Money Stuff: MoviePass Worked Out Great

BloombergOpinion Money Stuff

Matt Levine

The MoviePass economy Is there a Harvard Business School case study of MoviePass yet?[1] I feel like there are a lot of lessons to be learned from the MoviePass story, but maybe that's wrong. Maybe all of the lessons are just "if you do the opposite of normal business things, it will work, but only for a while." Maybe business school students should actively avoid learning that lesson. Anyway Jason Guerrasio has a big story on the rise and fall of MoviePass at Business Insider today. The basics of the story—MoviePass was a business that charged people $9.95 a month to see unlimited movies in theaters, and then paid the theaters full price for the tickets, losing money on each transaction and eventually falling into a huge and comical financial hole—were familiar to me, and probably to you, and it's not like we didn't already know it was weird. But I learned a lot from this article about how weird it was. For instance, under founder Stacy Spikes, MoviePass charged $50 a month for its service, but couldn't get enough subscribers to break even. Then it was acquired by Helios & Matheson Analytics, whose chief executive officer, Ted Farnsworth, came up with the idea of charging much less: Why Farnsworth settled on $10 is unclear. Several people told me he wanted a price that would grab headlines. ... But in July 2017, the MoviePass board agreed to the deal. And on August 15, the price drop went into effect. Thanks to word-of-mouth buzz and press attention, within two days subscriptions jumped from about 20,000 to 100,000. MoviePass had transformed from a scrappy startup trying to keep the lights on to a disrupter in the making. What an amazing sentence. It went from being "a scrappy startup trying to keep the lights on" (bad) to a buzzy "disrupter in the making" (good) by giving up on trying to keep the lights on. The trick is not to make enough money to cover your costs; it's to stop trying. Losing a lot of money is better than losing a little money; it has more panache, attracts more attention, certainly gives you that attractive hockey-stick user growth. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. Annual income twenty pounds, annual expenditure three hundred million pounds, result unicorn.[2] There are so many delights here. For instance, you might think that MoviePass, as a pure intermediary that doesn't own theaters or make movies but just takes money from customers and gives a larger amount of money to theaters for tickets, would at least have no operational problems in scaling up. Sure sure sure it loses money on each new customer, but this is not Tesla; it doesn't have to build a new car every time someone signs up, or expand the factory to meet demand. But, no, the main constraint on MoviePass's growth seems to have been the actual production of plastic prepaid credit cards, which it couldn't print fast enough: The company was overwhelmed by its overnight success and couldn't keep up with demand. A quarter-million new subscribers were signing up every month, and MoviePass customer-service lines were flooded with complaints from people who had been waiting weeks for their cards. MoviePass had lowballed the number of cards it would need after the price drop. It got to a point where the vendor making the MoviePass cards didn't have enough plastic and had to call on its competitors to fulfill all the card orders. Under Helios & Matheson, Spikes left and MoviePass got a new CEO, Mitch Lowe, who is lovingly described like this: Lowe's happy-go-lucky persona marked a shift from the all-business Spikes, whom he had replaced in the company hierarchy as CEO. On the rare occasions Lowe made it into the office, staff would need almost an entire day to get him up to speed. His general attitude, as one source described, was, 'Well, what do you think we should do?' But he did come up with a plan to stop losing so much money, which involved making it harder for "power users" to see many expensive movies each month. I remember reading about some aspects of this plan—limiting the number of movies customers could see each month, blacking out some blockbusters, etc.—but this one was new to me: Per Lowe's orders, MoviePass began limiting subscriber access ahead of the April release of the highly anticipated "Avengers: Infinity War," according to multiple former employees. They said Lowe ordered that the passwords of a small percentage of power users be changed, preventing them from logging onto the app and ordering tickets. It's an approach! I don't know about you, but if a service that I paid for locked me out because it didn't recognize my password, I would assume it was my fault; really, who can remember passwords? I would probably try to reset my password, though, and if that didn't work I might get suspicious. Things got worse for MoviePass, but for Spikes—who was pushed out before most of the madness—everything is great. He's got a new app called PreShow, and apparently it's easier to raise money as a repeat founder: "No one would care about PreShow if what happened didn't happen," Spikes said, without a hint of anger. "Things went a little sideways, so I thought talking to investors now would be, 'Ugh, you started MoviePass.' But it's 'You started MoviePass!' It's different than I thought ... My role in it is exactly what it was supposed to be." Corporate finance is a business of incentives. There are investors, who put up money, and there are entrepreneurs and managers, who do stuff with the money. The investors would like to get their money back with a profit, but the managers are the ones who control whether or not that happens.