Programming note: Money Stuff will be off tomorrow, back on Thursday. Nikola warrantsHere was a trade. Nikola Corp., the maybe-one-day-electric-truck-maker that went public via a blank-check merger last month, has a lot of warrants outstanding. Each warrant (ticker NKLAW) allows you to pay $11.50 to buy one share of Nikola common stock (ticker NKLA). The trade was: - Buy one warrant for $24.62.
- Pay $11.50 to exercise the warrant and get a share of stock.
- Sell the stock for $48.84.
You pay $24.62 + $11.50 = $36.12. You get $48.84. Your profit is $12.72. Pretty good, no? You can't do this trade now. Those numbers are closing prices from Friday, back when the trade was good. The numbers are different now: The warrants closed yesterday at $27.10; the stock closed at $38.45. If you do the trade now you'll lose 15 cents, never mind. Up until Friday you could do this trade and make a lot of money—Nikola shares got as high as $79.73 on June 9, when the warrants closed at $29.49, for a profit of $38.74 on this trade—but now you can't. The gap has closed. Well, you couldn't exactly do it before either. You could come tantalizingly close. Nikola's warrants were (and are) publicly traded on Nasdaq and pretty liquid, often trading more than a million warrants a day. The stock is also publicly traded and liquid. So you could buy the warrants and sell the stock. You could not, however, exercise the warrants. The warrants only became exercisable on Friday night, for securities-law reasons that I will tuck down below if you're interested.[1] The point here is that up until Friday, the warrants were a promise that one day soon you'd be able to pay $11.50 for a share of Nikola stock; on Monday, they became an actual immediate option to pay $11.50 for a share of Nikola stock. Still: tantalizingly close. If you have a promise that next week you'll be able to pay $11.50 for a share of stock currently worth $48.84, then that promise should be worth more than $24.62. (It should be worth $37.34, give or take.[2]) If you noticed this trade last week—it was not particularly unnoticed—how could you have done it? One classic way would be: Buy the warrant, sell the stock short, and wait. If you bought the warrant for $24.62 and sold the stock short for $48.84, you would have collected $24.22 in cash. You'd sit on that cash for a weekend, the warrants would become exercisable on Monday, you'd pay $11.50 of your cash to exercise, you'd get back a share of stock and deliver it to close out your short, and you'd keep $12.72. Nice trade. The problem is that you couldn't sell Nikola short: As a relatively new, weird, controversial and heavily shorted public company, it was extremely difficult and expensive to short. At one point in June "borrow fees jumped above 600% of the stock price ... making it by far the most expensive U.S. stock to short." That's an annualized rate that you would pay to borrow and sell the stock short, and if you actually did this trade for a week I suppose it would be profitable,[3] but a 600% stock borrow cost means less "you can borrow the stock if you pay 600% annualized" and more "you will not find anyone to lend you the stock." Clearly somebody did this trade—some 11.5 million shares of Nikola were sold short—but not enough people did it to close the gap between the warrants and the stock. There are variations on that trade involving options, but option prices reflect the price and difficulty of stock borrow, so these variations wouldn't have worked out much better. Here's another approach: Just buy the warrant, don't sell the stock, and wait. If the stock is worth $48.84 on Friday, you might think, the best guess of its value on Monday is $48.84, give or take. If you can pay $24.62 on Friday for the right to acquire it for $11.50 on Monday, for a total cost of $36.12, then you are getting a good deal. Stock prices move around a bit, so you might not make exactly the $12.72 profit implied by those numbers, but there's a lot of room for error there. That trade would have worked okay. If you bought the warrant for $24.62 on Friday, you could have sold it for $27.10 on Monday, for a profit of $2.48. Not $12.72, but greater than zero. Or you could have exercised the warrant on Monday, gotten the stock, and sold the stock for $38.45, for a profit of $2.33.[4] The problem is that the main assumption of the trade was mostly wrong: The stock was worth $48.84 on Friday, but it collapsed to $38.45 on Monday. Why did it collapse? Because the warrants became exercisable: Nikola Corp. shares nosedived on Monday as some investors will now be able to buy the company's stock at a fraction of recent prices. The electric-vehicle company late Friday said a sale of shares related to certain warrants was declared effective, which means the warrant holders will now be able to acquire one share of Nikola at $11.50 -- a 76% discount to Friday's close of $48.84. Apart from those nearly 24 million shares that are now exercisable through warrants, the filing also registered as many as 53.4 million shares held by private investors, such as mutual funds and other large institutions. "We believe the potential for a portion of these 77 million shares to hit the market through early investors selling, could create large technical selling pressure on Nikola stock," Deutsche Bank analyst Emmanuel Rosner said in a Monday note to clients.
