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Money Stuff: Uber Wants to Lose Less Money on Food

July 06, 2020
Money Stuff
Bloomberg

Uber Postmates

There is a cartoon version of certain gig-economy startup industries that goes like this. Several companies get into the market for, say, car services or food delivery or whatever. They compete for market share by, basically, losing a lot of money: You pay drivers $20 per trip, which is more than they could get elsewhere; you charge riders $5 per trip, which is less than they'd pay elsewhere; you make up the difference by raising money from venture capitalists or SoftBank. Your competitors do the same thing, and you collectively spend billions of dollars of venture money delivering people cheap burritos. You promise your investors "don't worry, after a few more cheap burritos we will have driven our competitors out of business and we'll be able to jack up the burrito prices to cover our expenses," but your competitors are promising their investors the same thing—sometimes it's the same investors!—so they all keep hanging around.

Eventually everyone does get tired of this, but rather than going out of business with nothing to show for it, the less viable competitors get acquired by the more viable ones. If you are a leading player in this sort of viciously competitive business, it can be worth a few billion dollars to you to get rid of a competitor: With less competition, maybe you can charge a bit more to deliver burritos and get closer to breaking even. You can reduce the pain a little bit.

If you believe this model ... if you believe this model then capitalism is broken, 1 + 1 = 3, water flows uphill, aliens are real, you can be your own grandfather, anything is possible. I don't mean that this model is wrong—I love it dearly and suspect it's basically right, though perhaps not quite in the cartoony form I just laid out—but it is a perpetual-motion machine of implausible consequences.

For instance, think about entry. If you take the model too seriously, this would be a perfectly viable pitch to venture capitalists:

  1. We'll get into the crowded miserable burrito-delivery business.
  2. We'll grow our market share by charging customers less and paying drivers more, losing a ton of money ourselves but also causing our competitors to lose even more money than they already do.[1]
  3. They'll hate that.
  4. Eventually they'll pay us a few billion dollars to stop. (Er, to acquire us.)
  5. All we need is a few hundred million dollars to subsidize our losses until the competitors give in and buy us.

You can lose money every step of the way, and never convince anyone that you'll ever make money, and still exit with more money than you started with. Present profitability doesn't matter, future profitability doesn't matter, all that matters is harming the profitability of an even more lavishly funded money-losing venture-backed company.[2]

That is: If you believe this model, in the short term, it might be in your interest to acquire competitors and reduce the pain. But in the long term, when you do that, you are demonstrating that "lose money until we get acquired at a premium" is a viable business model, so you'll be encouraging other people to jump into the sector without a plan to make money, and you'll have to keep buying them.

You can't really believe the model. Venture capitalists might subsidize losses for 10 years, but not for 100; eventually there has to be some sort of endgame. Possibly the endgame is "people come to their senses, the industry consolidates, and the remaining players find a way to make money." (You can tell that as a good story, selling a valuable product at a fair price, or a bad one, making monopoly profits from precarious labor.) Possibly the endgame is "people come to their senses, all these companies shut down, and we go back to picking up our own burritos." Obviously if you're invested in the space you are telling the former story, not the latter.

Uber Technologies Inc. announced today that it will acquire Postmates Inc. for about $2.65 billion in stock, combining the third- and fourth-largest U.S. gig-economy food-delivery services (Uber Eats and Postmates). This acquisition has been in the works for a while, and pretty much everything I have read about it takes the view, well, right, Uber Eats loses money, and Postmates loses money, but if they combine then they'll lose a little bit less money. Here is my Bloomberg Opinion colleague Tae Kim:

As an industry in aggregate, Uber Eats and its three other U.S. food delivery competitors — DoorDash, Grubhub and Postmates — has been hemorrhaging cash as they compete against each other with lavish promotions and deals. Uber Eats alone lost more than $300 million in adjusted Ebitda, a measure of profitability, in its latest reported quarter, while Grubhub posted a $33 million loss for its first quarter.

If Uber can take a player out of the equation, it would help rationalize the level of discounting, thereby lowering losses.