[3] The whole theory is about aligning incentives, setting things up so that it is in the managers' own interests to make money for the investors. There are a lot, really a lot a lot a lot, of very standard and well-known tools to do this. The managers are also shareholders and participate along with the investors; the managers get incentive pay that goes up as the investors' returns go up; the managers' future career opportunities depend on their track record of making money for investors; the managers have disclosure obligations, and the shareholders have the right to vote them out if things are going badly; the managers have fiduciary duties to the shareholders; the idea that the managers' duty is to make money for shareholders is taught in business schools and endorsed in the press and generally part of the cultural air that we breathe.  Or not? What are the incentives here? Surely not "be careful with your investors' money and work hard to maximize their returns." It's more like, goofiness leads to notoriety, which leads to attention, which leads to user growth, which leads to fundraising at high valuations, which leads to personal wealth and career longevity, something like that. Everyone makes fun of MoviePass constantly, but somehow it has made Spikes famous as a successful founder. If you start a modestly successful company, or a modestly unsuccessful one, you will have a hard time getting meetings with venture capitalists, but if you start a notoriously, nonsensically money-losing one, you will be a celebrity and investors will be happy to meet you. "This guy really knows how to hack user growth," they will think, and they will not be wrong, though it might be even more accurate to say "this guy really knows how to hack VC attention."  Maybe this is even correct! I can easily believe that in certain industries user growth and network effects are the most important things, and that venture capitalists should prioritize them above profitability. I am not saying that anyone is acting irrationally by flinging money at the founder of MoviePass in the hopes that he can deliver another MoviePass. I am just saying that it creates some strange incentives for managers. A basket of options The basic economics of managing a hedge fund are that you invest your clients' money for them, and if it goes up then you take 20% of the upside, and if it goes down you apologize. The apology is free. This is an asymmetric payoff profile, and there are good reasons for it—it properly incentivizes you to take risks, it rewards you for success, etc.—though it can be kind of awkward if you have a run of bad years. But that is not our problem here. For our purposes the point is just that the asymmetric payoff profile looks like a call option on (20% of) the portfolio: If the portfolio goes up, the manager makes money; if it goes down, he's flat.  Let's say you're a fundamental activist equity manager and you buy 10 stocks, all in the same size. If eight go up 20% and two go down 20%, then your portfolio returns 12%, and you get 20% of that. If two go up 20% and eight go down 20%, then your portfolio returns negative 12%, and you get nothing. (Well, you probably get your fixed management fee.) In a sense that's pretty good; your clients got worse than nothing. But in another sense, look, you did pick two stocks that went up. Where is your trophy for that? Shouldn't you get 20% of those gains? What? I don't know. Here's a story about Bill Ackman: When Pershing Square CEO Bill Ackman sold out of his investment in ADP last month, he crystalized his first performance fee in years. No matter what happens in the market — or the rest of its portfolio — Pershing Square will be pocketing a $60 million performance fee this year from the co-investment fund he raised to invest in ADP, according to Institutional Investor's calculations. It will be the first year since 2014 that the firm is guaranteed to earn a performance fee. … The ADP gains in the main hedge funds will contribute to Pershing Square's efforts in hitting its high-water mark — but they can't guarantee it. (All the funds except publicly traded Pershing Square Holdings have already hit that milestone, but they still have to hold into the gains until year end to earn the fee.)  That's not the case for about $321 million of that profit that accrued to the co-investment vehicle Ackman had raised to invest solely in ADP. That fund gained 49.7 percent, or 22.1 percent annualized over the two years of the fund's existence, it disclosed in a letter to those investors. … That fund also provided some much-needed incentive fees for Pershing Square. Pershing Square VI required the ADP investment to meet a hurdle rate of 10 percent before investors would have to pay a 20 percent incentive fee — considered high by co-investment standards.  The $500 million original investment was worth $821.8 million at the end of July, according to Pershing Square. That would translate into about $60 million in performance fees for Pershing Square.  The thing I remember best from my days of building and marketing derivatives is probably "a basket of options is worth more than an option on a basket." If you invest in 10 stocks, and get 20% of the upside on each stock, that is better than getting 20% of the upside on all of the stocks, as Ackman pleasingly illustrates here.  Supervision A weird thing about banks in the U.S. is that they have government officials—called "supervisors," working for the Federal Reserve, the Office of the Comptroller of the Currency or other agencies—who can show up at the bank any time and tell them what to do. Not in the sense that, if the supervisors see the bank breaking the law, they can say "cut that out." In the sense that, if the supervisors see something that they don't like but that is perfectly legal, they can say "cut that out." Their mandate is to stop "unsafe and unsound conduct," and their "discretionary authority" to do that is "liberally construed" by courts.