Dealmaking Gets Harder Under Trump
One area where Donald Trump is more economically populist than I had expected is: He really does seem interested in blocking big mergers. In November, for instance, the Justice Department sued to block AT&T Inc.'s planned acquisition of Time Warner Inc., and then yesterday Trump himself issued an executive order blocking Broadcom Ltd.'s proposed hostile takeover of Qualcomm Inc. on national security grounds. The worry of the Committee on Foreign Investment in the U.S. was not that Broadcom -- a Singapore-based company racing frantically to reincorporate itself in the U.S. -- would do bad things with the technology it acquired from Qualcomm, but rather that it would underinvest in the research and development and allow China's Huawei Technologies Co. to take the lead in building out 5G mobile technology.
That may well be right. "It's hard for Broadcom to battle those criticisms," writes my Bloomberg Gadfly colleague Brooke Sutherland: "The company has relied on cost cuts from acquisitions to propel its profit higher and most likely would have needed to cut deeply at Qualcomm to maintain its investment-grade credit rating." But while this is a common criticism of mergers -- that acquirers load down companies with debt and cut costs to repay it, eliminating jobs and stifling innovation -- it is not a traditional reason for the government to block them. Sometimes the target of a hostile deal will raise these complaints to its shareholders -- "don't vote for this deal, it will slash research and destroy what made our company so great in the first place," that sort of thing -- but it is usually for the shareholders to decide whether they believe that and how much it matters. If the shareholders would rather take the money and leave the business's fate to the acquirer, the governmental reaction has traditionally been "ehh, what are ya gonna do, capitalism."
But now, maybe, not so much? With (selectively) reinvigorated antitrust enforcement, reinvigorated CFIUS review, and a president who sure seems happy to block mergers for political or personal-offense reasons, there are just a lot more ways to stop a merger, if that's what you are looking to do. Antitrust review typically scrutinized horizontal combinations but gave plenty of leeway to vertical combinations of companies that didn't directly compete with each other; the AT&T/Time Warner lawsuit changed that understanding. CFIUS review typically scrutinized acquisitions by foreign companies that might make hostile use of U.S. technology; the Broadcom/Qualcomm order changed that understanding: Now a takeover by any foreign acquirer might be blocked on national-security grounds if it might lead to cuts in research. Lawyer John Kabealo "said the president’s order could dramatically change the world of mergers and acquisitions and open the door to the possibility that more bankers and lawyers would use reviews by the foreign investment committee to block hostile takeovers on national security grounds."
Traditionally the way the target of a hostile deal argues against that deal is by saying that it will be bad for shareholders; in some limited cases -- horizontal mergers in concentrated industries -- it might be able to block the deal by arguing that it will be bad for consumers. But now the audiences have broadened: You can block a deal by arguing that it will be bad for media concentration, or for U.S. technology innovation, or for Donald Trump's personal brand. There are more variables to play with, more scope for creativity, more room for a clever adviser to fend off a merger by finding the right people to appeal to and the right way to appeal to them.
Incidentally here's an odd thing about CFIUS's objections to the proposed Broadcom/Qualcomm deal. "Broadcom’s statements indicate that it is looking to take a ‘private-equity’-style direction if it acquires Qualcomm," says CFIUS, "which means reducing long-term investment, such as R&D, and focusing on short-term profitability." We have spent the last, I don't know, five years talking constantly about arguments that U.S. public stock markets encourage short-term thinking and discourage long-term investment. But CFIUS argues that taking a company out of U.S. public ownership -- by a private-equity buyout, or by a "'private-equity'-style" public-company merger -- makes the problem even worse. That is of course plausible -- there might be a hierarchy of long-termism in which venture-backed private companies are at the top, public companies range widely over the middle, and private-equity buyouts are at the bottom -- but it is still odd. Companies are valuable because of the long-term value of their expected future cash flows. If some segment of the market forgets this and myopically focuses on short-term earnings, then that would be strange enough, and you'd expect it to be arbitraged away: If public markets are too short-term-focused, you'd expect private-equity-backed buyouts that give companies enough room to focus on the long term; if private equity funds are too short-term-focused then you'd expect them not to be able to pay public-market valuations. But if everyone is too short-term-focused, then ... how could you tell? If everyone with money at stake agrees on the proper time horizon for valuation, then what does it mean to say that that time horizon is too short?