You can tell that as a story of "technical selling pressure" but the important thing to recognize was that there was a fundamental price disconnect. The warrants traded on Friday as though the stock was worth about $36 ($24.62 warrant price plus $11.50 exercise price); the stock traded on Friday as though it was worth $48.84. That made no sense, since the warrants and stock were almost interchangeable; somebody was wrong. On Monday, the warrants and stock became entirely interchangeable, and the gap between them really had no choice but to collapse. One way for the gap to collapse would be for the warrants to trade up (until they traded for about $11.50 less than the stock); another way for it to collapse would be for the stock to trade down (until it traded for about $11.50 more than the warrants). Both actually happened—the warrants traded up 10% yesterday, the stock down 21%—but the stock move was much bigger. It turns out that the warrant price was mostly right and the stock price was mostly wrong. This suggests another variation on the trade: If you just owned Nikola stock anyway—because you liked electric trucks and thought it will make good ones, or because you thought other people would think that, etc.—you could have sold that stock, bought the warrants instead, and then turned the warrants into stock after they became exercisable yesterday. The stock and the warrants were two more or less equivalent ways to own Nikola stock, but one (the warrants) was much cheaper than the other. If you owned the stock the expensive way (the stock), why not stop doing that and start owning it the cheap way? I don't have a great answer to that question. I have a bad answer, though, which is, you know, who has even heard of warrants, you just want to buy some of this hot new electric-truck startup, let's keep things simple. For a while Nikola was one of the most popular stocks on Robinhood, the day-trading phone app; the warrants were not. The stock benefitted from hype and publicity and momentum, but the warrants didn't, because they are called "warrants" and weren't mentioned in the first paragraph of all the news articles. If your thesis was "I like Nikola and don't want to think any more about it," you bought the stock. Meanwhile if you bought the warrants your thesis was probably more like "aha a relative value trade, aren't I clever," but the clever relative value trade was actually hard to execute. You couldn't do the things—exercising the warrants, shorting the stock—that would lock in the relative value that you had spotted. So if you bought the warrants you were stuck with a directional bet on Nikola: The practical way to profit was to buy the warrants, wait until you could exercise, and hope that the stock wouldn't go down too much before that happened. That trade worked out okay, but not nearly as well as the relative prices implied; your losses on the directional bet (the stock collapse) ate away most of your profits on the relative-value trade (the warrant being cheap). More to the point, if you noticed the relative-value trade, you might be exactly the sort of person who wouldn't have
wanted to make an unhedged directional bet on Nikola's stock. "Hahaha these idiots have bid up Nikola's stock so much that the warrants are $12 cheap," might be the way that you'd describe the trade, which is not the sort of thing that would make you want to be long Nikola. We talked last month about the Robinhood traders bidding up bankrupt companies like Hertz Global Holdings Inc., and about the "boredom markets hypothesis," my name for the theory that a lot of people seem to have started day-trading stocks in the pandemic because they don't have much else to entertain them. One weird thing in Hertz was that the stock was bid up even as the bonds traded at pennies on the dollar: Professional distressed-debt investors were sure that the bonds would be impaired and the shareholders would recover nothing, while amateur day-traders on Robinhood were confident that it would all work out for the shareholders. Those views were irreconcilable, and they were not reconciled. Just different groups of people, buying the stock and the bonds, each not really understanding what the others were up to. Here, too, the stock and the warrants appealed to two different audiences, and traded at different prices, and the usual tools that financial markets use to reconcile prices of similar instruments with different audiences didn't work. Fake takeoverMeanwhile: As the old stock market adage has it, buy the rumor, sell the fact. For investors who bought shares of Denbury Resources Inc. early Monday, it might be buy the fake news release, sell on the official denial. At 5:51 a.m. New York time, a statement carried by press release service Accesswire and purporting to be from the Texan oil driller said the company received a takeover offer at $1.20 a a share. Denbury's stock more almost tripled in pre-market trading, only to pare those gains after CEO Chris Kendall told Bloomberg News the release was "completely fraudulent." The company said it reported the matter to the New York Stock Exchange. Accesswire later rescinded the announcement, and a spokesman said an investigation is ongoing.
