PandeMAC[1] If you agreed to buy a company in the Before Times, you probably do not want to buy it anymore, at least not at the price you agreed to back then. If, for instance, you are SoftBank Group Corp., and you agreed to buy $3 billion worth of WeWork stock last October, that seems crazy now: People have stopped going to WeWorks, revenue is way down, and $3 billion worth of WeWork stock (at October prices) is not worth anything close to $3 billion. Or if you are private-equity firm Sycamore Partners, and you agreed to buy 55% of the Victoria's Secret retail clothing chain for $525 million in, wow, late February, you probably regret it: Retailers are closing up stores and furloughing workers, nobody is going out to malls to buy bras, and $525 million of Victoria's Secret stock isn't worth $525 million anymore. Now, if you agreed to buy a company in the Before Times, and then you closed the deal in the Before Times—you handed over the money and got the shares—you are out of luck; now you are stuck with a company that has no revenue. If you were negotiating a deal in the Before Times, but you didn't sign anything before the coronavirus hit, you are in luck; now you can keep your money and stop answering the phone when the company calls. But there are plenty of buyers in SoftBank's, or Sycamore's, position: They signed an agreement to buy a company in the Before Times,[2] but didn't close the deal before the virus hit. They still have their money, though they have promised to hand it over in exchange for the company. The money looks a lot more attractive than the company does, though, now. If you're in that position, can you get out of it? You have a contract. The contract says that there are certain circumstances in which you can walk away from the deal. These circumstances are pretty limited. Merger agreements tend to be less like "if the buyer changes its mind it can walk away" and more like "this deal will close unless the world ends." Well but now the world has ended, and Sycamore Partners has sued L Brands Inc.—the current owner of Victoria's Secret—to get out of its deal. Presumably there will be more cases like this, and Sycamore's complaint is an interesting example of how buyers might try to get out of their deals. Merger agreements typically have a clause called the "material adverse effect" (MAE, or "material adverse change," MAC) clause, which says that if the target's business gets drastically worse then the buyer can walk away. In the Victoria's Secret agreement it goes like this[3]: Since the Reference Date [Nov. 2, 2019], there has not been any state of facts, circumstance, condition, event, change, development, occurrence, result or effect that has had or would reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect. You might naively think, well, right, there has definitely definitely definitely been a Material Adverse Effect on Victoria's Secret's business, insofar as that business is closed. But it doesn't work that way! There is a long and detailed definition of "Material Adverse Effect,"[4] and the bulk of it is a list of exceptions. If really bad stuff happens to Victoria's Secret's business, Sycamore can walk away from the deal, unless the bad stuff is due to, essentially, anything anyone thought of in advance. If the business gets worse due to "national, international, foreign, domestic or regional social or political conditions (including changes therein) or events in general," that doesn't count as an MAE, and Sycamore can't walk away. "Events in general"! Did Victoria's Secret get worse because of events in general? I mean, yes? But that's just the first exception; there are lots more. "Changes or conditions generally affecting the industry" that Victoria's Secret is in: not an MAE. "Changes in any economic, financial, monetary, debt, credit, capital or banking markets or conditions": not an MAE. L Brands has lots of arguments that the collapse of its business doesn't count as an MAE. But it doesn't need any of them, because there's another, more specific exception: Changes to Victoria's Secret's business caused by "the existence, occurrence or continuation of any pandemics, tsunamis, typhoons, hail storms, blizzards, tornadoes, droughts, cyclones, earthquakes, floods, hurricanes, tropical storms, fires or other natural or manmade disasters or acts of God or any national, international or regional calamity" don't count as an MAE. It's right there in the contract! If Victoria's Secret's business gets worse because of a pandemic, Sycamore still has to buy it. The MAE does not help.[5] Ahh but the contract is long—101 pages—and it says lots of things, and you'd better believe that Sycamore's lawyers have gone through it carefully looking for other reasons not to close.