[4] We don't talk about this much around here. We don't talk about it in part because it is sort of invisible: Supervisory actions are often confidential, and so you only rarely hear about supervisors taking big discretionary actions. (There are exceptions; bank supervisors secretly prevented JPMorgan Chase & Co. from opening branches in new states, and the news got out. Also the Federal Reserve's stress tests are supervisory and public, and we talk about them from time to time.) It is also not clear that supervisors use their discretion all that aggressively. There are, after all, a lot of rules that apply to banks, and regulators and supervisors are busy enough enforcing them. And there is a sort of rule-of-law sense that the government should just enforce clear written generally applicable rules, rather than whimsically second-guessing the business decisions of private companies. But here is a fascinating new paper by Lev Menand on "The Monetary Basis of Bank Supervision." Menand traces the history of safety-and-soundness supervision and argues that it derives from banks' role as issuers of money. Historically banks, unlike other businesses (but like the government), are in the business of creating money, originally by issuing bank notes but in recent centuries mostly by issuing deposits and letting people pay for stuff with them. Most people pay for a lot of their stuff without ever touching government-issued currency; they use checks and debit cards and electronic bank transfers to move bank deposits from one place to another. Those deposits are money issued by banks, and at least at the origins of this system, it was pretty clear to everyone that the banks were doing that with a sort of franchise from the government. And because this was a state power that was delegated to the banks, the state kept the ability to supervise the banks' use of it, and to make sure that the money they issued was "safe and sound." Menand: This Article advances a new theory of supervisory law, one that better comports with the law's legislative history and the safety and soundness mandate as it was originally understood. It begins with a view of banking that predominated when supervisory law was written. On this view, banks are not just another species of for-profit lender. Banks serve a governmental function by augmenting the money supply. Banks do this by issuing short-term promises to pay "base" money—historically, gold and silver coin; today, Federal Reserve Notes—and by issuing more of these promises than there exists base money in the economy. In the eighteenth and nineteenth centuries, these promises often took physical form and were called "bank notes"; today, they are mostly recorded in ledger entries and are called "deposits." The legislators who invented bank supervision thought of banks as a kind of mint. And as minting money is a sovereign power, privately-owned mints were thought to exercise what A. C. Flagg—one of the world's first bank supervisors—described as delegated authority. Supervisors, in turn, were seen as monetary officials—the state's "currency cops." Supervisors were not commissioned to "intervene" in private market activity; supervisors, exercising the powers of a franchisor, were charged with ensuring that bank-issued money was sound and that the monetary system was safe. This explains, for instance, why a big U.S. banking supervisor is called the Comptroller of the Currency: The job was historically conceived as being about making sure that bank money was good money. There is a lot of fun history in the paper, including some Modern Monetary Theory from Alexander Hamilton ("Every loan which a bank makes is in its first shape a credit given to the borrower on its books") and a description of modern bank regulation as an outgrowth of supervision: As mentioned, supervision predates the modern regulatory apparatus, which was put in place to assist supervisors, not the other way around. For example, the modern capital rules grew out of supervisory guidance issued under § 1818 in the 1980s. That guidance was designed to clarify supervisory expectations during a period of historically low capital levels and declining profitability so that banks would not be surprised by cease and desist orders. It was only subsequent policy changes that led scholars to see supervision as a gap-filler instead of regulation as a failsafe. What does this story mean for bank supervision in 2019? Menand makes two sorts of argument. One is basically that bank supervision should be stricter, that some things that modern banks do—derivatives, etc.—undermine the safety and soundness of the money claims that they issue and should be banned by regulators. I don't know; I actually think that modern financial regulation (and the Fed, and deposit insurance, etc.) do a pretty good job of making sure that bank deposits are sound money, and are explicitly intended to do so. Compared to, like, the 1860s, modern America seems to have a pretty high level of confidence that a dollar in a checking account will be worth a dollar.  But the other argument is that bank supervision should be extended to "money claims" issued by non-banks, like money-market mutual funds and repo borrowers: Even after recent reforms, money market funds compete with bank deposits and pose threats to monetary stability. ... The biggest problem with shadow money issuers is not their size, complexity, or interconnectedness—their "systemic importance"; it is the fact that they are issuing money instruments without a license to do so. If Congress still wants supervisors to ensure safe and sound money, it should consider expanding their purview to cover all inside monies, either by extending their mandate to all shadow issuers or by restricting issuance to licensed, supervised banks. Indeed, the legislators who wrote our supervisory laws never expected supervisors to oversee only a part of the private money augmentation business. When Congress imported safety and soundness into the U.S. Code in 1933 and expanded supervisors' remedial powers in the 1960s, banks issued nearly all the "inside" money in the economy. It was not until the last few decades that nonbanks entered the banking business without a license and began issuing short-term debts that function as money and that cannibalize deposit credits. We have talked before about related theories, for instance Morgan Ricks's argument that also "sees money creation as an intrinsically public activity that is then outsourced" and calls for utility-like regulation of the issuance of money claims. This sort of regulation might ban non-banks from issuing very-short-term debt that is treated by its holders as the equivalent of money, because that sort of debt is money and should only be issued by regulated (and supervised) banks under a public franchise. On this theory, issuing overnight IOUs is not a regular commercial activity that anyone is free to get into; it is a form of minting money, and if you do it without a license you are effectively counterfeiting.  