Corporate Access and IPO Expectations
How much should investors pay to talk to corporate executives?
While corporate access has long been the subject of scrutiny over whether it gives some investors an unfair edge, it’s seen as a useful way for executives to explain their strategy and for asset managers to get a better sense of a company than filings can provide. The stakes are high: Rusling estimates that a one-on-one meeting with a big name CEO could be worth as much as $20,000.
Well, look. If it's a way for companies to explain their strategy, the companies should be willing to pay to do it. (In fact they are, a little: Adrian Rusling's company/investor matchmaking service, CorporateAccessNetwork, "charges companies 100 euros ($108) a month to use a premium version of its web-based platform to set up meetings.") If it's a way for asset managers to get a better sense of the company, they should be willing to pay for it. (In fact they are, a lot: "Investors globally spend more than $2 billion a year for corporate access, according to consulting firm Greenwich Associates.") If it's a mutually beneficial relationship in which companies get to explain themselves to their owners and owners get to learn about companies, then the market-clearing price should be around zero. Maybe one side or the other pays a bit for the matchmaking technology, fine. But if you are paying $20,000 for a meeting, the contents of that meeting are not a mutually beneficial exchange. The mutually beneficial exchange is: You get the contents of the meeting, and the other guy gets the money.
Or, I mean, someone gets the money. Traditionally the way it works is that investment bank research departments set up these meetings and capture the money. The companies get ... something ... from the banks. (They get better analyst ratings, is what they get, though you're not supposed to say that. Also they get to meet with investors and explain their strategy.) The banks, meanwhile, don't get paid anything for setting up the meetings. Instead, they get paid commissions for executing trades, which pays for the banks' research function, which sets up the meetings.
There are inefficiencies and conflicts at every step of that process, and, strangely, regulation might fix them. Europe's MiFID II rules, which require investors to pay explicitly for research rather than subsidizing it through trading commissions, also require investors to pay for research and corporate access separately. That has encouraged independent corporate-access matchmakers, which have some advantages for issuers. "I can trust that he’s going to reach out to not only the fast-money hedge funds, which typically pay a lot of commissions, but also the holders FedEx would prefer: long-term holders,” says a FedEx Corp. investor-relations employee about Rusling.
People who pay for corporate access with trading commissions are not necessarily the people whom companies want to meet. And better analyst ratings are not necessarily the currency in which companies want to get paid. A regulatory system that encourages companies to give access to the investors they want as shareholders -- and to be rewarded with better shareholders, rather than better research coverage or more trading -- seems like an improvement for the companies. It's not obviously an improvement for market efficiency; companies might prefer meetings with credulous lazy investors instead of sharp critical ones. But it's not like they're wasting corporate access on short sellers now.
A crucial part of the job of a capital markets banker is:
- You meet with the chief executive officer of a private company.
- He tells you that he wants to do an initial public offering, and that his company is worth $2 billion.
- "At least!," you chime in enthusiastically.
- You get the IPO mandate, because he believes that you believe in that $2 billion valuation, and are the banker best suited to achieving it.
- The IPO prices at a $1 billion valuation.
- He is happy.
This is not an easy job! It is not primarily about financial analysis, or even investor targeting and marketing. It is a job of client psychology. You have to gently introduce your client, who has lived his whole life with his private company, and who believes absolutely in its value, to the harsh realities of the public market. You have to persuade him that you are his guide and ally in this journey, not a cold unfeeling representative of the market yourself. And you have to leave him satisfied that the market's conclusion is rational and that he's better off in the public markets, even at a valuation way below what he wanted.
Anyway Saudi Arabian Oil Co.'s bankers, and employees, are facing a similar problem except that instead of billions it's trillions:
The country’s deputy crown prince, who is leading a push to overhaul the economy, has pegged the value of the company known as Saudi Aramco at $2 trillion. But officials working on the deal have struggled to come up with a scenario under which Saudi Aramco is worth more than $1.5 trillion, according to people familiar with the matter, even after factoring in a recent tax cut and other tools the government has to make it more attractive investors.
Oops! Such is life. I am just going to skip ahead to the bankers' next problem:
Also, the remaining Aramco shares in Saudi hands would be less valuable than the prince forecasts, lowering the amount of money the kingdom could borrow against those shares to fund economic diversification.
Borrow against the shares? The plan is to float about 5 percent of the company -- $75 billion at that $1.5 trillion valuation -- and leave the rest, for now, in the hands of the Saudi government. How much would you lend against that $1.4 trillion private stub? How much do you think the deputy crown prince will want his banks to lend? My guess is that those numbers will also differ by at least 12 digits. I do not envy the bankers in charge of negotiating the largest and strangest margin loan in history.