"If I come over to your house at Thanksgiving and I sharpen your knife, you will definitively know the difference right away," Goldman Sachs Group Inc. Co-President Harvey Schwartz told the New York Times in November, and while he was talking about his early job working in a butcher shop, there was at least the hint of a metaphor. Schwartz, a karate black belt and expert knife-sharpener, was locked in a succession battle with his co-president David Solomon, whose extracurricular activities run toward electronic music DJ'ing, eating at fancy restaurants and drinking expensive wine. While Solomon was partying, Schwartz studied the blade.
But yesterday Solomon was declared the winner in the succession battle, and all of the accounts of that battle so far are ... frankly a little tame? The story is basically that Solomon impressed the board -- and current Chief Executive Officer Lloyd Blankfein -- and so they declared him the winner, and Schwartz announced that he was leaving with gratitude for "an incredible 21 years." "Behind the Goldman Sachs Race to the Top Was a Quiet Battle for Blankfein's Favor," is the Bloomberg News headline, and I hope they baked him cupcakes on alternating days. ("How Solomon won cage match to become Goldman heir apparent" is the Financial Times's more dramatic headline, but nothing in the story is inconsistent with cupcakes.) I would like to assume there was at least a little dirty dealing, desperate lobbying, midnight intrigues, but so far none of that has really come out. On the surface everything seems pretty placid.
Schwartz and Solomon, who look uncannily like each other, Blankfein, and most other powerful Goldman executives of recent vintage (white, male, bald), are easy to interpret not as individual humans with different strengths and relationships and skills, but as symbols of the past and future of Wall Street. Schwartz grew up in the commodities sales and trading business, like Blankfein; Solomon grew up in leveraged finance. In crude terms, Schwartz codes as "trader," Solomon as "investment banker." When Blankfein came to power 12 years ago, traders were ascendant and Goldman was widely viewed as a hedge fund disguised as an investment bank; now that Blankfein is choosing a successor, traders are on the decline, regulation limits banks' risk-taking, and Goldman Sachs is accepting retail deposits and doing consumer loans on the internet. Of course Goldman's symbolic trader lost out to its symbolic investment banker.
That story feels a little overstated to me: Solomon is not a classic investment banker but a leveraged finance guy; his training is not so much in relationship-building as it is in knowing markets and committing the firm's capital to big transactions. "Unlike Mr. Blankfein and Mr. Schwartz, Mr. Solomon is not steeped in the firm’s cutthroat trading culture," notes the New York Times, but he worked at Salomon Brothers, Drexel Burnham Lambert and Bear Stearns before joining Goldman as a partner, so it's hard to imagine he never saw any throats cut along his way. Meanwhile Schwartz grew up in derivatives, sure, but his background is not all knives and karate: "As co-president, he helped shepherd the firm’s consumer-lending initiative, Marcus, to its 2016 launch." You could imagine a story of Goldman Sachs in which its sales and trading business becomes more commoditized and less risky -- where the innovation comes in computerizing trading rather than in building risky new principal-trading products -- while its investment banking business becomes riskier and more aggressive, in which Goldman's risk and capital commitments migrate more to the investment banking side as trading gets reined in.
(Disclosure: I used to work at Goldman, as a banker who built derivatives, so arguably I combine the best of both worlds and would be willing to shave my head if the right offer came along.)
Here is a story about a Goldman Sachs research note finding that "no safe havens -- and no assets or equity sectors -- have had a positive beta to the VIX recently." That is, when the CBOE Volatility Index goes up -- because the U.S. stock market becomes more volatile -- no asset class goes up with it; stocks and bonds and gold and oil all fall as stock-market volatility rises. (Bitcoin too, though Goldman doesn't say that.)
But you know what has a positive beta to the VIX? VIX products! (Not inverse ones!) Now that you can just go buy futures or exchange-traded funds that go up when the VIX goes up, you do not need to study correlation matrixes to find a product that will make you money when volatility increases. You can just go buy a thing that pays you money when volatility increases. The correlation of the VIXY ETF and the VIX is about 0.9.
