Snap Earnings and Emissions Fraud

Also whistle-blowers, social media and volatility, unicorn lawsuits and management philosophy.


Why would a company do an initial public offering? There is a traditional, boring, correct answer, which is to establish or deepen a relationship with the capital markets so that it can grow and strengthen its business. An IPO is not an endpoint; you don't take your company public and then jet off to your private island with a bag of money. Generally speaking, the chief executive officer is still the CEO, and still owns lots of stock. The venture-capital investors still own a lot of stock in the company, and in all the other companies they haven't taken public yet. The company still has a business that might require access to the capital markets. Everyone involved is a repeat player in a continuing game, so there's a shared desire to make everyone happy, to balance the desires of the sellers (get lots of money, don't give up much control) with those of the buyers (not overpay, get some shareholder rights).

Snap Misses Forecasts for New Users and Sales

But the basic business of finance is buying low and selling high, and it is sometimes hard to resist the secondary cynical explanation for going public, which is that you do an IPO to top-tick the market for your stock and sell at the very high point of hype. If for instance you are a social media startup, and Facebook Inc. is angling to kill you, and you are in that sweet spot after "so important that Facebook is obsessed with you" and before "Facebook has killed you," then that is maybe a good time to go public. And if you miss Wall Street expectations by a mile, in your very first quarterly earnings announcement after going public, then in a cynical sense you have done things exactly right: It's better to disappoint investors after you've taken their money than before.


Snap Inc. added fewer users than projected in the first quarter, a sign that Facebook Inc.’s strategy of copycatting virtually every feature of its Snapchat app is taking a toll on the newly public company. The stock tumbled 26 percent.

In its debut earnings report after a March initial public offering, Snap, whose mobile app lets users send disappearing video and photo messages, said it added 8 million daily active users in the period, for a total of 166 million, with growth from a year earlier slowing to 36 percent. Revenue also fell short of analysts’ estimates.

The shares hit a low of $17.12 in after-hours trading -- still a bit above the IPO price -- costing each of Snap's two co-founders about $1 billion, so their top-ticking wasn't perfect. (They each sold about $272 million worth of stock in the IPO, though, so it was fine.) Co-founder and CEO Evan Spiegel was also awarded about $750 million worth of stock for getting the IPO done, which helped cause Snap's incredible negative 1479 percent operating margin last quarter

Conventional business strategists would tell you that it's probably not a great idea to spend almost $2.4 billion to make just $150 million in revenue. But Snap didn't actually do that, not exactly. Of that $2.4 billion, almost $2 billion was attributable to stock-based compensation expense, "primarily due to the recognition of expense related to RSUs with a performance condition satisfied on the effectiveness of the registration statement for our initial public offering." A ton of employee stock vested on the IPO, and Snap's massive loss was due mainly to accounting for that stock.

We talk sometimes around here about how people are worried about non-GAAP accounting: There is a widespread view that executives like to report "fantasy" numbers, like "Adjusted EBITDA," in order to bamboozle shareholders and make themselves look good. There is particular scorn for companies whose non-GAAP numbers exclude stock-based compensation (because paying people with stock is a real cost) and extraordinary one-time expenses (because those expenses have a tendency to recur). And: sure. But U.S. generally accepted accounting principles are just a set of conventions that some accounting experts have decided strike the best balance between conservatism and accuracy most of the time, for most companies. It is not a perfect reflection of reality; the rules of GAAP are not rules of nature, and sometimes companies provide non-GAAP disclosure because it is more helpful in understanding their business than the GAAP numbers are. That seems to be the case here: If you evaluate Snap's business last quarter based on its massive GAAP net loss, you will be very confused about where the money went, and will have a hard time understanding what will happen next quarter. 

I mean, don't get me wrong, the "real" numbers are still terrible: Snap had a loss of $188 million on its preferred metric, "Adjusted EBITDA," and cash flow from operations -- a GAAP number -- was negative $155 million. But those numbers seem closer to reflecting what actually happened in Snap's business last quarter -- roughly, it spent a bit over $2 for every $1 of revenue -- than does its GAAP net loss.

One other thing about top-ticking. Snap sold stock for a lot of money at what may or may not turn out to be a high point for its business and valuation. But it also sold stock with no voting rights at what may turn out to be a high point for investor enthusiasm for big tech IPOs with shareholder-unfriendly governance provisions. If you are a shareholder who is unhappy with Snap's direction, guess what: There is not a lot you can do about it! Also: Snap's executives don't care! "At this point we're kind of famous for not giving guidance on the product pipeline," said Spiegel. "It should be a fun rest of the year," he added, which is probably not a sentiment shared by a lot of public-company CEOs who miss earnings expectations. But it will be, for him, in part because he doesn't have to answer to shareholders. Perhaps if the shareholders find it less fun, they will be more resistant to buying no-vote shares in the next hot unicorn to come along.


