Money Stuff

Uber Activism and Communist Boards

Also when bank regulators quit, what Libor means, what Apollo would do and crowdfunding.

Uber!

It is fun to imagine what life would be like for Uber Technologies Inc. if it was already a public company. Take Benchmark Capital Partners VII, L.P.'s fraud lawsuit against Travis Kalanick, Uber's former chief executive officer, which we discussed on Friday. Kalanick persuaded Uber's board and other shareholders to amend its governing documents to give him more power, including the personal right to appoint three directors; Benchmark claimed that he did this without telling them all the relevant facts about bad stuff Uber was getting up to.

I was dismissive of that lawsuit on Friday. Benchmark's central claim is that Kalanick was a bad CEO and should have told the shareholders that before they voted to give him more power. My bias is that that's kind of on them: The job of a private company's venture capitalist shareholder-directors really is to figure out if an entrepreneur-CEO is any good, and if they should trust him. But of course if Uber had been public, it would have had to mail out a 200-page proxy statement to shareholders before they voted to give Kalanick those powers, and that proxy statement would have had to describe every material fact about everything going on at Uber, and if later it turned out that there were some weird scandals that were not mentioned in the proxy, then shareholders would definitely have sued, and would have had a decent case. Beyond that, just asking shareholders of a public company to give the CEO more voting power would be weird: Google and Facebook have done it, sort of, but it's not exactly standard procedure. And you'd want a special committee of the board to look into it, and to formally document that the company was getting back something in return for giving the CEO more power -- rather than just a bunch of VC shareholders shrugging and saying "sure, he's a good CEO, let's give him more votes."

Or now there is this story about how "Uber’s board has voted to move forward on proposals by two investment groups to buy shares in the ride-hailing service and is considering a third offer, with any final decision set to affect who gains the upper hand at the company." That would not be a weird sentence to read about a public company that was looking to raise cash, but Uber isn't looking to raise cash: The investment groups are not looking to buy shares from Uber, but from its existing shareholders. In public companies, they'd just do that in the stock market; the board wouldn't get a say about who gets to buy stock. But because Uber is private, its board gets to decide. That complicates, and is complicated by, the current fight in the boardroom, in which Benchmark is trying to kick Kalanick off the board, while other shareholders have criticized Benchmark and are trying to kick it off the board. The shareholder leading that effort -- Shervin Pishevar of Sherpa Capital -- is also one of the potential buyers of Uber stock, but his proposal is contingent on buying out Benchmark's stake and getting it off the board.

It's a little like if a public company board got to meet to decide which activists to allow to buy its stock -- if the board were already deeply divided and fighting over who should be CEO and how the company should be run. Uber is now big and important and messy enough to have its own activist battles -- but it is still private, which gives the activist battles an extra layer of weirdness.

Actually I said that the investors weren't looking to buy shares from Uber, but there is a small, monumentally dumb exception to that: Two of the investor groups want to buy shares from existing shareholders at a discount to Uber's $68.5 billion valuation in its last funding round, but "would also purchase a small amount of new shares at Uber’s current valuation to keep the company’s value propped up on paper." The idea is that, if you raise money at a $68.5 billion valuation, and then shares change hands in the secondary market at a $50 billion valuation, and then an investor buys like one share from the company at a $68.5 billion valuation, then, what is the problem, your last funding round was at a $68.5 billion valuation, same as the previous one. You've never done a down-round! Your valuation is still $68.5 billion.

Obviously it would not occur to a public company to even try a ruse like this: If you sell stock at $68.50, and it trades down to $50 on the stock exchange, then selling one share to an investor at $68.50 will not convince anyone that your price is "actually" $68.50. The price is the price where shares trade. But if you are private, I guess you can convince yourself that this trick might work.

Communism.

Elsewhere in corporate governance:

Since 2016, at least 32 Chinese state-owned companies or units listed in Hong Kong have proposed changes to their corporate structures to install Communist Party committees that advise their boards of directors. The moves, most coming in recent months, are prompting questions from market participants about who holds power at these companies, and whether they will be run for the benefit of investors.

I am old enough to remember when the question "does the Communist Party want companies to be run for the benefit of investors?" had a really easy answer, but these are strange times we live in! Obviously the word "Communist" in "Chinese Communist Party" is at this point mostly a rueful joke, but it is funny to imagine a corporate governance system in which directors have fiduciary obligations not just to shareholders, and not just to stakeholders like employees, customers and communities, but also to the principles of international communism. How would that influence compensation committee discussions? "Sure the CEO beat his total shareholder return targets, but will paying him $20 million really bring about full communism now?" 

I kid, of course; these committees are about keeping state control on companies, not about following communist principles. If you want companies run on Marxist principles, there is always the United States, where people are worried that the rise of index funds has accidentally imposed Marxism on our public companies. It is true that, in the limit, if companies are looking out for their shareholders, and if their shareholders all own all other companies in proportion to their contribution to the economy, then companies really should do what is best for the economy, not for themselves. Doing what is best for the economy is not exactly Marxism, but it is a sort of 21st-century financial-capitalist flavor of Marxism anyway.