Requests for activists.
Here's a story about how Neuberger Berman likes to get activists to do expensive risky difficult work for it:
Last year it campaigned for change at another company in which it had invested, the technology company Ultratech. It secured two board seats, but the process, Mr. Amato said, was “in all honesty expensive and time-consuming.”
In the case of Whole Foods, Neuberger Berman lobbied for the activists to do the messy work of battling the company in public.
What's in it for the activists? The difficulty of activist investing is that if you buy 5 percent of a company's stock, mount an expensive proxy campaign, win, improve the company's operations, and end up adding a billion dollars in value, you only get to capture $50 million of it. You are constantly being under-compensated for the value you add. Of course it can be to your advantage to cultivate big traditional institutional investors: They have votes, and legitimacy, and if you are frequently mounting proxy fights it is helpful to have big shareholders who owe you favors. Still it seems like an uneven exchange.
Elsewhere in activism: "Arconic Delays Annual Meeting, Considers Adding Two Elliott Directors."
This is sort of a slick scheme. Kevin Amell, an options portfolio manager at Eaton Vance Management, would have his fund sell some options. These were listed options with very wide bid/ask spreads: Market makers might bid to buy the options for $15.00, and offer to sell them at $17.00. If you wanted to sell, you could come into the market with a market order and get $15.00 from the market makers. Amell would instead offer to buy the options in his personal account for $15.05, and then have the fund sell them at $15.05. So he made the fund an extra 5 cents, versus the national best bid.
Then he'd go and sell those same options, from his personal account, for like $15.80, clipping a 75-cent profit for himself. (These numbers are illustrative but in the right ballpark.) The Securities and Exchange Commission's complaint has a diagram:
The SEC calls Amell's trades with the fund "pre-arranged trades," but they all happened through public orders on the exchange. The intuition is that if you are an options market maker, and the spread is $15.00 to $17.00, you might see fair value at $16.00. If someone (Amell) comes into the market with a $15.05 bid, you don't do anything. And then if someone (Eaton Vance) comes into the market with a market sell order, they're going to sell to that $15.05 bid (Amell's). On the other hand, if someone (Amell) comes into the market with a $15.80 limit sell order, some market maker is going to find that attractive enough to take the other side (to buy below fair value). So buying at just above the best bid, and selling at just below the midpoint, was a viable strategy for Amell.
This did not work out especially well for Amell. He made "at least $1.95 million" doing it over about two years, but then he was caught and pleaded guilty to criminal fraud. He agreed to turn over the $1.95 million; prosecutors have "agreed to recommend a sentence of no greater than 27 months in prison."
Still I can't resist thinking that it's a slick scheme. Amell performed the traditional function of a market maker for his fund: He provided liquidity by trading with the fund at the national best bid; in fact, he gave the fund some price improvement over the best bid in the market. And then he took the risk of getting out of the position: If there had been no buyers at the midpoint, and the price had moved against him, he'd have lost money. That's what the bid/ask spread is: compensation for market makers to take the risk of providing liquidity to people who want to buy or sell immediately. It's a perfectly legitimate trading strategy.
Just: Not if you run the fund! Market makers trade for their own account, as arms-length counterparties to investors who want to buy or sell. They provide a valuable service, but it's not a fiduciary service. They want to buy as low as possible, and the investors want to sell as high as possible; a mutually beneficial deal can be worked out, but the market maker is not acting in the investor's best interests. A fund manager had better be acting in his fund's best interests.
Why did Goldman Sachs Group Inc. have a rough time in fixed income, currencies and commodities last quarter? I tend to think of bank trading activities as weighted random number generators; if you watch them long enough, they should be profitable, but any small sample will probably be above or below the long-term expected value. This is a boring structural explanation, though, that doesn't have much to say about any particular quarter. If you want the particular coin flips that went wrong, you can sometimes find them:
Traders got burned by a constellation of souring debts tied to a coal-mining giant and struggling mall retailers, as well as wagers linked to the U.S. dollar, according to people familiar with the matter. The bank incurred tens of millions of dollars in losses on companies including Peabody Energy Corp. and Energy Future Holdings Corp. Borrowings from retailers including Rue 21 Inc., Gymboree Corp. and Claire’s Stores Inc. also stung, the people said.
"We could have done a better job navigating the market," shrugged Goldman Chief Financial Officer Marty Chavez. (Disclosure: I used to work at Goldman.)
