Money Stuff

Spotify Will Pay Banks to Cut Out the Banks

Also bank earnings, societal value, airline conspiracies, cryptowhatsits and golf.

Spotify will be fine.

The most encouraging news that I've seen for the financial industry so far this year may be this Wall Street Journal article about Spotify AB's plan to disrupt Wall Street by avoiding an initial public offering and doing a direct listing, cutting out the banks and dealing "a blow to the already beleaguered stock-selling business." Because apparently the way you disrupt and beleaguer banks is by hiring three of them and paying them $30 million:

Spotify’s three advisers—Goldman Sachs Group Inc., Morgan Stanley and Allen & Co.—are poised to share roughly $30 million in fees, though that could change depending on the size of the company when it debuts and the success of the deal, according to people familiar with the matter.

Now $30 million is probably a bit less than they'd expect to get for leading a traditional IPO for a $15-billion-ish company like Spotify, and a big IPO would probably employ more than three banks. On the other hand, getting paid $30 million for not doing an IPO is not quite the same as being cut out entirely. Bloomberg's league tables list 184 U.S. IPOs in 2017 for a total of $42.7 billion raised and an average fee of 5.2 percent, so the average U.S. IPO pays its bankers about $12 million. Spotify will pay almost triple that not to IPO.

Employing all those banks may also make the process less weird than I'd hoped. The non-IPO non-bookrunner banks will try to coordinate the sale of shares from existing holders (insiders, employees, venture capitalists) to new investors, and will "build a quasi-book of demand at various price points based on conversations with potential and existing investors." (But the banks "won’t be able to choose which buyers receive which portion of the company’s shares—a key function in a typical listing.") When the stock first opens for trading on the exchange, it will be at a price determined in the shadow of some bank-led matching of buyers and sellers, just like in a regular IPO, though just like in a regular IPO the actual opening price may move pretty far away from the price the bankers worked out.

Which way will it move? I don't know, but I keep seeing people who assume that it will move down, and I am not sure I follow their reasoning. Here for instance is John Coffee:

The real difference will be that in “firm commitment” IPOs, the underwriters will have oversold the offering, building their book by hopefully lining up commitments to buy the issue that may be six or seven times the number of shares to be sold. Such a ratio ensures a “hot” offering with a large first day “pop,” which, back in the days of the late 1990s dot.com bubble, regularly produced first day price run-ups of over 100 percent. Absent such high-powered marketing, a first day price run-up is less likely in “direct listings” (and the first day returns might well be negative on average).

My assumption has been that without a normal coordinated IPO -- in which every insider who wants to sell shares has to do so on the first day (and then agree not to sell any more for about six months) -- there won't be much supply coming on the first day, as lots of Spotify's insiders and VCs will just wait a week to see how the price shakes out before selling any shares. Perhaps this is wrong -- perhaps the direct listing is a way for insiders to sneakily dump all their stock on day one, which would be awkward in an underwritten IPO -- but it does seem logical that if not everyone has to sell on day one, not everyone will. 

On the other hand there is plenty of reason to expect a lot of demand on the first day: Spotify's direct listing is a big event, it's a famous company, and a lot of people want to own it. The Journal suggests that demand might be weak, but only in a no-one-goes-there-it's-too-crowded sort of way:

It isn’t clear whether large mutual funds, unsure whether they will get a sizable enough allocation, would line up to buy the stock. If they opt to sit it out, Spotify’s roster of new investors could be filled with hedge funds looking for a quick flip—and not the kind of long-term investors companies covet.

If the mutual funds don't think they'll get a big allocation, that's because there is a long line to buy the stock. And if the hedge funds are buying for a quick flip, it's to flip to those mutual funds who are lined up looking for a big allocation. (If they want a lot of stock, and can't get allocated by underwriters, they will have to go buy in the market.) My worry with a direct listing of a huge famous unicorn is not that the price will languish or that there won't be an IPO pop; my worry is that the large coordinated day-one demand for a new company will meet with weak uncoordinated day-one supply of a non-IPO, and the price will pop much higher on the first day than where it will ultimately settle. (But here is a 2005 paper from François Derrien and Ambrus Kecskes on direct listings in the U.K., which finds that a strategy of direct listing followed by an equity offering "is less costly than an IPO because trading reduces the valuation uncertainty of these firms before they issue equity" -- suggesting that direct listings mostly work out normally.)

Still the most interesting thing for me -- and, disclosure, I was once an equity capital markets banker at Goldman so I am biased -- might be Spotify's endorsement of the role and value added by the banks. A lot of people are quite sensibly skeptical of the market for underwriting services, where banks' value is hard to measure and where fees are suspiciously clustered at 7 percent. Surely those high fees are a residue of custom or inertia or collusion or something; surely it is high time to sweep them away. And so Spotify came along with a bold plan to sweep them away, to pay only for the services it needed rather than to sign up for the package Wall Street wanted. And that plan involved paying three banks tens of millions of dollars. They must be doing something useful.

Banks.