Denbury is trading at around 25 cents a share now, down from as high as $1.62 in January, after missing an interest payment on its debt. I suppose if you are going to try to trick people into buying a stock with a fake takeover press release, it might as well be a small distressed oil company? Maybe that's where the gullible money is? BetasThere are companies that do boring traditional old-timey things; they manufacture ball bearings in factories or burn coal to generate electricity or whatever. And there are companies that do fancy high-tech things; they conduct biochemical experiments to develop new drugs, or program computers to become intelligent or whatever. Traditionally the old-time-y things are "boring," in some subjective aesthetic sense but also specifically in the sense that they tend to be less volatile businesses than the high-tech-y things. Utility companies have been burning coal to generate electricity for decades, they have stable locked-in customers with stable regulated rates, they are steady businesses where not much changes and where future earnings are highly predictable. The demand for ball bearings doesn't change that much from year to year. Meanwhile biotech companies might or might not discover the drugs they want, social-media companies might or might not find ways to scale and monetize, etc.; they are risky bets on the frontiers of human knowledge and you should expect them to have highly variable outcomes. You could tell a story about the coronavirus crisis that goes like this: Normal human activity has been disrupted, we've stopped doing all the things that we've been doing for decades, the ball bearings have stopped rolling, and we are just sitting at home with our intelligent computers and social networks, thinking about vaccines. The cutting-edge stuff carries on undisrupted; the basic stuff of human life has been thrown into chaos. The boring things are risky, the risky things are stable. That is an exaggerated oversimplified story but it is kind of what stock prices say? Here's a Wall Street Journal article about betas: A beta of 1 indicates a stock generally moves in lockstep with a benchmark, like the S&P 500, while a beta of 1.5 indicates a stock tends to rise 1.5% when there is a 1% gain in the index. ... The average beta of the technology sector dropped to 1.10 from 1.37, while that of the NYSE Arca Pharmaceutical Index fell to 0.81 from 1.11. Technology has led the way in the S&P 500 this year, with a gain of 20%, while the pharmaceutical index has gained 2.6%, outperforming the S&P 500. … The average betas of the real estate and utilities sectors of the S&P 500 rose to 1.16 and 1.05, respectively, from 0.43 and 0.27 in 2019, according to the George Mason data. That suggests those groups were posting bigger gains and losses than the broader index during the pandemic—and were previously more muted. Both groups have badly trailed the wider market this year.
Usually when markets go up a lot, utilities stocks go up a little, because utilities are boring and do not have a ton of leverage to the economy. Except now, when the economy has crashed because activity has stopped, so utilities are, relatively speaking, a white-knuckled ride. Meanwhile usually when markets go up, tech stocks go up even more, because tech stocks are more levered bets on an optimistic view of the future of the economy. Except now when videochatting on your computer pretty much is the economy. (Actually Zoom Videocommunications Inc., the big videochat company, now has a negative beta; its software has replaced the economy, so to the extent the economy comes back Zoom will go down.) As a matter of, like, which stocks to buy, this is weird enough. "Buy safe stocks like biotech companies and tech startups and stay away from risky bets like, uh, the entire physical economy," would I suppose be the advice to conservative investors? That's not my investing advice or anything but: "If you're managing somebody's money, typically if that person's young or wants to take on more risk, you would add work-from-home stocks, you would add pharmaceutical and biotech, you would add IT companies to their portfolio," Mr. Horstmeyer said. "Now you have to do the opposite." ... "There's a new factor in town, and it's corona," said Stephen Dover, head of equities at Franklin Templeton. "At least traditionally, the way that you think of beta is that a higher beta is associated with both higher volatility and potentially higher return. And now you have a situation with a few stocks that have higher return but have lower volatility."