An odd fact of the U.S. legal system for public companies is that every crime is also securities fraud: If a company does a bad thing, and regulators find out about it, then the bad-thing regulators can punish it for doing the bad thing, but the securities regulators can also punish it for not disclosing the bad thing to shareholders and deceiving them about the risk of punishment by the bad-thing regulators. (The exception is if the company does the bad thing and contemporaneously discloses it, but there are as far as I know no actual cases of that, so it is not worth worrying about. "Let's bribe a foreign government, and also put out a press release and 8-K announcing the bribe," is a thing rarely said by corporate counsel.) It is a strange combination: Generally speaking the companies do the bad things on behalf of shareholders -- to make more money for them -- but then the securities regulators come in and fine them for defrauding shareholders. And the fine comes out of shareholders' pockets, making the punishment doubly absurd: Companies do illegal things to make money for shareholders, and securities regulators protect those shareholders from that extra money by taking it away from them.

The German legal system is slightly different:

Volkswagen AG’s top two managers are being investigated over allegations of market manipulation, deepening the carmaker’s legal woes in connection with the diesel scandal.

Chief Executive Officer Matthias Mueller and Chairman Hans Dieter Poetsch -- along with former CEO Martin Winterkorn -- are being probed by Stuttgart prosecutors over whether they were too slow in telling Porsche SE shareholders about VW’s emissions cheating, said a person familiar with the matter, who asked not to be identified. Porsche owns the majority of VW’s voting stock, and the men at the time had dual roles at the holding company and Volkswagen.

I am impressed with the thoroughness of the German prosecutors' interpretation: The diesel scandal isn't just consumer fraud, and it isn't just securities fraud at Volkswagen (there's already a market-manipulation probe there); it's also securities fraud at Porsche. If you defraud consumers, you're probably also defrauding your shareholders, which means you're probably also defrauding your shareholders' shareholders. The securities fraud diffuses out through the capital markets. But I am also impressed by their focus on individuals rather than companies: If you really think that Mueller and Poetsch defrauded shareholders by not telling them about the emissions cheating, it does make more sense to punish them than to fine the shareholders.


Bank annual meeting season is fun this year because the scandals aren't grim complicated mortgage-crisis-and-Libor-type scandals, but bizarre follies like Wells Fargo & Co.'s fake accounts and Barclays PLC's whistle-blowing scandal. In that one, CEO Jes Staley tried to unmask a whistle-blower who complained about another senior Barclays executive, which you are really not supposed to do. The board gave Staley a "very significant compensation adjustment," but then he and Chairman John McFarlane also had to stand up in front of the shareholders and take some abuse. Fortunately they had good answers:

“You know me. If I believe he should go, you know he would go,” said Mr. McFarlane, who is dubbed “Mack the Knife” because of his track record in axing top executives. He said Mr. Staley had “gone through a red light” and “when you go through a red light you don’t lose your license.”

Mr. Staley had made a mistake and wasn’t planning to do anything malicious to the whistleblower, he said. “All he wanted to do was phone them up and ask them to stop sending the letters,” he said.

I have been pretty critical of Staley's behavior in the past, because trying to retaliate against whistle-blowers, even when you are sure that they are wrong and malicious, really does defeat the purpose of having a whistle-blower program. But I am sympathetic to this excuse; if I were the CEO of a bank, getting people to stop contacting me would be a big part of my day-to-day work. I am not entirely sure that Staley just wanted to have a friendly chat with the person who, in his view, was making unfounded anonymous attacks on his friend, but I guess if it's good enough for Mack the Knife it's good enough for me.

People are worried that people aren't worried enough.

Ah yes okay fine sure:

Mark Mobius has a left-field theory on why volatility in global stock markets is so low.

“Social media is having a huge impact,” the executive chairman of Templeton Emerging Markets Group said in an interview during a visit to Tokyo. “It’s creating confusion with a lot of false news,” he said. “You’re getting a situation where a lot of information is discounted immediately because people are afraid that maybe the information they’re getting is not true.”

The reality is the opposite: Stocks are constantly moving around on dumb fake news, or on dumb news about entirely unrelated companies. Also, you know, maybe you should be skeptical when you see "XYZ announces tender offer for ABC," or "Snap announces net loss of $2.2 billion on $150 million of revenue" -- but then you can check, and once you do, prices should move. It makes no sense to say "well, I have seen this earnings report on the Securities and Exchange Commission's website, and on the company's website, and I listened to the earnings call, but I just can't trust it because Twitter exists."

Still doesn't it feel like this theory should contain some germ of truth? There seems to be a sort of consensus that there is too little volatility now, and we are due for a reversion to the right amount of volatility. But it is also possible that there was too much volatility before, and now we are getting the correct amount of volatility. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?" asked Robert Shiller in a famous paper in 1980, back when the one-year realized volatility of the S&P 500 Index was about 11 or 12 percent. (Yes, was his answer.) One-year realized vol is now about 10 percent. Perhaps, trained by Twitter, investors and their algorithms have become more thoughtful, less prone to knee-jerk overreaction and excessive emotion, more inclined to take the long view rather than constantly obsess about the latest news.