Elsewhere: "Record ETF inflows fuel price bubble fears."

Financial regulation.

Here is a funny Federal Reserve staff working paper that tests whether bank regulators have any effect by seeing what happens when they all quit:

In 1983, the 9th district Federal Home Loan Bank (FHLB) was hastily relocated from Little Rock, Arkansas to Dallas, Texas. The move was spurred by a desire to be located in the largest metropolitan area in the district with its attendant status as a transportation hub, which allowed for easier travel both throughout the region and to Washington, D.C. During this time, each of the twelve FHLBs maintained a role as the primary supervisory agent of the savings and loan associations (S&Ls) in its district. As a consequence of the move, the vast majority of employees in the 9th district’s division of supervision, including the chief, quit their jobs rather than relocate to Dallas.

Turns out that when all the regulators quit, "affected institutions took on much more risk than their unaffected counterparts." There is another lesson here, which is that natural experiments are not only the best way to test many economic propositions, they are also funny. If you and all your colleagues quit your important jobs en masse for some weird exogenous reason, make sure to let an economist know, so that one day you can feature in a paper like this.

Elsewhere: "Trump Chips Away at Postcrisis Wall Street Rules." And: "Retirement Rule Casualty: Brokers’ Mutual-Fund Offerings."

Someone told Matt Taibbi how Libor works.

I mean, he's not exactly sweating the details -- "If LIBOR rates are high, it means bankers are nervous about the future and charging a lot to lend" -- but he did read a Bloomberg article about how Libor is not really based on market transactions, and had a downright existential panic:

Think about this. Millions of people have been taking out mortgages and credit cards and auto loans, and countless towns and municipalities have all been buying swaps and other derivatives, all based on a promise buried in the fine print that the rate they will pay is based on reality.

Since we now know those rates are not based on reality – there isn't a funding market – that means hundreds of trillions of dollars of transactions have been based upon a fraud. Some canny law firm somewhere is going to figure this out, sooner rather than later, and devise the world's largest and most lucrative class-action lawsuit: Earth v. Banks.

"A 28 Days Later style panic is not out of the question," he writes. Obviously it is not true that the fine print in your mortgage says that Libor "is based on reality." It just says that Libor is Libor. As Pascal-Emmanuel Gobry says, "for decades Libor's function hasn't been to be an accurate representation of bank's overnight funding costs,  but to be a number that people could plug into their spreadsheets to price derivatives and other products."

Still I am reminded of the notion that banks work by concealing risk. The essence of banking is to issue "risk-free" claims (deposits), and use the money to fund risky activities (loans). This is impossible -- you can't really turn risky activities into risk-free investments -- and also socially necessary, in that it mobilizes savers' money into productive activities. "A banking system," writes Steve Randy Waldman, "is a superposition of fraud and genius that interposes itself between investors and entrepreneurs" to make everyone better off. But like any fraud, it suffers from exposure: If everyone thinks too hard about the fact that banks use risk-free deposits to fund risky loans, then the system collapses. (This, arguably, describes 2008, and every banking panic.)

Similarly, Libor solves (solved?) an important coordination problem by sheer brazen magic: A number was needed, and everyone agreed to provide a number, and not to worry too much about whether the number was "real." Everyone involved kind of knew that, but the people who weren't involved -- including most borrowers and derivatives customers -- didn't, and were happier for not knowing. They just assumed "that the rate they will pay is based on reality." Now that it is seeping into popular consciousness that Libor was fake, its usefulness is also evaporating.

Elsewhere, here is a story about how the Dow is a dumb index.

Covenants.

The real proof of your influence as an investor is if your competitors make your name a catchphrase, and then an abbreviation, and then something to be engraved on a bracelet. Good work, Apollo:

Apollo Global Management has developed the reputation as the most creative and tenacious fighter in battles with credit investors. Creditors are so sensitive to Apollo that the debt of its portfolio companies is priced to reflect the anticipation of a brawl down the road should the company falter. At a recent creditor conference, one banker noted that Apollo’s rivals were now pondering the question, “What would Apollo do?”

I tend to assume that investors don't carefully read the legal terms of stock and bond offering documents: They'll accept pretty much any "market" terms without pricing them, but will occasionally and randomly push back against some terms that are too far off-market. (That seemed to happen with an off-market change-of-control put price in a Vivint Inc. junk bond deal, and arguably it happened to offerings of non-voting stock, which were rejected by index providers, though after Snap Inc. got its offering done.) But it turns out that investors read at least as far as the name on the offering documents, and will charge you more if your name tends to be associated with difficult terms.

Crowdfunding fraud.