But it's also just a measure of the weirdness of this time. The way you'll know things are back to normal is when the boring stocks are boring again. Fake it til you get caughtOne thing that you do not see a lot of is private tech startups that raise money from professional venture capitalists and turn out to be complete frauds. Theranos Inc. probably fits that description, and was big and famous, but there aren't a ton of others. I don't know why that is. One possible explanation is that professional venture capitalists are good at due diligence, and are rarely swindled by pure frauds. Another good one is that the line between "pure fraud" and "visionary tech company working on a difficult unsolved problem, optimistically telling investors that it can solve the problem, and ultimately failing to solve that problem and going bust" is a little blurry. If you're an early-stage venture capitalist, your whole job is to invest in companies that haven't quite figured things out yet. If they never do figure things out, you will have wasted your money, but that's okay; you take a portfolio approach, making a lot of low-probability-but-high-payoff bets and hoping that a few will transform the world and make you a lot of money. And if one or two of those bets are on people who never planned to figure things out, and who just stole your money, it might not be in your interests to go to the police. You were sort of budgeting for them to lose your money anyway, so you don't care about the money that much. And you want to maintain your reputation for being good at due diligence, so telling everyone "hey, look over here, I bought shares in a fraud! A fraud I say!" is not necessarily the best idea. Here's a Securities and Exchange Commission fraud case against YouPlus Inc., a startup founded by Shaukat Shamim that "purports to have developed a machine-learning tool to interpret and deliver customer insights from videos on the internet for marketers, researchers, and brand managers." (There is a parallel criminal case.) The SEC has no particular objection to the technology; its complaint is that YouPlus never figured out its business model, but told investors that it had: In or about April 2019, Shamim sent purported "financial statements" to a prospective investor, in which he misrepresented that YouPlus had earned revenue of $4.6 million in 2018. That representation was false. In or about May 2019, Shamim sent two different "financial models" to investors that contained false revenue numbers. Shamim provided one of the members of the venture fund's Investment Committee a "financial model" that falsely reflected 2019 actual revenue of more than $3.55 million through April. Shamim provided a different investor a "financial model" that falsely reflected 2019 actual revenue of approximately $3.97 million for the same time period. In or about June 2019, Shamim circulated a YouPlus "Investor and Shareholder Update" to all investors that touted YouPlus's "amazing growth and market traction" and falsely represented 2019 actual revenue of $4.62 million through May with "projected revenue for 2019 [of] $17.8 million." At the time these representations were made, Defendants knew, or were reckless in not knowing, that YouPlus had earned only a small fraction of the millions of dollars in revenue represented to investors. Indeed, by the end of October 2019, Shamim had acknowledged to the venture fund investor that YouPlus had not even earned $500,000 in total
revenue since the company was founded in 2013. … In or about June 2019, Shamim separately provided a spreadsheet to at least two investors that purported to report YouPlus's "customer pipeline" with nearly $1 million in monthly realized revenue." The spreadsheet falsely identified more than 150 purported YouPlus customers, including a number of well-known Fortune 500 companies. In reality, all or nearly all of the customers identified on the spreadsheet were not paying customers of YouPlus. At the time Defendants made these representations, Defendants knew, or were reckless in not knowing, that they were false and misleading. In truth, YouPlus had only managed to obtain approximately four paying customers during the life of the company.
He raised about $17.5 million in seed funding for his company, and the SEC says that the $11 million that he raised in 2018 and 2019 was fraudulent, which means that the other, earlier $6.5 million presumably wasn't. In the beginning it was apparently real technology, or at least a real technology idea, that he sold on the promise of maybe one day being a viable business. After a while he had to start selling it on the premise that it was a viable business, which it wasn't, so, you know, fake customer lists. Also here is some retrospective due diligence for you: On or about October 18, 2019, several representatives of the venture fund met with Shamim. At that meeting, the venture fund confronted Shamim about its concerns. Shamim agreed that YouPlus had exaggerated its historical revenues and customer traction, and conceded that he "got ahead of [himself]." On or about October 25, 2019, counsel for the venture fund sent Shamim an email memorializing the October 18, 2019 meeting. Counsel for the venture fund wrote that Shamim had "admitted to misrepresenting both YouPlus's actual revenue earned to date, and its projected revenue for the 2019 fiscal year, in order to secure the [investor's] investment in YouPlus." He also noted that Shamim had "provided the [investor] with forged bank and payroll statements in an effort to conceal YouPlus's true financial condition." (emphasis in original). Shamim responded to the letter in an email sent on or about October 27, 2019. Shamim conceded that despite his previous representations that YouPlus has earned millions of dollars in revenue, YouPlus "did $499,972 in sales and other revenue since inception (from both USA and India)." Shamim also stated that he had personally received approximately $1.3 million from the company. On or about October 29, 2019, Shamim and counsel for the venture fund met in person. At that meeting, Shamim again conceded that he had overstated YouPlus's revenue in communications with investors. When asked whether he had made the false statements in order to get investors interested in the company, Shamim responded that he "probably" had.