[6] Here's the hook that Sycamore has hung its argument on: Less than one month after L Brands entered into the Transaction Agreement with Plaintiff, however, it closed nearly all of its approximately 1,600 Victoria's Secret and PINK brick and mortar locations globally, including all 1,091 of its Victoria's Secret and PINK stores in the United States and Canada. More importantly however, L Brands also took the following voluntary actions with respect to the Victoria's Secret Business: furloughed most of the employees of the Victoria's Secret Business; reduced by 20% the base compensation of all employees at the level of senior vice president and above, and deferred annual merit increases for 2020; drastically reduced new merchandise receipts which, when coupled with L Brands' failure to dispose of existing out-of-season, obsolete and excess merchandise, has saddled the Victoria's Secret Business with a stock of merchandise of greatly diminished value; and failed to pay rent during April 2020 for its retail stores in the United States. All of these actions were taken by L Brands in violation of the Transaction Agreement. Yes, right, the world ended, no one was coming to stores, often stores weren't allowed to be open; lots of retailers closed their stores and furloughed their workers. All of this stuff sounds like another way of saying "Victoria's Secret's business collapsed due to a pandemic." But not quite, argues Sycamore: That these actions were taken as a result of or in response to the COVID-19 pandemic is no defense to L Brands' clear breaches of the Transaction Agreement. Specifically, L Brands agreed that a condition to Plaintiff's obligation to close the Transaction is that L Brands "shall have performed in all material respects all of its other obligations [under the Transaction Agreement] required to be performed by it on or prior to the Closing Date." Those obligations included L Brands' covenant that it "shall and shall cause its Subsidiaries to conduct the Business in the ordinary course consistent with past practice." See, one condition of closing the acquisition is that there hasn't been an MAE on Victoria's Secret's business; that business has collapsed, but not in a way that counts as an MAE. But another condition of closing the acquisition is that L Brands has done everything that it agreed to do in the merger agreement, and one thing that it agreed to do—one thing that targets and sellers always agree to do, a standard piece of boilerplate that no one thinks too much about—is to conduct Victoria's Secret's business "in the ordinary course consistent with past practice."[7] If you agree to buy a successful retail business and then the seller stops maintaining the stores and starts being rude to customers, you are not getting what you bargained for; of course the seller should agree to keep running the stores the way it always has. Except that the world ended and L Brands can't run Victoria's Secret the way it always has. So it shut down stores, and Sycamore said, gotcha, you are not running your business "in the ordinary course consistent with past practice," so we can walk away. I assert that there are zero businesses in the United States right now that are running "in the ordinary course consistent with past practice," but that's not the point; the point is that the contract says Victoria's Secret has to act normally, and this covenant, unlike the MAE, has no exception for pandemics. Sycamore says: The financial position of the Victoria's Secret Business has taken a devastating hit as a result of L Brands' material breaches of the Transaction Agreement. The impact of just the actions taken that have been publicly disclosed: the loss of experience and skill of the Victoria's Secret Business employees that have been furloughed that will never return to work for Victoria's Secret; the cost and disruption of onboarding replacement employees and furloughed employees; the negative impact of salary cuts and furloughs on employee morale and retention; the lost sales, increased markdowns and reduction in cash flows resulting from the stockpiling of out-of-season, obsolete and excess merchandise; and the long-term damage to relationships with landlords associated with not paying rent, all has caused incalculable damage to the Victoria's Secret Business. The negotiated terms of the Transaction Agreement are clear. Until the closing, L Brands was required to operate the Victoria's Secret Business in the ordinary course of business consistent with past practice. The plain and simple fact is that L Brands has materially breached this covenant in a myriad of ways that have materially and irreparably damaged the Victoria's Secret Business and impaired its value. What remains of the Victoria's Secret Business is not what Buyer agreed to purchase under the Transaction Agreement. That last sentence is clearly true; it's clearly true of pretty much any business that any buyer agreed to purchase in the Before Times. None of those buyers are getting what they wanted. The question is whether all those buyers can get out of all those deals.[8] I don't know? There is something that feels a bit too cute about this argument; the agreement put the risk of a pandemic ruining the business on the buyer, so letting the buyer out of the deal because a pandemic ruined the business seems to violate the spirit of the thing.