Here's Shira Ovide:

Big picture, right now, in the real world of 2020 America, food delivery isn't working out for just about everyone involved — including restaurants, delivery couriers and certainly not the app delivery companies. They are almost all losing money. Even now, yes, when many of us are ordering more takeout and delivery.

For the food delivery companies, the fastest way to fix this rotten system is to stop spending money in pointless ways and to squeeze more dollars from customers like you and me, the restaurants, the delivery couriers and anyone else involved in this chain of operation.

The way to less stinkage — for the delivery companies — is having fewer but bigger companies that have the muscle to charge more for what they do.

This view is so much the consensus that I half-expected Uber's announcement to be like "this acquisition will lessen competition in the sector so we can stop losing so much money," and was surprised to read, in the actual announcement, about normal non-antitrusty things like "Postmates' strong relationships with small- and medium-sized restaurants" and "more tools and technology to more easily and cost-effectively connect with a bigger consumer base." Obviously you can't say "we are doing this deal to reduce competition because our business is not really viable," even if it's what everyone thinks.

Anyway this news made me want to get into the food delivery business. Postmates has raised about $900 million of venture capital and doesn't seem to be profitable, but a lot of people made a lot of money off of it anyway. Maybe there's room for more of that.

IPO pops

Oh man, this thing is back:

For a second straight week, a tech company has more than doubled in value upon its stock market debut. Last week, it was Chinese cloud software developer Agora, which surged 150% in its first day of trading on the Nasdaq. And on Thursday, insurance-tech company Lemonade jumped 139%. …

While they may be saving money on travel, they're still leaving piles of cash on the table. Lemonade sold 11 million shares at $29 a piece, bringing in just over $300 million and giving new investors the $444 million difference, based on the closing price of $69.41. That's a big deal for a company that had cash and cash equivalents of about $567 million before the IPO.

"They are ignoring demand when they price. On purpose," said venture capitalist Bill Gurley of Benchmark, in a text message. "This problem is systematic. Because the system is broken."

Gurley, who has been among the loudest IPO skeptics, posted a similarly themed tweet after Agora's IPO, expressing amazement "that there is a financial exercise on this planet involving hundreds of millions of dollars where its OK to not even get to 50% of the actual end result."

I like to think of the IPO pop—the amount that a stock rises on the first day of trading after its initial public offering—as a sort of bid-ask spread. A company wants to sell its stock. Some people are willing to buy it, but they are in a sense doing the company a favor: They are providing a lot of liquidity, all at once, for a stock that has never traded before. If you're trying to sell a bunch of stock all at once, you will sell it for less than its true value; the discount to the true value is the buyers' compensation for giving you a lot of money when you need it. The investors who buy in the IPO are in a sense middlemen, taking the risk of your stock price for a brief but important period (the very beginning of trading) and collecting a profit for doing so.

When markets are volatile, bid-ask spreads get wider, and so in these weird times if you go public your expected IPO pop should be higher. Here's investor Matt Oguz:

"Uncertainty always brings with it a discount," said Oguz, who is a partner at the firm Venture Science. "On one hand you're getting a lot of money right up front. On the other hand, if a pop like this happens then you may be leaving money on the table."

We talked the other day about Bill Ackman's new investment vehicle, a special purpose acquisition company (SPAC) called Pershing Square Tontine Holdings Ltd. The idea of PS Tontine is essentially that it will raise about $4 billion and use that money to do some tech unicorn's IPO all by itself: Instead of marketing a deal and selling a bunch of stock to a bunch of investors, some big private tech company will just sign a deal to sell $4 billion of stock directly to PS Tontine and thereby become public.

That's a trade that doesn't really make sense in a time of smooth certainty: If companies can easily go public by selling stock to a bunch of regular investors at a price very close to its true value, they should just do that; they get no benefit by selling all the stock to one big investor, and that one big investor isn't likely to get a discount to the true value. But in volatile uncertain times, when companies regularly price their IPOs at less than half of the ultimate trading price, there's a lot of money to be made in buying a whole IPO. If you're a SPAC, you can theoretically offer companies a price that is (1) higher than they'd get in an IPO and (2) still way lower than where the stock will ultimately trade. When middlemen are making a ton of money, it's a good time to get into the middleman game.

