settlement with CVR Energy, Inc. gives me the opportunity to tell the story of CVR Energy again and, while it is not exactly a new story, it is one that I love to tell, not only because it is so dumb but also because I know everyone involved. One day CVR Energy woke up to find Carl Icahn trying to take it over. He launched a tender offer for $30 a share in cash (plus a contingent value right). CVR did not want to be taken over by Carl Icahn, certainly not for $30 per share, so it sensibly went out and hired fancy lawyers (Wachtell, Lipton, Rosen & Katz) and fancy bankers (Goldman Sachs Group Inc. and Deutsche Bank AG) to defend it. Here is where I disclose that I used to work at both Wachtell and Goldman, which are both good and fancy places full of smart hard-working people who are dedicated to doing what's right for their clients, and I mean that sincerely, despite what's coming next.

The fee arrangements that CVR had with its banks went like this: If they fought off Icahn and kept CVR independent, they would each get $9 million (plus, possibly, a $4 million discretionary bonus). If they found a white knight to rescue CVR from Icahn and buy it at a higher price, they would each get 0.525 percent of the transaction value. If they accomplished nothing, failed utterly in their defense, and Icahn ended up taking over CVR for the $30 a share that he had originally proposed, then ... wait ... this isn't right ... then the banks would also get 0.525 percent of that? Yes, that's what the engagement letters said, as Wachtell discovered when it was calculating its own bill:

During this time, Outside Counsel separately began to calculate its own legal fees as well as fees owed to the Banks. Through this exercise, Outside Counsel concluded that the Banks would be owed a “success fee” even though the Activist Investor had prevailed. On April 14, 2012, lawyers of Outside Counsel prepared a fee chart for their internal use and determined that in the event of a successful tender offer, each Bank would receive a sales transaction fee in the amount of $18 million. An email message between lawyers of Outside Counsel expressed surprise that “there’s nothing carving out a hostile deal with [the Activist Investor] from the definition of a sale” and that this created a “weird perverse incentive for [Bank 1] and [Bank 2].”

And then that happened. The banks failed to fend off Icahn, and were paid twice as much as they'd have gotten if they had succeeded. Oops! This led to a series of lawsuits, in which Icahn -- who now owns 82 percent of CVR Energy -- tried not to pay Goldman and Deutsche Bank their fees and then, when that failed, sued Wachtell for malpractice.

And now there is this SEC case, finding that CVR should have done a better job of disclosing the banks' odd incentives here to its shareholders. The theory is that shareholders would have wanted to know about the fee arrangements before tendering into Icahn's offer, so they could revisit their tendering decisions, or at least have a good chuckle. Obviously now that Icahn owns CVR, it would be a little silly for the SEC to fine CVR for these disclosure violations. So there's no fine. The settlement just requires CVR not to do this specific thing again, and it's hard to imagine anyone doing this specific thing ever again. (Or even the first time!) I guess the settlement has the advantage of shaming the banks and lawyers so that they'll be more careful next time, except that the SEC, unlike me, very kindly decided not to name them. (It may still help with Icahn's malpractice claims.) It all feels a little pointless, but I guess the SEC just loved this dumb story and wanted the opportunity to tell it itself. I know the feeling.


Elsewhere in contract interpretation involving M&A failures, what do you make of Anthem Inc. and Cigna Corp.'s ugly Valentine's Day breakup?

Cigna, as part of its lawsuit against Anthem, is seeking a $1.85 billion breakup fee, plus $13 billion in additional damages it says are owed after “the path for regulatory approval of the transaction was fatally compromised” by the larger insurer.

Anthem called the move “invalid” and said it had already extended the time the two companies will have to complete the takeover to April 30. The merger was blocked by a federal judge last week, though Anthem has said it would seek an expedited appeal of the ruling.

Writing a merger agreement is hard, but Cigna and Anthem prepared very carefully for this exact risk. Their merger agreement has a whole long section (section 7.3(e) on page 74, if you're interested) that precisely covers what happens if the deal is blocked on antitrust grounds. In that case, Cigna can terminate the deal and get the $1.85 billion breakup fee, but nothing else. ("Such payment shall be the sole and exclusive remedy," etc. etc. etc.)

But Cigna doesn't just want the $1.85 billion; it wants another $13 billion to cover "the amount of premium that Cigna shareholders did not realize as a result of the failed merger process." Meanwhile Anthem is suing to block Cigna from terminating the deal. No one wants to use the very tidy contractual solution that Anthem and Cigna and their lawyers prepared for exactly this eventuality. They have their reasons -- essentially, each side accuses the other of willfully failing to live up to its obligations to help get antitrust approval -- but it adds a second layer of disappointment. Not only did the deal fail, as they thought it might, but their preparations for that failure also failed.