[9] The coronavirus pandemic, and the governmental and business response to it, is so completely abnormal that merger agreements—business agreements in general, really—were not ready for it. A basic boilerplate requirement of all merger agreements is that the seller has to act normally between signing and closing, and acting normally is the one thing that no one can do right now. USO Let's say you run an index fund. You are good at it, you keep expenses low and track your index faithfully, and every year your returns exactly match the returns of your benchmark index. Then you meet a genie, who offers you the following proposition: You can always outperform your benchmark, by a reasonable, randomly varying amount. Some years you will outperform your benchmark by 0.25%, sometimes by 1.5%, whatever. You will never underperform; your investors, who bought your fund for exposure to a specific index, will always get at least the performance of that index. Should you accept? I mean, fundamentally, yes, duh, of course. More money is better than less money. Investors buy an index fund not because they love indexes but because they think it maximizes their chance of reliably making money, and if you can give them the index return plus more money then that is strictly better for them. There are practical objections. You will have tracking error, always in one direction, always positive, but tracking error nonetheless. Astute institutional allocators will ask you about it: "Why does your performance not track the index particularly well?" You will reply: "Well it's always higher, see?" They will reply: "Yes, but the fact that you don't track the index perfectly makes us worry that you are doing something risky and will eventually underperform it; what is the repeatable, reliable process by which you outperform the index?" You will reply: "Well I've got this genie." Weird reply! Still in general it seems like consistently outperforming your index would be such an obvious win for your investors that you'd want to do it. (And in fact there are "enhanced index funds," which shoot for this sort of thing, though of course they don't have genies so they can't guarantee it.) Now let's change one thing in the hypothetical: Instead of running an index fund, you run an exchange-traded fund, benchmarked to the same index. It's a different technical structure, but it is also, I think, a different philosophy. An index fund is a pot of money that would like to get the highest possible returns, and that is passively invested in an index because of a (quite well supported) belief that that's the best way to maximize returns. An index ETF is a machine to replicate an index, a quasi-derivative, a single tradable security that can be substituted for the index anywhere the index appears. Its purpose is not to maximize expected returns but to provide the experience of the index as precisely as possible. The ETF's users are different from the users of regular index funds. Regular index-fund users are investors who want to have more money at retirement. ETFs have users like that too. But they are also used by short sellers, who use them to bet against the index, or to hedge other, related positions. If the ETF significantly outperforms the index, short sellers will not get the experience they expected; their hedges won't work, their bets won't pay off. ETF market makers—the brokers and trading firms that buy and sell the ETF's shares from and to regular customers—also sometimes have to go short to provide liquidity to investors, and might hedge those shorts by buying the underlying stuff in the index; if the ETF doesn't track the index then the market makers will be burned. ETF arbitrageurs who keep the price of the ETF in line with the index rely on the expectation that the price of the ETF should track the index, that ETF shares are convertible into the underlying stuff in the index; if this expectation is wrong then the arbitrage doesn't work. Unlike a regular index fund—which takes your money and buys stuff with it—the ETF relies on this ecosystem of market makers and arbitrageurs; if you want to buy shares of an ETF you buy them in the market, from a market maker, not from the ETF sponsor. Short selling can also drive growth in an ETF's assets, as Izabella Kaminska explains here. So the whole system of ETFs is built around accuracy in both directions; an ETF that outperforms its benchmark is good for long holders but bad for short sellers and arbitrageurs and market makers, so it doesn't work. I find this so unintuitive that I am surprised every time I notice it again. Here, for instance, is a story from Bloomberg's Luke Kawa and Katherine Greifeld about the United States Oil Fund LP, or USO, the big oil ETF that has been in the news a lot this week. USO's basic business is holding near-term West Texas Intermediate crude oil futures, and those futures have developed a new