WM SMR

If you're a company doing a big merger, you might want to borrow money from the bond market to pay for the merger. There is a timing issue here. You can't do the merger first and then borrow the money, because you can't close the merger without the money.[3] You have to borrow the money first and then close the merger. But what if the merger doesn't close? It happens; even after you sign a merger agreement there's always a chance that something will go wrong—you won't get regulatory approval, the shareholders will say no, whatever—and you won't close the deal. Then you'll have all this money that you didn't need.

And so there is a convention that, if you are selling bonds to fund a merger, the bonds can have a "never mind" clause. It is called "special mandatory redemption," and it normally says that if the merger doesn't close you'll just automatically pay the bonds back at 101 cents on the dollar. (Plus any interest you had to pay along the way.) Effectively you sell bonds to pay for the merger, you put the money in your bank account until the merger closes, and if it doesn't close you just give the bondholders back the money with a little extra for their trouble. 

At Barron's, Alexandra Scaggs has a story about the bonds of Waste Management Inc., a company that, uh, manages waste. In April 2019, it agreed to buy another trash company called Advanced Disposal Services Inc. In May 2019, Waste Management sold $4 billion of bonds to pay for the deal. The deal has dragged on, because they are two big trash companies and the Justice Department worried about the antitrust implications of combining them. They still plan to do the deal, but it hasn't closed yet, and they're trying to satisfy the Justice Department by divesting some assets.

Meanwhile the bonds have a special mandatory redemption provision saying that if the deal hasn't closed by July 14, Waste Management will have to buy back all the bonds at 101. The deal will not close by July 14. In the abstract you might think this is annoying for Waste Management: It went to the trouble of raising $4 billion to pay for this deal, it's been paying interest for a year, and now it has to pay back all that money with a little kicker and go out and raise more money to pay for the deal that it's still planning to do.

But, nope. May 2019 was a pretty good time for investment-grade bonds—these bonds carried interest rates from 2.95% (for five years) to 4% (for 20 years)[4]—but July 2020 is, for some reason, an insanely great time for investment-grade bonds. And so these bonds, which were issued at low yields a year ago, now trade at even lower yields. Or at least they did a few weeks ago. Scaggs:

Those coupons didn't seem high until the Federal Reserve cut interest rates to zero in March, prompting investors searching for yield to pile into higher-coupon bonds.

The demand helped push the prices of Waste Management's bonds well above par. The bonds were trading between $1.07 and $1.15 per dollar of face value in mid-June, and that pushed their yields as low as 1% for four-year bonds and 2.8% for 30-year debt.

If you have bonds outstanding that trade at $115, and you can buy them back for $101, then you have to do that, that is just science. And so Waste Management announced last month that it will do the special mandatory redemption and buy back the bonds for $101.

Investors, whose bonds were recently worth $115 and who now will have to sell them for $101, are sad. Scaggs:

"There's no easy way out," said David Knutson, head of credit research in the Americas for Schroders. "On one side are shareholders who say they should be able to refinance. On the other, [bondholders are] saying 'Wait a minute, this isn't emerging markets. We just lost nine points and that doesn't happen every day in investment-grade bonds.'" ...

Knutson is vice chair of an industry group called the Credit Roundtable that urged Waste Management to rethink its decision in a June 29 letter. The group said the deal's delay came as a surprise, after executives told investors in a May 6 earnings call that the acquisition was on track to close by the end of the second quarter.

"We would strongly recommend that [Waste Management] attempt to pursue alternative courses before redeeming these bonds if the acquisition is still pending," the group said in its letter. "This demonstrates the difficult position that Investors face with bonds that include [special mandatory redemption clauses], as currently structured."

While SMR clauses make bond repurchases a requirement and not an option, Waste Management could offer to exchange the debt, or work with investors to change the bonds' contracts.