My Bloomberg View colleague Lisa Abramowicz argues that Goldman's rough quarter is a good argument against the repeal of the Volcker Rule: Goldman skates closer to the line on taking large speculative trading positions than its rivals do, and those positions seem to have hurt it this quarter. Maybe. But the weird thing about post-crisis invocations of the Volcker Rule is how the intent seems to have changed. When the Volcker Rule was first proposed, it was viewed as a way to reduce the risk of systemic financial crises. Later -- in the JPMorgan Chase & Co. London Whale debacle, for instance -- the goal was to prevent large banks from losing a lot of money, even though the London Whale losses probably posed no systemic risk. Banks are supposed to be boring now, and even non-systemic big losses need to be regulated away.
Now, Goldman had a disappointing quarter. But it made money! Net revenue was $8.03 billion; net income was $2.26 billion; FICC trading net revenue was $1.7 billion. That was "about $340 million below estimates and barely higher than a year earlier," but it's still positive. If the justification for the Volcker Rule is now that it will prevent banks from making less money than analysts' estimates, then that is a pretty weak justification.
Failed bank alumni clubs.
Speaking of systemic risk, what do you do about the fact that people who worked at failed banks seem kind of proud of it?
Psychologists say that forging such connections is a natural way for humans to respond to high-stress situations such as combat or being held hostage. But a bank failure? “It’s surprising,” says Frank Ochberg, a psychiatry professor at Michigan State University and expert on post-traumatic stress disorder.
Failed-bank devotees say outsiders wouldn’t understand. “There’s a very strong loyalty because of that,” says Ms. Ensor.
One former Washington Mutual employee "lost half her retirement savings when WaMu failed, but she still adores it." Regulators talk a lot about changing banking culture by clawing back bonuses and so forth, but what if that just increases the all-in-it-together romance of working at a bank that explodes? Really they should ban failed-bank reunions, and selling memorabilia on eBay.
How rich are Renaissance Technologies executives?
So rich! Here's a Bloomberg calculation that estimates that two -- founder James Simons and Henry Laufer -- are multibillionaires, while two others -- co-CEOs Robert Mercer and Peter Brown -- are at least very close to being billionaires. If and when they are billionaires, Renaissance "will have created more billionaires than any other hedge fund." The best part about being a Renaissance billionaire is that the firm has sort of moved past the concept of "skin in the game." Its main Medallion fund is closed to outside investors and capped at about $10 billion, meaning that when it generates big profits year after year, the partners cash out the profits instead of leaving them tied up in the fund. Usually, if you are a successful hedge fund manager, the better your fund does, the greater the percentage of your net worth will be tied up in the fund. With Medallion it's the reverse. Though I guess if you have a perpetual-motion profit machine you might be sad that you can't put more money into it.
If you are interested in latency arbitrage and colocation and front-running, well, here is an article about video-game server latency:
He had to learn how to “see into the future,” he said, and predict and input moves in advance. Elento likens the scenario to that of a football player, but “instead of being a regular football player, he has to close his eyes for a quarter of a second for every second, and he has to judge all of his decisions based on information he knew before, and he has to just plug in the information for the last quarter of a second.”
Of course you can solve this problem via colocation: "That’s partly why all the big tournaments — the ones where the winning team gets cash prizes of over $1 million — happen in big stadiums, and in person." But if you live in Hawaii, colocating near the "League of Legends" game servers in Chicago may not be that appealing.
Here is an amusing description of Harvard Business School, from a Wall Street Journal review of Duff McDonald's book, "The Golden Passport":
When America’s corporations floated out of World War II on an ocean of cash, the wise men of Harvard decided that management was all about creating vast, technocratic amoebas that could swallow any business in their path. When Wall Street began to eat those amoebas for lunch, they suddenly realized that management was all about maximizing shareholder value.
People are worried about unicorns.
Here we are dealing in sub-unicorns, but my excuse is that they are funny sub-unicorns. First, Yik Yak is getting partially acqui-hired:
Square Inc. acquired the engineering team of Yik Yak, according to a person familiar with the matter, marking the decline of the once-popular anonymous social network.
The payments processor paid less than $3 million for between five and ten of Yik Yak’s engineers, according to the person. Atlanta-based Yik Yak’s Chief Executive Officer Tyler Droll will not join Square, the person added, asking not to be identified talking about a private matter.
Yik Yak reached a $400 million valuation at its peak, but is now being sold for parts at a fraction of that valuation. Elsewhere in amusing sub-unicorns and their parts, Ben Einstein took apart a Juicero Inc. juice squeezer to find out why it's so expensive. The answer seems to be that venture capitalists gave Juicero too much money:
Our usual advice to hardware founders is to focus on getting a product to market to test the core assumptions on actual target customers, and then iterate. Instead, Juicero spent $120M over two years to build a complex supply chain and perfectly engineered product that is too expensive for their target demographic.
Don't miss the diagram explaining how Ellen Huet's hands squeeze a bag of juice a lot more efficiently than the $400 Juicero.
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