Yeah look I never give legal advice around here but I have to say, if your investors' lawyer ever sends you an email saying "just want to confirm in writing that you confessed to fraud and forgery," the right move there is probably not to reply "yeah sorry about that" and then meet with them in person again! I don't know what the right move is, and I know that I throw around the phrase "flee to a non-extradition country" a little too glibly, but, I don't know, "it's a little more complicated than that, I'll call you" strikes me as a better reply than either confirming it in writing or showing up to get arrested. Things happenEU Clinches Massive Stimulus Deal to Bind a Continent Together. A Glimpse Into the Fiscal Gloom Bearing Down on America's Cities. Argentina bondholders team up on new restructuring proposal. A $1 Trillion Glut of Bonds Is Dwarfing Central-Bank Demand. Wall Street Firms Consider Moving Jobs from NYC, Study Says. SoftBank Pulls $700 Million From Credit Suisse Fund. Is Hedge Fund Secrecy a Sign of Skill — Or a Red Flag? University Endowment Sued for
Underperforming the S&P 500. Biden Proposes $775 Billion Plan Funded by Real Estate Taxes. Shelton Moves Closer to Fed Seat With Key Senator to Vote 'Yes.' Boxed Negronis. 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] Nikola went public via a SPAC: A special purpose acquisition company called VectoIQ Acquisition Corp. raised $200 million in an initial public offering in 2018, and merged with Nikola in June to turn it into a public company. Like most SPACs, VectoIQ went public by selling units consisting of a share plus a warrant; the units cost $10, and you got one share (nominally worth $10) and one warrant to buy another share at $11.50. The conditions to the exercise of the warrants are explained on pages 9 and 10 of the VectoIQ prospectus, but one condition is that they would not be exercisable until at least 30 days after VectoIQ found and completed a merger. (Which it did, with Nikola, on June 3.) They also would not be exercisable until VectoIQ (now Nikola) registered the offering of shares on exercise of the warrants with the SEC: Warrant exercise is a public offering of securities (warrant holders give Nikola cash and get back shares), so you need to register it with the SEC. Nikola did that—the registration statement became effective—on Friday just after the close. If Nikola had failed to register the shares within 90 days after the merger, that is by about September, the warrant holders would have been allowed to do cashless exercise: Instead of paying $11.50 and getting back a share, you'd hand in a warrant and get back, roughly, a fraction of a share equal to (the stock price minus $11.50) divided by the stock price. So based on yesterday's $38.45 close, the warrant was worth $26.95 ($38.45 minus $11.50), so you'd get back about 0.7 shares (the $26.95 warrant value divided by $38.45 per share). (The actual math involves a 10-day averaging period.) But that didn't happen; they registered the shares so you can do physical exercise (hand in cash, get back a whole share). The warrants expire five years after the merger is completed, and can be "called," i.e., the company can force exercise if the stock trades above $18 for 20 out of 30 trading days. (If it calls the warrants, you can still exercise them, though the company can require the exercise to be cashless.) The stock is obviously way above that price so, while the company has not issued a redemption notice, you should probably expect it to do so. [2] I mean traditionally one would use the Black-Scholes formula (possibly dilution adjusted) to come up with a value for that option, but it's so in-the-money that the intrinsic value seems good enough. [3] Though there was some uncertainty around when exactly the warrants would become exercisable, and if you did this trade for a *month*, at a 600% borrow cost, it would be borderline. [4] I am consistently using closing prices, and you could have done better if you'd done all of this earlier in the day on Monday, though still not $12.72. | 
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