No, no, I am sorry, there is an easy way out. The easy way out is exactly what is happening: The company calls the bonds for $101 and high-fives its bankers for including the special mandatory redemption clause. "Waste Management could offer to exchange the debt, or work with investors to change the bonds' contracts," sure, of course, but that would be nuts: Why agree to pay $110 or whatever for these bonds, when you have an ironclad contractual right and indeed obligation to pay $101? Waste Management got a delightful win, and the bondholders got a surprising loss; of course the bondholders want Waste Management to renegotiate that, but there's no particular reason that it should. As it is extremely well aware:

"We received and reviewed the June 29 letter from Credit Roundtable," said Andy Izquierdo, spokesman for the company. "However, we continue to believe that compliance with the redemption provisions is in the best interests of [Waste Management] and its stockholders, considering applicable fiduciary duties and other relevant considerations."

Well, I mean, there is one catch in this plan, which is  that Waste Management still does need to pay for the merger. In the current environment for investment-grade credit that should not be particularly challenging, but then again Waste Management is kind of annoying bond investors right now? It will buy these bonds back for $101 and then … immediately go sell the same bonds for $115, pocket the difference, something like that?[5] Maybe not; it says:

Waste Management is well positioned to fund the transaction, with its strong balance sheet, significant free cash flow generation, investment grade credit rating and favorable access to capital markets. … Waste Management currently anticipates funding the transaction using a combination of credit facilities and commercial paper but is evaluating other longer-term financing options. 

In a very different world from our own, you could imagine bond investors being so outraged about this that they refuse to buy any new bonds to pay for the acquisition. In the actual world, memories in the financial markets are short, and if Waste Management redeems these bonds and then sells new ones three days later, all the people who complained about the redemption will line up to buy the new ones.

Loosely speaking the way bonds work is that they are issued at fixed interest rates for fixed terms, and everyone mostly prices them on the assumption that they'll pay the fixed rate for the fixed term, and they have a lot of embedded options, weird situations in which they might not pay the fixed rate for the fixed term, and those options are generally underpriced or not priced at all. And then every so often an option gets exercised against investors and they howl pitifully: We didn't know we had sold an option![6] How could you exercise an option against us! What treachery! I don't know, man, it says it right in the documents. 

Due diligence

Here's a story about Tommy Tuberville, the former Auburn football coach and current Senate candidate in Alabama, who co-ran a scam hedge fund a while back. The scam was perpetrated by his partner, a former broker named John David Stroud, who did the actual investing and went to prison for losing and stealing much of the money; Tuberville basically did investor relations and was not charged with any wrongdoing (though investors sued him). I do, however, very much like how he got into business with Stroud:

Mr. Tuberville and Mr. Stroud were introduced in 2008 by a fund-raiser for the Auburn athletic department, and they became friends. Mr. Stroud accompanied Mr. Tuberville and other friends and family on a trip to Jamaica. The next year, after Mr. Tuberville left Auburn, he was investing money with Mr. Stroud. Soon after, they started the fund.

During a deposition in the civil litigation, Mr. Tuberville was asked if he had done "anything to check out" Mr. Stroud's background before embarking on their business venture. He said he had not. "I just got to know him more as a guy hanging around, going out with us," he said, adding that he had not even Googled him.

I bet a lot of hedge funds get started that way.

Oh Elon

One possibility is that Elon Musk reads this newsletter religiously, and hates me, and if I am ever foolish enough to say something like "maybe Elon Musk will go five minutes without doing anything outrageous," he rubs his hands together with glee and cackles "oh I will show this guy, he's gonna regret that," and then he serves up his worst tweet yet. I am not saying that that's the most likely explanation or anything. But the other day I did speculate that, for corporate-governance reasons that honestly are not worth getting into, Musk might spend the next 90 days behaving himself relatively well. And then the next day:

Elon Musk provoked the U.S. Securities and Exchange Commission in the course of taking a victory lap on Twitter over Tesla Inc.'s surging share price.

The chief executive officer first taunted short sellers in a string of tweets, writing that the electric-car maker would "make fabulous short shorts in radiant red satin with gold trim." That's an apparent reference to jokes he's repeatedly made about sending "short shorts" to investors who bet against Tesla's shares, such as hedge fund manager David Einhorn.

Musk, 49, then wrote Thursday that he would send shorts to the SEC, referring to the agency again as the "Shortseller Enrichment Commission." He first used that phrase in October 2018 after the regulator sued him for securities fraud.

