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Companies Want Buybacks to Be Easier

Also unicorns subsidizing consumers, consumers subsidizing unicorns, Moelis & Co. and space bitcoins.

People are worried about stock buybacks.

One reason that people sometimes worry about stock buybacks is that they are supposedly a form of market manipulation: If a company buys its own stock, it’s probably because it wants the stock to go up, and that is arguably manipulative. People who dislike stock buybacks often make this argument. But people who like stock buybacks also seem to assume that they are a little manipulative, and so you often get articles where people worry that, without enough corporate buybacks, there’ll be no one to prop up the prices of stocks. 

And in fact the original understanding, way back in ancient financial history, was that corporate stock buybacks were probably illegal market manipulation, and so companies rarely did them. And then in 1982 the Securities and Exchange Commission came along with Rule 10b-18, which gives companies a “safe harbor” from manipulation liability if they follow its requirements. The requirements are basically designed to limit the impact on the stock: Companies can’t buy more than about a quarter of their stock’s volume, or buy at the beginning or the end of the day, and they can’t push the stock up by paying more than the highest independent bid (or the last trading price, if that’s higher) for the stock. If the market for a stock is $10.00 bid, $10.02 offered, and the last trade was at $10.00, the company can’t come in and bid $10.02 to get more shares, because that might be viewed as manipulative.

Some people are weirdly mad about these rules:

But the “safe harbor” rules have not been revised since 2003 and critics say they do not reflect the electronic, fragmented nature of today’s markets, which makes share repurchase orders easy to spot and trade in front of by high-speed trading firms, leading to higher prices for companies that buy back stock.

“Everybody knows there is a corporate order flow so they front-run it and that just pisses me off because they will raise the price high enough where then they will sell it back to me. That’s just not fair,” Gary Barth, assistant treasurer at United Parcel Service Inc, told Reuters.

Okay first of all I am not a corporate treasurer but I have some doubts about this story. I agree that it is inconvenient for corporate buybacks not to be allowed to cross the spread: Companies “cannot buy shares at the best offer available” ($10.02 in my example), because they are stuck paying the best bid, which can slow down their purchases. And I agree that “everyone knows there is a corporate order flow” because companies do have to announce their buybacks in advance. But I am skeptical that all the evil high-frequency traders can recognize corporate order flow—by its non-aggressiveness, its refusal to cross the spread—and then jump in to “front-run” it. Corporate buyers aren’t the only buyers who try to avoid crossing the spread to bid up stock. And intuitively you’d expect aggressive buying—the kind that crosses the spread, takes out higher price levels, etc.—to push up the price; quietly sitting on the bid should have less of an impact. After all, the point of the SEC rules is to reduce the impact of corporate buying.

Also: What is the point of a buyback, anyway? I tend to think that the most reasonable purpose of a corporate buyback is mostly to return cash to investors in a tax-efficient way, and the second-most-reasonable purpose is to buy back the company’s own stock when it is undervalued, but there really are a lot of proponents of the theory that the purpose is to keep the price of the stock up. And that theory has some foundation: The company wants its shareholders to be happy, after all, and a high stock price is the main source of shareholder happiness. So if high-frequency traders really are spotting corporate buybacks and pushing the price up, then perhaps corporate treasurers should think of that not as “front-running” but as “leverage”: They get more of a stock-price impact per dollar that they spend, because other traders are also buying stock alongside them and pushing the price up more. Again I do not quite believe this—again it is exactly what Rule 10b-18 is meant to prevent—but if you’re a corporate treasurer who does believe it, then you might conclude it’s a good thing.

Also here is UPS’s description of its share buyback program:

From time to time, we enter into share repurchase programs with large financial institutions to assist in our buyback of company stock. These programs allow us to repurchase our shares at a price below the weighted average UPS share price for a given period. During the fourth quarter of 2016, we entered into an accelerated share repurchase program, which allowed us to repurchase $300 million of shares (2.6 million shares). The program was completed in December 2016.

In order to lower the average cost of acquiring shares in our ongoing share repurchase program, we periodically enter into structured repurchase agreements involving the use of capped call options for the purchase of UPS class B shares. We pay a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock. Upon expiration of each agreement, if the closing market price of our common stock is above the pre-determined price, we will have our initial investment returned with a premium in either cash or shares (at our election).

Yeah I mean … these guys are not just idly sitting on the bid worrying that the market is getting ahead of them, you know? They’ve actually found a way to get paid a premium if the market gets ahead of them.

In any case:

Exchange operator IEX Group has petitioned the SEC to let firms buying back shares do so using hidden orders that only execute at the midpoint between the best bid and the best offer. That would make it difficult to move the stock price while making the activity harder to spot.

Honestly that should probably be allowed; hidden midpoint peg orders do not seem like a particularly aggressive way to manipulate up stock prices. But mostly I love this story because it is a showdown between two of my favorite unfairly maligned financial villains. On the one hand, you’ve got corporate buybacks, which are widely criticized for wasting corporate cash and enriching executives and shareholders at the expense of workers. (Also for being manipulative, sure.) On the other hand, you’ve got high-frequency traders, who are widely criticized for front-running legitimate investors. Now the corporate treasurers, who people think are manipulating their stocks, want permission to manipulate those stocks a bit more, to save them from the high-frequency traders, who they think are front-running them as they try to manipulate the stocks. Which side will get less popular sympathy?