Elsewhere in good news for banks, tax cuts are good for them:

JPMorgan Chase & Co. and Wells Fargo & Co. will reap an even bigger windfall from U.S. tax cuts than most analysts had predicted -- a combined haul of about $7 billion this year for two of the biggest corporate taxpayers.

Now, executives have to decide how to divvy up that fortune.

Borrowers including small businesses and big corporations will want better pricing. Employees from tellers to rainmakers will press for raises and bigger bonuses. And then there’s the political pressure banks face to invest more in communities, particularly those with the least access to credit.

I don't know, the tax cuts were called the "Tax Cuts and Jobs Act," and lots of companies have celebrated with stunty $1,000 bonuses for employees. And I tend to think of the big banks as socialist collectives run for the benefit of their workers, so if they come into some money it is natural for it to go to the workers. If your political preference is to see tax cuts being returned to workers in the form of higher wages, then banks might be an ideal setting for that -- except that your political preference might not be for higher wages for those particular workers.

In worse bank news, bond trading is bad now:

Until a few years ago, traders at big banks spent much of their time wagering on the future direction of markets. Sometimes those trades were executed on behalf of clients; often, they were done using the banks’ own cash. Successful traders pocketed a percentage of their winnings, earning Hollywood-style glory in the financial media.

Trading jobs are much different now — less risky, less glamorous and, most of all, less lucrative.

I am not sure how true that first part is -- how many traders at banks ever obtained "Hollywood-style glory"? -- but the less risky/less glamorous/less lucrative thing seems to be true. 

Still there is some room for fun. Citigroup Inc. announced earnings today; here are the press release, financial supplement and presentation. Citigroup was one of the banks leading the Steinhoff International Holdings NV margin loan, which JPMorgan specifically called out in its earnings release last week (and which lost JPMorgan $143 million); Citi did the same. "Equity Markets revenues of $530 million decreased 23%, primarily driven by an episodic loss in derivatives of approximately $130 million, related to a single client event," reports Citi, and it is less embarrassing to have a big single-trade loss if everyone else does too.

Should companies add value to society?

There is a theory, once popular in certain circles, that the way you build a big profitable company is by providing some valuable good or service to the rest of society. If you build a billion iPhones and sell them for $500, and a billion people get more pleasure out of an iPhone than they do out of $500, then those billion people will be better off for your efforts, and you will have $500 billion. This straightforward theory -- it is sometimes called "capitalism" -- runs into some complications with rents (if you build a lifesaving pill for $1, patent it, and sell it for $100,000, the person who buys it will be better off in a sense, but you might still be a jerk) and externalities (if you build a delightful social network, sell lots of ads for it, and it happens to undermine democracy and civil society, then you might be subtracting value even as people are happy to buy your ads), but like I said it used to have a certain popularity.

In particular, people in the financial-services sector tended, as a matter of professional pride, to believe in it. For one thing, people in the financial-services sector themselves provide a nebulous and hard-to-explain value to the rest of society. "Wait, you allocate capital? What does that mean?" their aunts ask them at family gatherings, creating a certain touchiness that can only be assuaged by their paychecks. For another thing, people in the financial-services sector usually allocate that capital based on profitability metrics -- they'd rather allocate capital to a stock that goes up than one that doesn't -- and so they have a natural tendency to think that profitability is a good measure of social value. You'd hate to buy a tobacco stock and have it go up and think that that was bad.

But now the largest capital allocator in the world seems to have renounced the theory:

Laurence D. Fink, founder and chief executive of the investment firm BlackRock, is going to inform business leaders that their companies need to do more than make profits — they need to contribute to society as well if they want to receive the support of BlackRock.

"To prosper over time," Fink's letter to chief executive officers says, "every company must not only deliver financial performance, but also show how it makes a positive contribution to society." "The financial performance is what shows how we make a positive contribution to society," the CEOs might reasonably have responded not too long ago, but that answer apparently no longer cuts it. 

Obviously this is a ... strange ... approach for a massive provider of index funds? Pick your least favorite public company -- guns or tobacco or oil or opioids or Facebook or whatever you think is doing the most harm to society -- and BlackRock Inc. is among the top five holders. Fink's threat -- contribute to society or you'll lose BlackRock's support -- rings a bit hollow since BlackRock's index funds can't sell. (They can vote against directors, sure, but what exactly do you want a gun maker's directors to do?) 

And BlackRock's own central function is making investing and capital allocation more efficient with smart strategies and economies of scale. That is, you know, fine. It clearly adds value to society; you can tell because Larry Fink is very rich. Still you would not expect too many starry-eyed idealists to dream of growing up to allocate capital efficiently. As a contribution to society, it is one that looks better in an income statement than in an inspirational letter. "Well what is your positive contribution to society, Larry Fink?" his targets might ask. I suppose the answer is that he invests people's retirement savings in fossil-fuel companies, but also writes strongly-worded letters about it. 

Should index funds be illegal?