I guess there are probably a lot of these, but this is the first case I can remember seeing:

Acting Manhattan U.S. Attorney Joon H. Kim said:  “Vedoutie Hoobraj allegedly concocted an elaborate story about having cancer when she did not, using GoFundMe pages and accepting money raised by a local high school, all supposedly to fund her medical care.  Hoobraj even falsified medical records for donors to conceal the fraud.  I commend our law enforcement partners for thwarting this allegedly brazen fraud.”

According to the criminal complaint: Hoobraj's GoFundMe pages claimed that she had both leukemia and liver cancer, whereas in fact she had been diagnosed not with cancer but with "adult failure to thrive." She also told police that the cancer diagnosis had come from a doctor at Sloan Kettering "who died in an earthquake in Nepal," which I guess seemed like a good way to avoid follow-up questions?

The moral here, which is not legal advice, but which does have perhaps broader applicability than just medical crowdfunding, is: Just because you are not promising people anything in return for their money, that doesn't mean you're not defrauding them! Crowdfunding has an obvious appeal to hucksters: If you raise money to start a fake hedge fund, eventually investors are going to ask for their money back, but if you raise money to cure a fake cancer, your backers have already reconciled themselves to losing their money. 

And crowdfunding is not just America's main source of funding for medical care; it is also, loosely speaking, how a lot of cryptocurrency projects work. But just because your initial coin offering doesn't come with governance or ownership rights -- just because you think it isn't a "security" under Securities and Exchange Commission guidance -- that doesn't mean that lying about it can't be fraud. It's just a different kind of fraud. 

Blockchain blockchain blockchain.

"Bitcoin soared past $4,000 for the first time on growing optimism faster transaction times will hasten the spread of the cryptocurrency." And: "The Game is promoting the initial coin offering of a company owned by a former Miss Iowa who is looking to usher in the weed revolution."

People are worried that people aren't worried enough.

Well not quite, but here is a story about how people are worried that no one will be around to trade the, you know, nuclear war and stuff:

“I’d better start building my bunker,” Ian Winer, director of equities at Wedbush Securities Inc. in Los Angeles, said jokingly when asked about his weekend plans. The truth: “I’m going to relax on the beach. We’re not seeing anybody de-risk their portfolios because they’re worried.”

There is an obvious logic to that: If you're not worried about nuclear apocalypse, there is no reason to de-risk your portfolio, and if you are worried about nuclear apocalypse, why bother de-risking your portfolio?

By one school of thought, the larger the potential conflagration, the smaller the market reaction should be. If the outcome is binary—a choice between nothing happening and a global thermonuclear conflict—then it makes no sense to sell stocks. That seemed to be the conclusion during the Cuban Missile Crisis, when the world came closer than ever to that possibility and the Dow fell less than 1% for the week.

And: "Don't be reassured by small market reactions to risk of apocalypse."

Meanwhile in other dumb potential crises, the U.S. still might default on its debt for no reason.

People are worried about stock buybacks.

Here is a good story about the slow sad decline of Sears Holdings Corp., which features a triple whammy of a difficult retail environment, some questionable managerial decisions, and some aggressive financial engineering that has left Eddy Lampert's hedge fund as both a major shareholder and a major creditor. But stories of corporate decline pretty much inevitably come with an unflattering glance at stock buybacks:

In the early days of the merger, when times were better, Sears used its cash to buy back shares, a move businesses often use to try to drive share prices higher. From 2005 to 2012, the company spent $6 billion buying back its own shares at prices as high as $174 a share.

Today, Sears Holdings stock trades at $9.30 a share, a decline of 95 percent from its highs.

Yes, well, Sears Holdings stock seems to have been a bad investment for Sears, and for everyone else. But would investing that $6 billion in Sears stores -- given the difficult retail environment, questionable managerial decisions, and other financial engineering -- have been better for the company? Or did the (ex-)shareholders who got that $6 billion go and use it more productively than Sears would have?

People are worried about unicorns.

Remember "Angry Birds"? I do, dimly. Apparently the company that makes it, Rovio Entertainment Oy, "is planning an initial public offering as early as next month that could value the maker of the Angry Birds mobile games and movie at about $2 billion." It's an Angry Flying Unicorn (Elasmotherium volans iratum). The use of proceeds would include -- this is true -- helping to "fund the 'Angry Birds Movie 2,' planned for 2019."

Things happen.

Brussels seeks tighter vetting of foreign takeovers. Democrats Renew Push to Probe Deutsche Bank Russia Scandal. Investors Take On Mortgage Risk From Taxpayers. Aswath Damodaran: "Tesla is singularly unsuited to using debt." Whatever happened to the global savings glut? GoDaddy Boots White Nationalist Site After Protest Violence. Uber, but for white nationalists. Trump attacks Merck CEO for stepping down from manufacturing council in protest. Trump's Business of Corruption. Rich Hamptons Buyers Don't Want Mega-Mansions. Century-old fruitcake found in 'almost edible' condition. The hardest unsolved problem in AI.

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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

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