| Programming note: This will probably be the last Money Stuff for a few months, because I expect to be going on parental leave soon. There may be a few special editions of Money Stuff during my leave, and you can follow me on Twitter (@matt_levine), but for the most part I expect to be busy elsewhere. Thanks as always for reading; I will genuinely miss you all, and I look forward to returning later this year. Stress test appeal When there is a big economic and financial crisis, like the one precipitated by Covid-19, an investment bank's trading division will probably either make a lot of money or lose a lot of money. Financial asset prices are moving around a lot, and you're either going to be on the right side of those moves, or the wrong side. As we have discussed before, it is more likely that you will be on the right side: The banks' trading divisions are mostly in the business of providing liquidity to clients, not holding a bunch of assets; what happens in a crisis is not only that asset prices go down (though, in the case of Covid, also rapidly up again) but also that the price of liquidity goes up, and if you are selling liquidity you make a lot of money. But the banks are exposed to asset prices too, one way or the other, and if they're on the wrong side of the assets they can lose a lot of money. And so in practice most of the big U.S. and European banks' trading divisions absolutely printed money in the first half of 2020, but there were some glitches; Société Générale, for instance, was "penalised heavily" by volatility in the first quarter. These things happen. When there are wild dislocations in financial markets, that doesn't mean that banks' trading divisions automatically and easily get rich. It means they come in and work long stressful days with the constant risk of losing a ton of money, and then probably get rich. One of the main tools of modern bank capital regulation is the stress test: Regulators imagine some sort of economic and financial crisis and ask what it would do to each bank's capital; each bank then has to have enough capital now so that it would still be well capitalized even after the imagined crisis. One oddity of this year's U.S. stress tests is that the imagined crisis, which was announced in February, was not as bad as the actual Covid crisis that hit in March, so all the results feel particularly arbitrary. But there is a deeper and more general oddity, which is that the stress tests generally assume that banks will lose money, in their trading divisions, in a crisis, while in reality—this year, but also more generally—those divisions often make tons of money in crises. You could imagine a stress test that says "well if there's an economic collapse each bank will lose a lot of money in its commercial and mortgage loan books, but they will make a lot of money in their trading divisions, which will partly offset their losses." I mean, you could imagine it, but banking regulators wouldn't; it just does not feel right as stress tests go. Regulators want stress tests to be conservative, to be stressful; they want them to be reasonable-worst-case scenarios. Some banks will lose a lot of money in a crisis! You can't assume that everyone will take every crisis as an opportunity and navigate it perfectly. When the stress-test results came out in June, I wrote: If you're a bank, and the Fed asks you to model how you'd handle a huge financial crisis, you can't really write down "I would simply make a ton of money trading derivatives." It is too cute, too optimistic. Well you can try though: The Federal Reserve has turned down Goldman Sachs' request for less onerous treatment after the results of its annual stress test, leaving the bank with the highest capital requirement among its large peers. The Fed on Monday published the final common equity tier 1 (CET1) requirements for the 34 largest US banks. Goldman's requirement, at 13.7 per cent, was unchanged from the figure indicated after the stress test result was delivered to the bank in June. The US central bank revealed that Goldman was among five banks that formally appealed the result. ... Goldman said on a call with investors last month that the bank was in "active dialogue" with the Fed about its stress test results. One person familiar with those conversations said Goldman believed its strong second-quarter results, which featured bumper capital markets revenues, showed that its trading operation was "countercyclical", because revenues had risen with volatility. They did not take my advice I guess. Goldman Sachs Group Inc. (disclosure, where I used to work) got a disappointing grade on its stress tests, and appealed the results by saying, essentially, "in a crisis, we would simply make a ton of money trading derivatives." They have some evidence on their side! In the actual crisis that occurred—as opposed to the imagined one in the stress tests—they did in fact make a ton of money trading derivatives! In that actual crisis, investment banks that did lots of trading were arguably safer than banks that did lots of boring old lending. It is not a terrible argument, empirically, but it is not one that you would expect to resonate with the Fed, and it didn't. Hertz! I would love to read an oral history of the Hertz at-the-market offering. Basically what happened is: - Hertz Global Holdings Inc. ran into a lot of trouble (nobody renting cars during a pandemic, used-car values declining and triggering margin calls on its used-car securitization, etc.) and filed for bankruptcy.
- Instead of trading down to zero, as you might expect (bankruptcy tends to zero stocks), the stock traded up, on heavy volume, due to retail day-trader enthusiasm and the general mystery of financial markets in 2020.
- Hertz was like, okay, well, if people really want to buy Hertz stock, we have Hertz stock, we should sell them some.