There is by the way a third possible conclusion. There were good historical reasons for governments to charter banks to provide the money supply, but it is not totally obvious that those reasons still apply. The Federal Reserve has computers now, and will offer real-time payment processing by, um, 2024. One could at least imagine a world in which the Fed just let everyone keep a bank account at the Fed, rather than effectively franchising banks to provide deposit money. And people have imagined that world. We have talked a few times, for instance, about TNB USA Inc., a "narrow bank" that would just take customers' money and deposit it directly at the Fed. (Ironically it can't seem to get a government franchise to do this.) In fact Menand has imagined it; we talked last year about a proposal by Ricks, John Crawford and Menand to give "the general public—individuals, businesses, and institutions—the option to have a bank account at the Federal Reserve." If the essential concern of bank supervision is the soundness of the currency, then offering an unlimited amount of perfectly sound Federal Reserve money to anyone who wants it would seem to solve most of the problem.  Blockchain blockchain blockchain When would you have guessed was the busiest time for companies pivoting to blockchain? I would have confidently said December 2017, when the price of Bitcoin peaked and Long Island Iced Tea Corp. announced that it was changing its name to Long Blockchain, a thing that we have talked about several times even though every time I type it I worry that I must have dreamed it. And that's close! The actual answer is apparently the first quarter of 2018, right after the Bitcoin peak.[5] Here are a blog post and related Management Science article from Stephanie Cheng, Gus De Franco, Haibo Jiang and Pengkai Lin: In January 2018, Securities and Exchange Commission Chairman Jay Clayton highlighted a growing trend of blockchain disclosures from public firms with no meaningful track record in blockchain technology. Our paper aims to answer whether public firms opportunistically disclose their blockchain activities and how investors react to these disclosures. ... We review each firm's initial blockchain disclosure and classify the company as a Speculative (Existing) company if its initial blockchain 8-K reveals that the company lacks (has) a significant commitment to or a track record in blockchain technology. Speculative firms are more likely to mention blockchain in a vague way and issue blockchain 8-Ks in the context of board member changes, future plans, developments involving subsidiaries, or investments. Conversely, Existing firms disclose news about more substantive topics that arguably should result in these firms gaining greater economic exposure to the potential success of blockchain technology. Such subjects include mergers and acquisitions, products and services, acceptance of bitcoin payment, and customer exposure. Speculative firms' 8-Ks are more consistent with hyping the firms' exposure to blockchain technology, whereas Existing firms' 8-Ks are more consistent with not hyping the firms' blockchain exposure. Figure 2 plots these initial blockchain disclosures as well as the Bitcoin price on a quarterly basis. We observe that blockchain disclosures and Bitcoin price move together (with a small lag) over time.  You might think that the transformative power of blockchain technology would be independent of the price of Bitcoin and that corporate interest in blockchain projects would simply grow over time rather than bouncing up and down with public attention to cryptocurrencies hahahaha no obviously you would not think that, come on. Anyway yeah companies pivot to blockchain when there's a lot of Bitcoin hype and not when there isn't. An event This afternoon I will be doing a conversation with Patrick McKenzie of Stripe Inc. about tech and finance topics. It will be livestreamed on Bloomberg Opinion's Periscope, and on the Bloomberg Terminal at LIVE , starting at 3pm Eastern time today, August 7. (A recorded and edited version will eventually follow.)  Things happen Does SoftBank Really Have $108 Billion for Its Vision Fund 2? SoftBank's Profit Beat Shows Its Vision Fund Is Delivering. Chat app Kik fights back against SEC's cryptocurrency lawsuit. New Tax Laws Drive More Americans Into Muni Bonds. WeWork Wanted to Land Video Deals With NBC and Martin Scorsese. Tesla received a cease-and-desist letter from US agency over Model 3 safety claims. Blankfein and Bezos Party With Geffen on a Yacht in the Balearics. Asparagus Makes Way for Weed in Canada's Fields. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] Of course there is. [2] MoviePass was never a unicorn: It was owned by a public company, for one thing, and never seems to have raised money at a billion-dollar valuation. But I am asserting a more general proposition here. [3] I mean, I oversimplify; generally things are not entirely in the managers' control either, and the models normally leave room for some random chance such that even loyal and diligent managers can fail. But the manager is the active party compared to the investor, anyway, classically. [4] Here I am quoting Menand quoting the D.C. Circuit Court of Appeals. [5] Technically the authors break things down by quarter, and it's possible that the biggest *month* for pivots was December 2017, but I don't know and accept their view that there's probably a lag between Bitcoin price and blockchain pivots. You gotta take time to write the 8-K, at least, and maybe even to develop some sort of blockchain business plan.

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