I think sometimes about "smart contracts," the idea of putting economic arrangements into self-executing code (on the blockchain, of course) to free them from ambiguity and human meddling. Would that have helped here? The Anthem/Cigna merger agreement is 86 pages long; it covers a lot of stuff. And yet at the key points it remains open, interpretable, uncertain. Presumably a smart contract would be closed, precise, mechanical. Would that be good? (There'd be fewer pointless lawsuits after the fact, what one analyst called "posturing in what comes down to a legal fight over the breakup fee.") Or is that uncertainty and vagueness what forces the merger parties to work together in good faith to get the deal done, rather than playing games to maximize their contractual payoffs? Not that it especially worked here, but that's usually the idea.

Jocks vs. nerds.

Here is a story from Bloomberg's Simone Foxman about "Why Data Nerds Struggle to Gain Power at Hedge Funds":

They are discovering that the marriage of old-school managers and data-driven quants can be rocky. Managers who have relied on gut calls resist ceding control to scientists and their trading signals. And quants, emboldened by the success of computer-driven funds like Renaissance Technologies, bristle at their second-class status and vie for a bigger voice in investing.

The complaints on both sides are charming. Stupid quants, always theorizing about data:

When the group obtained new data sets, it spent too much time developing theories about how to process them rather than quickly producing actionable results.

Stupid non-quants, always undervaluing theoretical rigor:

When quants showed their risk analysis and trading signals to fundamental managers, they sometimes were rejected as nothing new, the people said. Quants at times wondered if managers simply didn’t want to give them credit for their ideas.

It seems blindingly obvious that "quantitative" techniques should be useful to "fundamental" equity and credit investors. The trick is the interface. Here is a bad interface:

  1. Hedge-fund manager wants to screen for companies whose executives have the best golf handicaps, so he can short them
  2. Manager meets with quants and asks for this screen.
  3. Quants debate how to acquire and structure the data set.
  4. Quants get into esoteric argument about controlling for course slope and cross-referencing skiing and tennis abilities.
  5. Manager gets bored and wanders off.
  6. Three months later, quants present integrated database with a custom measure of every public-company executive's skills at 15 major recreational sports.

Here is a good interface:

  1. Hedge-fund manager wants to screen for companies whose executives have the best golf handicaps, so he can short them. 
  2. "Siri, which companies' executives have the best golf handicaps?"
  3. His phone gives him a list.

That second interface is what the manager wants, but makes the quants into underappreciated tool-builders. The first interface bores the manager, but is fun for the quants. It's also how quant funds work, which is why the quants prefer to work for quant funds.

Tough times at Goldman Sachs.

Elsewhere in embarrassing Goldman Sachs news, "Goldman Sachs Group Inc. didn’t pay 2016 bonuses to about 100 bankers who advise on takeovers and underwrite securities offerings, signaling to a bigger crowd of underperformers that they’re probably better off elsewhere." I joked on Twitter that they should publish that list the way they do the partner list. Sure it would be cruel to those 100 bankers, but think of all the envy and misery that the partner list brings to thousands of Goldman employees and alumni, and then think about what sweet consolation the doughnut list would bring. ("Around the industry, it’s known as getting 'blanked,' or receiving a 'goose egg,' a 'bagel' or a 'doughnut.'")

But of course they don't publish the list. Really what Goldman should do is just say that it zeroed 100 bankers, without actually doing it. Then it could pay like 500 bankers terrible bonuses and they'd all think "well at least I didn't get blanked like those 100 poor chumps." There is value in signaling to bad performers that they should leave, but keeping good performers without paying them much also has an appeal.

Meanwhile all the mergers-and-acquisitions bankers are going to be replaced by computers anyway:

Goldman's strats recently launched "Sellside," an application that allows junior bankers to quickly compile deal information, such as when bids from different buyers arrive. They have also made it possible for senior bankers to check deals remotely while traveling, instead of calling analysts for updates.

As certain tasks get automated, it could become harder for junior bankers to learn the basics of their job and advance to more senior positions, said Jeanne Branthover, managing partner at executive search firm DHR International.

"The pipeline of talent will dwindle," she said.

My initial reaction to this was: Oh come on. The stuff that Goldman's strats (i.e., quants) are automating is not the stuff that makes a good senior banker. Banking is a weird business in that the work done by junior bankers -- formatting pitchbooks, building financial models, keeping track of due diligence -- is so unlike the work done by senior bankers -- golfing with clients, advising on strategy, negotiating deals. If the junior bankers spend less time on pitchbook formatting and writing lists of bidders, they'll have more time to spend thinking about strategy, and will end up being better prepared to be senior bankers. 

But I don't know. There's something to the dumb stuff. Building hundreds of merger models is what trains you to do basic merger math in your head, so you can quickly intuit which potential deals might work. Keeping track of bidders helps you remember who the bidders are, not something you want to have to look up online when your client asks. Formatting pitchbooks helps you care about pitchbook formatting, which probably doesn't matter economically, but do you want to carry around ugly pitchbooks? What kind of life is that? Maybe this is just my own indoctrination talking, or maybe as the M&A software gets smarter the M&A bankers really will get dumber.

Good times at Goldman Sachs.

Here are some good milestones:

On Tuesday, shares of Goldman hit a record high, passing a bar first set in 2007 before the financial crisis. J.P. Morgan also hit an all-time closing high.