Or just airlines? Here is another paper about how airlines are involved in a price-fixing conspiracy that is hiding in plain sight. But whereas the previous theory is that the large institutional shareholders who own big stakes in each airline implicitly push the airlines not to compete too hard on price, this paper -- "Public Communication and Tacit Collusion in the Airline Industry" by Gaurab Aryal, Federico Ciliberto and Benjamin Leyden -- focuses on how airline managers communicate with their competitors:

We investigate whether the top management of all legacy U.S. airlines used their quarterly earnings calls as a mode of communication with other airlines to reduce the number of seats sold in the U.S. We build an original and novel dataset on the public communication content from the earnings calls and process it using Natural Language Processing techniques from computational linguistics, and we use it to estimate a causal relationship between communication and the carriers’ market-level capacity decisions. The estimates show that when all legacy carriers communicate about artificially reducing the number of seats, i.e., engage in “capacity discipline,” prior to a given quarter, it leads to a substantial reduction in the number of seats in that quarter. 

It's a little unclear what I am supposed to take away from this: The paper finds that when all the airlines say on their earnings calls that they are going to cut capacity, they cut capacity. Perhaps they have found a nefarious way of conspiring with each other -- by saying publicly what they'll do -- but the alternative explanation is just that they say what they're going to do because that's what they're going to do. 

The crypto.

I don't know, Bitcoin has fallen to around $12,000 or so, for reasons that are deep and interesting but that we unfortunately have no time to get into here, you will just have to trust me that my fundamental model predicted all of this. There's that famous Robert Shiller paper about how stock prices are too volatile to be explained by actual changes in future dividends, and I hope someone will write a similar paper about cryptocurrencies just as soon as they figure out what fundamentals cryptocurrency prices are supposed to be discounting. Elsewhere: "China is escalating its clampdown on cryptocurrency trading, targeting online platforms and mobile apps that offer exchange-like services." And: "Government attempts to tighten control over cryptocurrency trading are sparking a fierce public backlash in South Korea." And: "Companies that have seen their fortunes -- and share prices -- soar with the crypto-craze are now facing a little bit of a reality check."

And in further crypto miscellany:

  • "A single actor likely drove the USD/BTC exchange rate from $150 to $1000 in 2 months."
  • "Whether it’s all built on sand or not, the crypto castle has risen. There’s an actual house called the Crypto Castle ...."
  • "TapJets, the largest private jet instant booking platform, now accepts Ethereum cryptocurrency as a form of payment."
  • "The real sign of our times is Japan’s new all-girl pop group Kasotsuka Shojo, each of whose eight members represents a different cryptocurrency."
  • "It might take some time for doctors to figure out how to revive Sungir Man from his temporarily dead condition, but once they do, boy will he be excited about hypermammothization."

Business golf.

Among the tax deductions eliminated by the 2017 Tax Cuts and Jobs Act is the 50 percent tax deduction for business-related entertainment expenses, which will be bad news for stadium luxury-box sales and golf courses. Here is Golf Magazine's coverage, which supports my view that the point of golf is to walk around and exchange stock tips in the open air:

"There's entertainment where you're basically just buttering up a client," Karen said. "But that's not what happens on a golf course. Spending an afternoon on the course with someone is very different from going to a concert, where you're not really conducting business because, let's be honest, you can't even hear."

Deals on the Green author Rynecki agrees. "For those of us trying to build relationships, golf is probably the biggest or at least the best form of business-related entertainment," he said. "Actually, it's really less entertainment, though the IRS might think it is, than it is having a walking meeting that involves discussing specifics but also getting to know another person, whether a potential hire, a client or a customer."

Golf, say its advocates, is not meant to be entertainment. People don't play golf for fun. Golf is work; it's a convenient way to hold a business meeting that happens to involve balls and sticks and scorecards and expensive lawn maintenance. 

Things happen.

Inside Uber’s $100,000 Payment to a Hacker, and the Fallout. World Bank Unfairly Influenced Its Own Competitiveness Rankings. Nine banks accused of rigging key Canada lending rate. GE to Take $6.2 Billion Charge Tied to Long-Term Care Insurance. The Momentum Game Has Returned to the Stock Market. The Mysterious Twitter User Drawing a Swarm of Japan Traders. Misconceptions of Interest Benchmark Misconduct. Whatever Happened to “Just Prices?” Democrats Add Momentum to G.O.P. Push to Loosen Banking Rules. Bad News and Good News for the Single Resolution Board. Shell Bids a Long Goodbye to Middle Eastern Oil. Platinum, Clinging to Its Status as a Top Precious Metal, Faces a Crisis. "Strategists at Bank of America Merrill Lynch simply left a blank space in the credit section of a recent cross-asset strategy report." "SuperHoldCo PIK note." Balcony Collapses at Indonesia Stock Exchange, Injuring at Least 70. This Ex-Banker Has Wall Street-Sized Ambitions as a Wine Critic. Texas man turns up dead after wife searches 'how to kill someone and not get caught.' 

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    Matt Levine at mlevine51@bloomberg.net

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