Elsewhere: “Apple expected to boost shareholder returns by at least $100bn.”

People are worried about unicorns.

I half-joked the other day that “WeWork’s business model is getting SoftBank to buy beer for software workers,” but of course that basic idea—rapidly growing a business by selling its products below cost, subsidized by huge venture-capital investments, in the hopes of one day flipping to profitability once you’ve achieved scale—is pretty standard in Silicon Valley. There are, for instance, many who believe that Uber Technologies Inc.’s product is a below-cost taxi service subsidized by tens of billions of dollars of venture-capital funding. 

A basic law of finance is that where there is a well-known business model that reliably produces uneconomic decisions—index-fund rebalancing, or let’s say corporate buybacks—then someone will arbitrage it. And here he is:

A new type of bargain hunter has found an Eden in the epicenter of the tech boom. The city is full of growth-hungry startups rich with venture capital, which offer consumers free trials and discounts on a scale that dwarfs the grocery-store coupon flier.

Such profligacy helped Mr. Yu cover most of the cost of purchasing a used Mini Cooper convertible, provided months of free meals, made him bitcoin rich and landed him on charter jets free.

“The entire S.F. economy is V.C. subsidized,” said Mr. Yu, who last year co-founded a blockchain technology startup called Stream. “It’s a historical world of excess.”

There is even an automated scalable version with a pleasingly literal name:

Elad Ossadon and Noam Szpiro, who work in software engineering, have become referring pros. In 2016, they created a website called VC Fund My Life, which catalogs discounts and freebies. When a user signs up for the startups listed, they get a referral bonus ….

Is this … a … good … way to run an economy? You can imagine, if you want—and lots of techno-utopians do—that we are on the cusp of the end of scarcity, a new productivity revolution in which robots will produce everything necessary for human life, freeing us from the need to work. If that is true, or true-ish, or close to true, or possibly true in the very far future, then the big problem will be the distribution of prosperity: If robots produce abundance but eliminate jobs, the concern is that the people—tech founders and venture capitalists, probably—who own the robots will become unimaginably rich and powerful, while the people who don’t will be unemployed and dependent on those founders and VCs for their necessities. Various solutions to this (rather distant and abstract) problem have been proposed, of which two of the most prominent are (1) socialist revolution and (2) a universal basic income; Silicon Valley types seem to like option (2) in part because it might forestall option (1). 

But that is not the entire choice set! You could have lots of other ways to redistribute tech wealth to everyone. For instance the VCs could own the robots and just give away their services. Why would the VCs do that? Well, to forestall a socialist revolution, would be one answer. Out of the goodness of their hearts and a sense of noblesse oblige, would be another. But it is pleasing to imagine that the VCs might give away their products because they are (1) rapacious growth-hungry capitalists and (2) confused. “Please give me free food so that you can grow your daily active user base,” you’d say to the robot-farm monopoly, and its owners would reply “yes, scale, we must scale, here is your food,” and you’d be pleased to have put one over on capitalism.

Obviously the other possibility is that the VCs are completely right about the power of scaling and the functioning of the profitability switch, and that once they give away enough products to become ubiquitous, they can take over the world. Arguably Facebook Inc. is the paradigm here. But if the basic business model of post-post-post-modern capitalism consists of venture capitalists giving people free stuff in order to pursue perpetual user growth, then that model actually seems pretty well suited to address the problems of the future.

On the other hand.

There are other financing models. Tesla Inc.’s, for instance:

Tesla is holding customer deposits for two vehicles that aren’t even in production yet: an electric Tesla Semi ($20,000 deposit) and a next-generation Roadster (either $50,000 down or the $250,000 retail price paid up front to reserve a limited edition). ...

There’s an additional source of free money from loyal believers: An unknown number of customers have paid up for vehicle features—$3,000 for “Full Self Driving” capability, for example—that Tesla thus far hasn’t figured out or released to anyone.

The consumer psychology that sees hundreds of thousands of people essentially extending an interest-free loan to a public company is unusual, to say the least. 

“I would offer a kidney to him if he needed it,” says one Tesla repeat customer about Chief Executive Officer Elon Musk. Obviously this is the opposite model: Instead of powerful tech companies giving free stuff to customers, this is customers giving free stuff to powerful tech companies. Free stuff like money, sure. Or kidneys. Please, powerful technology billionaire, take my body parts. My sacrifice is as nothing compared to the honor of helping you achieve immortality. I have to say it is a much more conventional dystopia! 