and worrying ability to go negative. USO's futures never went negative—the May WTI contract went negative on Monday, well after USO had rolled out of it into the June and later contracts—but the fact that near-term oil futures can go negative is a problem for an ETF. The ETF can't go negative—if USO's contracts go negative, USO can't go ask its shareholders for more money—so there is a potentially problematic mismatch, a possibility that USO could owe more money on its oil futures than it has. USO has addressed this concern by, basically, changing its model from "we will buy front-month WTI oil futures" to "we'll buy some oily stuff but it may not be what you expect," with more discretion and a higher reliance on longer-dated contracts. Kawa and Greifeld write that "moving money to longer-dated contracts means the fund is incurring roll costs, but is protecting against the possibility of having its net asset value fall below zero in the event that front-month oil futures turn deeply negative again." We discussed this move yesterday, and I said that it was "the right approach, really," but I was thinking of USO as, like, an investment. If you own an investment, you would prefer that it not have a negative value! If your investment manager takes steps to prevent your investment from having a negative value (or, for USO shareholders, a zero value), that is probably a good thing. But from the ETF perspective it is not: At the same time, frantic reshuffling of its holdings has wrecked any claim the ETF has to being a passive product. In its filings, U.S. Oil Fund repeatedly notes that the strategy untethers it from its stated investment objective. "In an attempt to save the fund and boost its price, they have destroyed the utility of the product," said Peter Cecchini, Cantor Fitzgerald's chief market strategist. That struck me, at first, as a weird thing to say. If you do things to increase the price of an investment product, and those things work, then you have clearly increased the utility of the product, because the purpose of an investment product is to go up in value. But of course Cecchini is right and I was wrong: The utility of an ETF is not about going up in price; it's about being a reliable substitute for some other financial index, here, an index of near-term oil futures. If you are in the business of trading financial instruments linked to oil, an oil ETF that tracks near-term futures prices in a predictable way is a useful tool, something that you can buy or sell to hedge other positions or to express a specific view on oil prices. An oil ETF whose mission is "make money, try not to go below zero, and be generally oily" is useless, for a professional; it can't be arbitraged, it can't be one leg of a hedged position. It's just an active investment product, and you don't want that. Elsewhere in oil futures, CME Group Inc., which administers the WTI futures that went negative, has mixed feelings about them: CME Chairman and Chief Executive Terrence Duffy said in an interview that WTI futures worked as designed, and their foray into negative territory was a signal of real market forces at work. "It's not a price that makes you feel good," he said. "But the reality is, there is oversupply, there is under-demand that's virus-driven, and there is nowhere to put the stuff." Still, the episode has raised suspicions of abusive trading. In a Tuesday letter signed by oil tycoon Harold Hamm, executive chairman of Continental Resources Inc., the company asked CME's regulator, the U.S. Commodity Futures Trading Commission, to investigate whether "possible market manipulation, failed systems or computer programming failures" caused the drop into subzero prices. I suspect both of them have a point. As I wrote yesterday, it's pretty easy to understand how the lack of demand for oil, and the lack of places to put it, could make prices negative. On the other hand prices actually went negative only briefly, for relatively few trades, and when they did they went very negative very quickly. It just looks a bit more like "something broke a bit in the market" than like "actually the price people put on oil is negative $37.63." And elsewhere in oil: "A historic decline in energy demand that has led refiners to make less fuel and caused storage tanks to fill up with crude is pushing Gulf Coast producers to shut down high-cost wells in both shallow and deep federal waters." There are weird aspects of the recent wild moves in energy prices, but this isn't one of them! If you embark on expensive and risky quests into dangerous and inhospitable parts of the planet to extract a dangerous but precious resource, and then the price of that resource collapses and it stops being precious, you should stop doing those quests! Just go home to your family instead of helicoptering out to a platform in the ocean to pump oil that no one wants! That is some pretty basic economics. People are worried about unicorn liquidity There was a time, a few years ago, when everyone was worried about