Now this is not exactly a satisfying response to Goldman's note. VIX ETFs are not really a big asset class, and if you wanted to hedge a multibillion-dollar portfolio against the risk of equity volatility, you might find it annoying to do via VIX futures. But ... why would you want to hedge a multibillion-dollar portfolio against the risk of equity volatility? Why do you care about volatility? You might want to hedge your huge portfolio against the risk that things in it go down; you might do that by buying things that go up when other things go down. That might be more challenging than it used to be, but it is also a different challenge from buying things that go up when volatility goes up. You could imagine a story in which the development of volatility products caused this breakdown in correlation: Back in the olden days, when you needed to buy gold to hedge against rising equity volatility, gold prices obligingly went up when equity volatility did. But now that you can buy equity volatility directly there is no need to hedge against it with gold, and gold has quite sensibly become a worse hedge against volatility.
People are worried about unicorns.
Dropbox Inc. announced the pricing range for its initial public offering, and it looks like it will be a down round:
Silicon Valley darling Dropbox Inc. is aiming to go public at a valuation well below the $10 billion it clocked in its last private funding round, despite posting healthy revenue growth and turning cash-flow positive in the intervening four years.
So that's a little weird: The private markets valued Dropbox more highly when it was a worse company than the public markets seem to now that it's a better company.
The gap between private valuations and public market aspirations highlights the disconnect between the premium that private investors put on potential innovation, and the financials-based analysis that public market shareholders are focused on.
I guess that is right, but I am troubled by the notion that valuation choices between "Silicon Valley" and "Wall Street" are essentially aesthetic, that private investors like companies that look like this while public investors like companies that look like that. The more traditional analysis is that stock prices are the discounted present value of estimated future cash flows, and that if the public market and the private market estimate those cash flows differently, one of them is wrong. We might not know which until the long term arrives, but if there are persistent valuation differences between public and private markets it seems unlikely that they are attributable entirely to different preferences. More likely they involve different factual beliefs, too, and eventually one market or the other will have to revise its valuations to reflect reality.
In other unicorn-listing news: "Spotify Technology SA plans to list shares on the New York Stock Exchange the week of April 2, according to people with knowledge of the matter, giving the company weeks to prepare for an unconventional debut."
This is reassuring!
The Binance exchange is offering $250,000–paid in cryptocurrency–to anyone who provides information that leads to the arrest of the hackers who attempted to steal funds, it said on Sunday. Additionally, Binance said it has set aside up to $10 million in crypto reserves for bounty awards against any future illegal hacking attempts.
“Even though the hacking attempt against Binance on March 7th was not successful, it was clear it was a large-scale, organized effort,” Binance said. “This needs to be addressed.”
Imagine if a bank announced that it had set aside millions of dollars to pay bounties when it gets hacked. I feel like regulators would be like "do you not have ... more reliable methods to keep your data safe?" Reserving money to pay bounty hunters is such a strange combination of modern accrual accounting methods and ancient techniques of vendetta; obviously it is perfect for a cryptocurrency exchange. Also it is impressive that the reserve is 40 times the bounty they are offering here. It suggests that they are expecting 40 more similar hacks in the future. How excited would you be to give your money to an exchange that plans to be hacked 40 times?
Elsewhere, crypto miners can be annoying neighbors. And: "Ripple Loses Bid to Keep Its Cryptocurrency Fight in California." And: "Endowments and foundations are steering clear of the crypto-craze. At least for now."
People are worried about bond market liquidity.
We talked last week about Martin Fridson's argument that high-yield bonds aren't volatile enough: They "exhibit fewer extreme price moves than would be expected in a properly functioning market." Here is Alexandra Scaggs with more about why that might be; one possible answer is, of course, liquidity:
The logic to this idea is that during market selloffs, traders might just look at the prices of bonds that are trading, and use those prices to figure out how far they should mark down the bonds that aren't trading. Seems sensible enough.
The only problem is that the bonds that get traded during a selloff are probably the same ones that get traded all the time, like bonds held by ETFs. And those are more likely to command premium pricing in a selloff, when HY companies face rising risk of default. “The fear of getting trapped in a failing credit all the way to bankruptcy becomes more acute at such times,” Fridson writes.
That is: High-yield bonds don't look especially volatile because the high-yield bonds whose values are volatile don't trade much, especially during times of volatility, so that volatility doesn't show up in their prices.
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