Seriously, in awkward parallel to the rise of VC Fund My Life, we do seem to live in a golden age of companies financing themselves by pre-selling products. When you read textbooks about corporate finance you can find sections about how companies fund themselves using bank debt and bonds and equity and convertible bonds and preferred stock and venture capital and friends-and-family and maxing out their credit cards, as well as by bootstrapping by selling products and reinvesting the proceeds in the business. But it feels like pre-selling products—selling products that haven’t been built yet—has not historically had a prominent place on the menu. But these days Tesla’s customer-financed model is not that unusual. There’s Kickstarter, of course, but there are also hundreds of initial coin offerings, in which ventures fund themselves by (in theory) selling not a share of their profits but rather a token that will ultimately be used to access the network that they’re building, when they build it. 

Why? Like, why is there so much more early-stage corporate finance through pre-sales than there used to be? Is it just that big companies were always funding themselves by taking up-front cash for long-term contracts, but now particular weird early-stage forms of it gets more attention? Is it a legal arbitrage, in that the requirements for crowd-funding are more lax than the requirements for selling shares, and entrepreneurs flock to the easiest approach? Is it mostly a story of technology: In a pre-internet age you could perhaps pre-sell your product to people in your town who knew and trusted you, but you need the internet, and a particular complex of social and identity and reputational tools on the internet, to find millions of people to trust you without ever meeting you or sampling your product. Or is it mostly fortuitous: Did ICOs happen to get a lot of hype because Bitcoin (not really a product pre-sale) had a boom, and did the ICO boom make people generally more comfortable with pre-buying products that don’t exist, just as one charismatic billionaire was experimenting with financing options including pre-sales and flamethrowers

How’s Ken Moelis doing?

Bloomberg’s Sonali Basak and Tom Metcalf profiled Ken Moelis, the just-became-a-billionaire founder of boutique investment bank Moelis & Co., and while I am not sure that obtaining fabulous wealth in the financial sector is primarily a matter of hard work, I will say that this sort of thing was obviously one barrier (no doubt of many) to my achieving that sort of wealth:

He often starts dialing the phone at 5 a.m. and will jet across the world to see a client at a moment’s notice. Friends say dinners are frequently interrupted by hours of work calls. One former colleague recalls Moelis insisting on making an extra call at the end of each working day to generate hundreds of additional prospects a year.

“Kenny learned maniacal work habits from Milken,” said Don Engel, an early boss of Moelis’s at Drexel Burnham Lambert who now serves on the board of Blink Charging Co., which operates electric-vehicle charging stations. “There was no such thing as a Saturday or Sunday at Drexel.”

An extra call compared to what? It’s not like investment bankers universally make 10 calls a day and he made 11. It’s more like, if you were a person who was already going to wake up at 5 a.m. and make calls all day, make one more. If you were a person who was already going to make one more call, make one more than that. It is an infinite loop; eventually you finish your calls for the day at 4:59 a.m., just in time to roll into the next day’s calls.

A fair description of my habits as an investment banker would be that I insisted on skipping one call at the end of each working day to generate hundreds of fewer prospects each year. I would come up with excuses not to get on a plane, at a moment’s notice. And now I write a newsletter!

Anyway in this era of senior leaders at big investment banks rediscovering the weekend, it is … differentiating? … to have a boutique led by a 24/7 client-pestering champion. Some of the awful workload in banking is about pointless work, but a lot of it really is the value-added but never-ending work of servicing clients and finding new ones, and if the big banks don’t want to do that constantly then I guess there is room for someone else to.

Space Bitcoin.

From my email inbox:

Crypto mining company has decided to launch a balloon equipped with mining equipment into stratosphere. The goal is to mine a bitcoin at the altitude of more than 35,000 meters (more than 100,000 ft) as a symbol of company’s belief the bitcoin’s value will go up.

Sure. This is, what, the third space-Bitcoin gimmick we’ve talked about around here? I am going to declare that I no longer care about them, and if you send me a press release about how you’re doing Bitcoin stuff in space, or in a balloon near space, I am going to ignore it. If you start mining Bitcoins in the Marianas Trench, as a symbol of your belief that Bitcoin transaction costs will go down, I will consider it. Also I guess really if Elon Musk puts a Bitcoin mining rig into a Tesla and blasts it to Mars or whatever I will probably have to mention it, but I won’t be happy about it.

Things happen.

Sprint, T-Mobile in $26.5 Billion Deal to Take On AT&T. Sprint-T-Mobile Deal Faces Tough Path Through Trump’s Washington. DOJ’s Antitrust Case Against AT&T Merger Has Been a Slog. Marathon to Buy Andeavor in $23.3 Billion Oil-Refining Deal. Al Gore’s global equity fund is beating the market. Pimco Pushes Further Into the Lucrative but Risky World of Alternatives. How are David Einhorn and John Paulson doing? SocGen deputy chief quit to limit US penalties over Libor. China Cracks Open Door for Foreign Fund Managers. Blockchain “holds out the promise of using market mechanisms to order your life online, rather than relying on monopolies to do it for you.” Which Antitakover Provisions Matter? Is Stock Market Volatility Good for the Art Market? I’m Sorry To Report Instagram Is Bad Now. It is unfair to gorillas to compare them to alpha men. Wildlife photo competition disqualifies 'stuffed anteater' image. 

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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

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