Here is a ... milestone:

Meanwhile, Bank of America traded in line with its net worth—or the difference between its assets and liabilities—for the first time since late 2008. The bank had been trading as low as 15% of this level in March 2009.

The way I like to characterize that statistic is that, from 2009 through 2016, a dollar in the hands of Bank of America Corp. was worth less than a dollar. The market viewed Bank of America's business as just a destroyer of value, a way to turn a dollar into 15 cents. (There are other possible characterizations, like: The market didn't really believe in Bank of America's asset values.) Now, it doesn't. Now, banking finally feels like a way to make money again.

Corporate political speech.

A few state attorney generals are investigating Exxon Mobil Corp. because it lied about climate change in public policy debates for a long time. Actually neither side would like that characterization. Exxon Mobil would say it never lied. The attorney generals would say: No no no, we are not investigating the lies in public policy debates; we are investigating Exxon's lies to its shareholders (or to consumers). This is important because attorney generals can punish companies that lie to shareholders, or consumers. (That is fraud.) They cannot punish companies that lie in politics. (That is politics.) 

Exxon, meanwhile, is fighting back by saying: No, the attorney generals are really investigating us for our political speech. This is, I think, obviously true. (It would be completely absurd for state attorney generals to care that Exxon may have harmed its shareholders by lying about global warming, or to try to solve that problem by taking the shareholders' money. The real concern is that Exxon may have harmed the public by lying in politics.) I also think that it is a pretty good argument against these investigations. (As I once wrote, "it would also be very bad if the government -- in the form of the unelected head of a quasi-independent regulatory commission -- could punish citizens for saying wrong things in the course of policy debates," even if those citizens run corporations.) But it seems to generate no sympathy anywhere. Here are Jeff Clements and John Coates railing against Exxon's legal efforts to block the investigations:

That’s why Exxon’s attack on the state investigations says so much about the damage to our constitutional framework wrought by the Supreme Court’s invention of these new corporate rights. In our federal system, attorneys general are the highest law enforcement officers in the state, generally elected directly by people, and charged with protecting the public interest and checking the abuse of corporate power. Yet in the post–Citizens United world, Exxon — with a virtually unlimited budget — can summon any officials with the temerity to do their job into physically distant courts. Trumped-up “civil rights” litigation of this kind has self-evident potential for the harassment and intimidation of would-be investigators.

Sure? Right, like, suing an attorney general to stop her from investigating you is I guess "harassment and intimidation"? But of course she has the power to put you in prison, which she seems to be using to punish you for your political speech. That also has some potential for intimidation. I suppose the question is, which do you find more sympathetic: government efforts to criminalize dissent, or giant oil companies' efforts to conceal their destruction of the planet?

Drinking at work.

Bad news: "Lloyd’s of London, the insurance market, has issued new guidance to its 800 employees that includes a 9-5 prohibition on drinking alcohol." Were they doing a lot of that?

Market insiders say that, despite a general trend away from lunchtime drinking elsewhere in the City, it is still popular in the insurance world. “It still goes on more than you might expect. There is still a short hours and long lunch culture in some places and there are stories of brokers sitting in pubs handing out contracts like Jabba the Hutt,” said one person close to the insurance market.

I ... did Jabba ... what? Perhaps everyone involved in this story is drunk. In other terrible news: "New Office Sensors Know When You Leave Your Desk."

People are worried about unicorns.

Here you go:

Silicon Valley folk tend to be very self-aware, which is why they're vicariously enjoying the current batch of card games ruthlessly mocking the very culture they hold dear. The last couple of months has seen the arrival of two competing card games, Disrupt Cards from a small startup team, and Cards Against Silicon Valley, created by software company CB Insights.

Here is the Cards Against Silicon Valley home page. It's cute! "What keeps Fred Wilson up at night?" "Peter Thiel's freezer of millennial blood," goes one sample pair. I'm sure it's a big hit at game night in the Enchanted Forest. 

Things happen.

SoftBank to Buy Fortress Investment Group for $3.3 Billion. EU Sends Envoy to Salvage Greece Deal as February Date Looms. ABN Amro Profit Rises on Interest Income, Lower Provisions. Credit Agricole Shares Rise as Consumer-Banking Profit Climbs. Morgan Stanley Settles Charges Related to ETF Investments. The Dodd-Frank Rule Banks Want to Keep. Trump signs bill killing SEC rule on foreign payments. The most intriguing idea in House Republicans’ bill to gut class actions. Money White House posts wrong versions of Trump's orders on its website. Trump’s ‘Stew of Uncertainties’ Puts Hedge-Fund Managers on Alert. In Trump Age, Taking a Different Tack on Workplace Diversity. Market Funds' Floating NAVs Stay in Narrow Range for Now. Howard Stern Sued for Broadcasting Woman's Conversation With IRS. On the front lines of Syria with the young American radicals fighting ISIS. Maniac Killers of the Bangalore IT Department. What Supercars Cost Around the World. Ghost Sex.

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