Musk then tweeted a cryptic but profane play on the agency's initials, prompting Ross Gerber, a fund manager who regularly engages with him on Twitter, to write back: "Dangerous." Musk responded: "But sooo satisfying."

"Cryptic but profane" is a lovely description of Musk's tweet, which reads "SEC, three letter acronym, middle word is Elon's." It is an amazing illustration of the beauty and subtlety of the English language that everyone who reads that tweet seems to understand immediately what the other two words are. "Seize Elon's Cellphone," suggested "Ivan the K" on Twitter.

In Musk's defense, you are allowed to say mean things about the SEC; it is not all that smart or anything, but it's probably a better use of his time, from a legal-liability perspective, than, like, tweeting misleading claims about Tesla's finances. Juvenile though that tweet is, it is surely not securities fraud.

In my own defense, I said that Musk arguably has some financial incentives to behave himself for 90 days, but I also said that "if Elon Musk is utterly unswayed by financial incentives and just does whatever amuses him at all times, then you should expect him to be equally silly now and later," and that "that's the bet I'd make." Technically he has not proved me wrong. He could prove me wrong by never tweeting anything obnoxious again, I am just saying, in case he is reading this.

Oh also the shorts are real?

The "Short Shorts" on the Tesla shop website feature gold trim and "S3XY" in gold across the back, which also happens to be formed from Tesla model names.

The shorts cost $69.420, the last three digits an apparent reference to Musk's infamous tweet in 2018 that he was considering taking Tesla private for $420 per share, with 420 also a code word for marijuana.

That is not really how fractional U.S. currency works but apparently 420 is a weed joke.

Things happen

Buffett's Berkshire Ends Deal Drought With Dominion Bet. Wirecard's core business has been lossmaking for years, audit shows. Luckin Coffee Probe Says Chairman Knew or Should Have Known of Fabricated Transactions. World Bank ditches second round of pandemic bonds. Bundesbank to keep buying bonds after court challenge. The Cost of Bad Market Timing Decisions in 2020 Was Annihilation. Quant Fund Gains 108% by Dumping China Stocks a Day After Buying. 'So Unstable and So Volatile': Oil Crash Crushes Individual Investors, Prompts Trading Overhaul. Commerzbank's CEO and Chairman to Resign Amid Pressure From Activist Cerberus. Toshiba clash with activist poses first test of national security law. Banks Are Ditching London Offices and Not Just Because of Covid-19. Nigerian Instagram Star Extradited to Face U.S. Cybercrime Trial. A 'Viral' New Bird Song in Canada Is Causing Sparrows to Change Their Tune. Bubonic plague. NYC tattoo shop says coronavirus is becoming sought-after ink design.

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[1] I mean, if they lose money on every burrito, you might be causing them to lose *less* money, but in the model they are hyper-focused on market share so they'll cut prices to keep up their volume.

[2] We have talked before about Joe Weisenthal's thought experiment of launching a startup that undercuts some public-company incumbent by selling a product below cost, and profiting by buying puts on the incumbent's stock. This is a private-market analogue; you get rich not by making a profit on your business but by making the incumbent so miserable that it has to buy you. The mechanism is not "incumbent's stock drops" but "incumbent's shareholders stump up more money so as not to write off their investment."

[3] You can get a bridge loan: Borrow the money briefly from your banks to close the merger, then refinance into bonds right after the merger closes. The banks would rather not have that risk through funding, though.

[4] There was also a 30-year 4.15% bond, but that doesn't have an SMR and won't be called.

[5] Obviously the actual trade is that you buy back the bonds for $101 and then sell new bonds with lower coupons for $100—you make your money in coupon savings, not in selling new premium bonds—but same basic economics.

[6] We have talked about SMRs before, when Qualcomm Inc. called some bonds it had issued to pay for an acquisition. Back then, in 2018, interest rates had gone *up* between the issuance and the call, and Qualcomm decided it could call the bonds for $100 (using its regular make-whole call provision, another option embedded in the bonds) rather than $101 (using the SMR). Investors complained.
 

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