- Hertz went to the bankruptcy judge and said that. "There are forces at work that us non-financial people, that we can only observe," they told her. She had no objections.
- On the morning of Monday, June 15, Hertz filed a prospectus announcing that it would sell up to $500 million of stock in an "at the market" ("ATM") offering, meaning that Hertz's bank (Jefferies) would just sell the shares on the stock exchange from time to time; if you bought stock, you'd have no way of knowing if you were buying it from Hertz or from one of the many other people who were selling Hertz stock. Of course the stock was probably worthless, as Hertz said in the prospectus: "We expect that common stock holders would not receive a recovery through any plan unless the holders of more senior claims and interests … are paid in full, which would require a significant and rapid and currently unanticipated improvement in business conditions to pre-COVID-19 or close to pre-COVID-19 levels." But if you bought stock on the exchange, the odds that you read the prospectus were nearly zero.
- On the afternoon of Monday, June 15, the U.S. Securities and Exchange Commission called up Hertz and said: "Come on! Come on! Come on!" This is not an exact quote, which is why I really need an oral history here. Surely the SEC said something funny. Surely the SEC lawyer tasked with calling up Hertz prepared a few zingers. I guess I would have started low-key with "so, you probably know why I'm calling."
- "Promptly thereafter, the Company suspended all sales of Common Stock under the ATM Program." That is an exact quote, from Hertz's 8-K at the time, but it does not capture the flavor of the conversations that Hertz had between the SEC call and the suspension a few minutes later. Did the Hertz lawyers who got the SEC's call shrug, call up Jefferies and say "they're on to us, kill it"? Were they surprised? Did they push back on the SEC? "No, I don't know why you're calling, everything seems totally normal here, is something wrong?"
So many unanswered questions. But here's an answered one! Hertz Global Holdings Inc. raised $29 million selling its likely worthless stock before regulators dissuaded the bankrupt rental-car company from selling more. The Florida-based company, which filed for chapter 11 protection in May, on Monday disclosed the results of a controversial effort to sell as much as $500 million in shares despite the severe financial strains that drove the company into bankruptcy. When Hertz initially did, and then rapidly canceled, this offering, it was coy about how many shares it actually sold between filing the prospectus that Monday morning and hearing from the SEC that Monday afternoon. When you cancel an offering after a few hours after an irate call from the SEC, it is best to pretend that the whole thing never happened. But you can't keep quiet forever; yesterday Hertz filed its 10-Q for the second quarter, and it had to say how many shares it sold. "Hertz Global issued 13,912,368 shares under the ATM Program for net proceeds of approximately $29 million," it says, which works out to selling about 9% of the company's stock at about $2.08 per share. The volume-weighted price of Hertz's stock that day was about $2.14 per share; it closed at $1.69 yesterday, which still seems pretty optimistic for a bankrupt company. (To be fair the 10-Q reports shareholders' equity of about $673 million, much more than Hertz's $240 million market capitalization.) On the day of the offering, 176 million shares of Hertz were traded, so Hertz sold fewer than 1 in 10 of them. If you bought worthless Hertz stock during the day that Hertz was opportunistically selling it, there's a 92% chance you bought it from someone other than Hertz. And that wasn't even the biggest day; the previous Monday, June 8, the stock closed at $5.53 on volume of almost 534 million shares. Hertz didn't sell any of them! Back in June a lot of people were desperate to buy worthless Hertz stock, and a lot of people were happy to sell it to them. Only Hertz was told to knock it off. Cause If you are the chief executive officer of a public company, and the board wants to get rid of you, they can fire you either "for cause" or "without cause." "For cause" is a term of art meaning that (1) you have murdered someone, (2) you have been convicted by a U.S. court of that murder, and (3) all of your appeals have been exhausted and your conviction is final. I mean, I exaggerate a little, but only a little: "Cause" definitions in executive employment agreements are often narrow, and in many cases merely committing a crime is not sufficient to be fired for cause. If you murder a director in the boardroom, and the rest of the directors see you do it, they can't fire you for cause until you've been arrested, tried and convicted. Most cause definitions are broader than that, but still fairly narrow: If you manifestly refuse to perform your duties, or commit horrible scandals, that will count as cause, but the bar is high and the facts will be debatable. "Without cause" means anything else. For instance if you are just bad at your job, and the board fires you because they want to hire someone who is good at it, they will usually fire you without cause. Or if the board just wants to replace you with someone they went to college with, that is also without cause. Or you murdered one of them but haven't been convicted yet. Really a wide range. The main difference is that if you get fired without cause you get paid a ton of money in severance, and if you get fired for cause you don't. In theory the reasoning is something like this: - You want the board to be able to fire the CEO the minute they lose confidence in her: The board has to be in control, and if they think that the CEO is not the right fit, for any reason, they have to be able to get rid of her without being second-guessed by lawyers.