bond market liquidity, and everyone's response was to set up electronic trading venues for bonds. It was hard to buy and sell bonds, was the theory, and the solution was to get everyone in one place, electronically, where they could all buy and sell bonds with each other. As a theory this is not terrible, but the problem is that it kept occurring to different people, so there was a new electronic bond trading platform every week. Getting everyone on one platform to trade bonds might or might not improve liquidity, but getting people on 100 new platforms to trade bonds will not, because if you want to buy a bond on platform 26 and someone else wants to sell it on platform 71, you will never meet. Everyone noticed this problem, but their solution was always another platform, which just made it worse. There is a relevant xkcd. We are not quite there yet with electronic trading venues for private companies but it's off on the horizon somewhere: One of the top electronic trading firms at the New York Stock Exchange plans to launch a new online marketplace where investors can buy and sell shares of private companies. New York-based GTS is set to unveil the venture, called ClearList, later Wednesday. The first transactions on ClearList could come within a month, executives of GTS and ClearList said. The venture may appeal to investors hoping to get in early on the next Facebook Inc. or Zoom Video Communications Inc., at a time when companies have been waiting longer to hold initial public offerings. "There's been frustration among our clients at their lack of ability to participate in early-stage investments," said Steve Quirk, an executive vice president at TD Ameritrade Holding Corp. and senior adviser to ClearList. Other backers of ClearList include hedge-fund billionaire Paul Tudor Jones, whose firm, Tudor Investment Corp., is a minority investor in the venture. To be sure, ClearList is far from the first effort to create an exchange-like marketplace for shares of companies that aren't yet public. But GTS—the majority owner of ClearList—is betting it can build a more vibrant marketplace than existing private-shares trading platforms, by acting as the main dealer for shares on ClearList. Ah actually that last part is kind of cool: A key difference between ClearList and its rivals is that GTS plans to continually buy and sell shares on ClearList, much like it does on the NYSE, where GTS is a designated market maker. Such firms oversee IPOs and help ensure orderly trading in stocks of NYSE-listed companies. GTS's trading will help ensure that ClearList's users can always see prices for private-company shares, and buy or sell at those prices, because GTS will take the other side of the trade. On the websites that presently offer trading in pre-IPO shares, availability can be sporadic, with shares intermittently cropping up for sale as company insiders sell chunks of stock. Back in the Before Times, when the soaring valuation of tech unicorns was a thing, I often used to say that "private markets are the new public markets." If you ran a successful private company, and you didn't want to go public but there was some feature of being public that you liked, you could probably get it. You could become a household name, you could raise billions of dollars at 11-digit valuations from mutual funds and individual investors, you could offer employees and early investors secondary-market liquidity, etc., all while staying private. Pretty soon, if the feature that you like about public markets is "I want a high-frequency trading firm to make continuous two-sided markets in my stock," you'll apparently be able to get it. On the one hand I have trouble imagining a lot of tech-company founders thinking exactly that. High-frequency traders are often viewed, by CEOs, as a bad part of public markets. On the other hand if I had to pick the one most important feature that makes public markets different from private ones, I might go with "high-frequency traders make continuous two-sided markets in public stocks." What makes a stock public, in practical terms, is mostly that you can always go to the exchange and buy or sell a large amount of it, instantly, anonymously, without personally tracking down a buyer and negotiating terms and seeking permissions. If GTS will do that for private companies, why bother going public? How's Martin Shkreli doing? Well, he's keeping busy. There's the biochemical research: Martin Shkreli asked a federal judge to release him early from prison, saying he "has been conducting significant research into developing molecules to inhibit the coronavirus" and would continue doing so if set free. … "Mr. Shkreli has spent countless hours while incarcerated researching disease treatments and possible cures for Covid-19," his lawyers wrote. "His current project has been well received. One company is prepared to begin working on clinical trials of Mr. Shkreli's work within weeks." But it's not all work and no play, for Martin Shkreli, in prison; he has