This is ... the exact opposite ... of my experience of social media? But maybe it is nonetheless true of investors; maybe modern investing technology -- high-frequency traders who smooth out price moves, indexers who ignore individual-stock news -- has actually made markets more efficient by causing them to react less to news.

People are worried about unicorns.

Why would a company do an initial public offering? Is the answer really "to get free advertising on the bottom of financial television screens"?

But he conceded that an IPO, aside from giving investors an opportunity to cash out, would boost Lyft’s marketing efforts. A ticker that crawls across TV screens would serve as a daily reminder of the company, and people who owned stock would feel closer to the brand, he said.

“We are a consumer brand,” he said. “It’s important for the community of drivers and passengers to own the stock.”

That's from an interview with Lyft Inc. Chief Financial Officer Brian Roberts, who says Lyft isn't going public anytime soon, which makes sense if a TV ticker is really the best reason they've got for going public.

Elsewhere in unicorns, Magic Leap, Inc., the augmented-reality unicorn, settled a pretty explosive sex-discrimination lawsuit; the complaint contained allegations like this:

Euen Thompson, an IT Support Lead, on November 16, 2016, gave a tutorial to a group of seven new hires, including two women, how to use Magic Leap’s IT equipment and resources. One woman asked Thompson a question in front of the group and Thompson responded, “Yeah,women always have trouble with computers.” The women in the group, in apparent disbelief, asked Thompson to repeat what he said and Thompson replied, “In IT we have a saying; stay away from the Three Os: Orientals, Old People and Ovaries.”


Chief Administrative Officer Vlietstra spoke to Campbell and told her that he understood what Thompson did was very offensive, but Thompson was both humiliated and sorry and would not be allowed to do the new hire orientation in the future. Campbell asked Vlietstra why Magic Leap hadn’t fired Thompson and Vlietstra responded that he couldn’t fire Thompson because he was African American and there were white men who had done “far worse” and if Magic Leap fired Thompson, he could sue them because he had been fired, but not the white guys. Campbell, outraged, asked, “Why not fire them all?” Vlietstra answered: “Because we need the white guys. They’re important. We need them. I know you’re upset, but my hands are tied.” 

I am not convinced that augmented reality is going to be an improvement over the regular one.

Management philosophy.

Talk-show host Steve Harvey apparently sent a memo to his staff that is the most beautiful memo I have ever seen, full of managerial insight like:

There will be no meetings in my dressing room. No stopping by or popping in. NO ONE.


My security team will stop everyone from standing at my door who have the intent to see or speak to me.


Do not wait in any hallway to speak to me. I hate being ambushed. Please make an appointment.

I promise you I will not entertain you in the hallway, and do not attempt to walk with me.

"Any hallway"! There is no hallway on earth where you can wait to speak to Steve Harvey. He knows your tricks, he sees you lurking at his door, and he wants no part of it. "Everyone, do not take offense to the new way of doing business," he explains. "It is for the good of my personal life and enjoyment." 

I sympathize with Harvey's dread of unscheduled meetings, but you may not; perhaps you are a Sorkinesque walk-and-talker yourself. But you cannot argue with that last sentence, which should be engraved in two-foot-high letters over the doors to Harvard Business School. "It is for the good of my personal life and enjoyment." It is the only management philosophy worth discussing. What is the point of writing memos, or being a boss, or doing anything at all, if it is not for the good of your personal life and enjoyment?

Elsewhere in workplace advice: "To Be More Creative, Schedule Your Breaks."

Pharma Bro.

There's a musical about Martin Shkreli. It is called "Pharma Bro." It opens tomorrow. I guess I have to see it. It is "the musical heist you never knew you wanted but would DEFINITELY go see." More financial scandals should probably be turned into near-instant Off-Broadway musicals, though I suppose the Shkreli story -- in which the Wu-Tang Clan features prominently -- lends itself to musical theater more easily than, like, the Barclays whistle-blower thing.

Things happen.

Deutsche Bank’s Big Shareholder Heavily Financed Its New Stake. Ackman Says Secret Pershing Stake Up 30%, 2 Targets in View. Bond Traders' Bonuses Set to Rise 15% as Banks Resume Big Raises. Puerto Rico’s Debt Crisis Claims Another Casualty: Its Schools. Bank of England Says Smooth Brexit Could Mean Faster Rate Increases. Investors Now Have More than $4 Trillion in Exchange-Traded Products. Whole Foods, Pressured by Restless Investors, Shakes Up Board. Auto Loan Fraud Soars in a Parallel to the Housing Bubble. Power Company Calpine Explores Sale. Which Dealers Borrowed from the Fed’s Lender-of-Last-Resort Facilities? The Eurosystem collateral framework explained. Trump’s Newest Wall Street Watchdog Sidesteps Ethics Scrutiny. How the ‘Trump Effect’ Is Driving Foreign Students Away From U.S. B-Schools. "The political and policy downside is limit-down." Robots Aren’t Destroying Enough Jobs. New York dog names. Caity Weaver on Dwayne Johnson. The prize in the bacon-eating contest is more bacon.

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