also found time for romance: The 37-year-old disgraced Pharma Bro has a fiancée, his attorneys said Wednesday in a compassionate release request to spring Shkreli from a minimum-security prison in Pennsylvania. Shkreli is asking to spend the remainder of his seven-year sentence with his bride-to-be — whose name is redacted in court papers — at her Manhattan apartment so that he can, they say, work on a coronavirus cure. Look if they let him out and he cures coronavirus, he's got my vote for president, let's make this simulation as dumb as possible. Things happen U.S. Jobless Claims at 4.43 Million in Rout's Fifth Week. Coronavirus Made America's Biggest Banks Even Bigger. Argentina wrestles with creditors over repayments as default looms. Rating agencies put 1,000 CLO slices on review for downgrade. Anguish Grows in Russia Oil Industry Overwhelmed By Price Crash. Rosneft on brink of closing trading arm hit by US sanctions. Venture Capitalist Bill Gurley Isn't Joining Benchmark's Next Fund. Norway oil fund chief admits he 'screwed up' in flight scandal. 'Pure Hell for Victims' as Stimulus Programs Draw a Flood of Scammers. Three Hours Longer, the Pandemic Workday Has Obliterated Work-Life Balance. Lockdowns lower personal grooming standards, says Unilever. 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] This pun is stolen from CNBC's Leslie Picker on Twitter. [2] I say "buy a company" but really this could be buying a company, or buying a part of a company, or buying stock in a company, etc. SoftBank is already a huge WeWork owner—it paid a lot of money, and obtained majority control, back in October—but it has a deal to buy more. Victoria's Secret is a business line of L Brands (or, really, several business lines), not an independent company, and Sycamore agreed to buy 55% of it, not 100%. [3] This is Section 3.09 (page 36) of the Transaction Agreement, "Absence of Certain Changes." [4] It's on pages 10-11 of the Transaction Agreement. [5] This is oversimplified. There are two prongs of the MAE; loosely speaking, it's an MAE if (1) L Brands can't perform under the agreement or (2) the business collapses. The MAE exceptions (like the pandemic exception) apply only to the second, business-collapsing prong; there are no exceptions if L Brands can't perform under the agreement. Sycamore argues, on page 11 of its complaint, that (1) there has been an MAE preventing L Brands from fulfilling its obligations under the agreement, and (2) the pandemic exception doesn't apply here, because it's an MAE under the first prong of the definition. This is essentially secondary to Sycamore's argument that L Brands hasn't complied with its covenants: If L Brands hasn't complied with its covenants, then that's an independent reason for Sycamore not to have to close. But I think the point here is that, if L Brands replies "well we haven't complied with our covenants because that's impossible," Sycamore can respond: "Yes, exactly, it's impossible because the world has changed, but if the world changes in a way that makes it impossible for you to comply with your covenants then that is an MAE, with no exceptions, so we can still get out of the deal." Again it's secondary to the question of whether L Brands has breached the covenants, but it is an important backup to Sycamore's argument. [6] This is what SoftBank did: SoftBank's agreement with WeWork didn't even have an MAE clause; no matter what happened to WeWork's business, SoftBank has to close. But SoftBank found some other reasons—regulatory troubles, hold-ups in a Chinese share swap—and asserted those as reasons not to close, even though everyone knows that the reason SoftBank doesn't want to close is that WeWork's business got worse. [7] The ordinary-course covenant is Section 5.01(a) (page 54) of the Transaction Agreement. The closing condition incorporating it is Section 8.02(a)(ii) (page 89). Section 5.01(b), by the way, contains a long list of specific changes that L Brands isn't allowed to make without Sycamore's permission. They are mostly legal-y and corporate-finance-y things; none of them are like "you can't shut down all the stores and furlough all your workers due to a pandemic." That's not the sort of thing people were thinking about back in, gosh, February. [8] Or, practically speaking, renegotiate them at lower prices. Sycamore has been open to that; its complaint says that it tried to "have an informed negotiation about adjusting the purchase price and other economics of the contemplated acquisition of the Victoria's Secret business to take account of the COVID-19 situation." L Brands, of course, would prefer not to renegotiate the price that it agreed to back in February. [9] But see footnote 5; arguably—arguably—the MAE definition puts the risk of "revenue goes down due to pandemic" on the buyer, but the risk of "it becomes impossible to operate the stores due to pandemic" remains with the seller. Those things are not so different really. | 
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