- But you want to attract impressive people with good outside options as CEOs, and they will want some sort of security; they don't want to upend their lives and take the CEO job only to be fired a month later.
- Also you want CEOs who are bold and willing to take risks, etc., even with their career on the line.
- So the compromise is: The CEO can be fired for any reason or no reason, but if she is, she gets a lot of money.
- Also though if the CEO murders someone you don't want to give her a lot of money.
So the normal way to fire a CEO—even a bad CEO, even a scandalous CEO—is without cause; everyone knows going in to the CEO relationship that it might not work out, and that if it doesn't work out the CEO will get a lot of money, and that is the trade they all agree to. The only reason you fire a CEO for cause is, basically, that she's done something so egregious that it would be embarrassing to give her the money. Firings for cause get litigated, getting in a lawsuit with your former CEO is always going to be disruptive and embarrassing, and a board will only fire a CEO for cause if it would be even more disruptive and embarrassing to pay her severance. Anecdotally it seems like a wide range of on-the-job sexual misconduct used to be treated as no big deal and not a fireable offense, and then it became scandalous enough to fire the CEO but not scandalous enough to litigate, and in recent years it has become potentially, a "for cause" event. Alphabet Inc., for instance, has gotten negative press and shareholder lawsuits and employee walkouts because it let executives accused of sexual misconduct leave with big severance packages. Not too long ago that was the way to avoid scandal: You pay them the severance to leave quietly, instead of having a big public fight about their misconduct. Now letting them leave with their severance causes a scandal, so you might as well fire them for cause and keep the money. That still doesn't explain this, this is just kind of weird: McDonald's Corp. said it is suing former Chief Executive Steve Easterbrook and seeking to recoup tens of millions of dollars it paid in severance and benefits, alleging that he lied to the board about sexual relationships with employees before his ouster last fall. The fast-food giant dismissed Mr. Easterbrook without cause in November 2019, following an investigation into his conduct. Investigators found he had a short-term, consensual relationship with an employee over text and video, but Mr. Easterbrook denied any physical sexual relationships with McDonald's employees, according to the complaint filed Monday. ... McDonald's reopened the matter after it received an anonymous tip in July about a relationship between Mr. Easterbrook and an employee, according to the lawsuit. An investigation found that Mr. Easterbrook allegedly engaged in three additional relationships with employees that were sexual in nature, including the one that triggered the July inquiry. Investigators found that Mr. Easterbrook destroyed evidence about the sexual relationships and lied about his behavior during the initial investigation last fall, the complaint said. One thing that is weird about it is that if he had disclosed all the other relationships back when the board was investigating him, it is not at all clear that they could have fired him for cause. From McDonald's complaint: Terminating Easterbrook with cause would deprive him of all his severance benefits. But doing so was also certain to embroil the Company in a lengthy dispute with him. To prevail in a dispute with Easterbrook over whether his conduct constituted "cause," the Company would need to show that his conduct constituted "dishonesty, fraud, illegality or moral turpitude." The directors had no assurance that Easterbrook's conduct (as they then understood it) would be found to clear that high bar. The evidence before them indicated that Easterbrook's relationship with Employee-1 was consensual, non-physical, and did not involve any allegation of sexual harassment. Easterbrook insisted (falsely, as was later revealed) that he had not engaged in a personal relationship with any other McDonald's employee. And none of the evidence obtained in the investigation indicated that he had engaged in another such relationship or had engaged in any harassing or otherwise nonconsensual conduct. The directors thus had no confidence that Easterbrook's conduct would be found to constitute "cause" as a legal matter. After weighing the alternatives, the directors concluded that it would be in McDonald's best interest if Easterbrook's separation was accomplished with as little disruption as possible. So they instructed management to seek to negotiate a separation agreement designed to protect the Company's interest without insisting on a for-cause termination. Now they have discovered evidence of other relationships, but they don't claim that any of them were non-consensual or involved harassment. (They do claim that one of them involved "a special discretionary grant of restricted stock units—worth hundreds of thousands of dollars" to one of the employees that was approved by Easterbrook.) There is no real claim that these relationships were more dishonest, fraudulent, illegal or turpitudinous than the one they already knew about. Instead the claim is that Easterbrook lied about them, and that was fraudulent: Easterbrook's silence and lies—a clear breach of the duty of candor—were calculated to induce the Company to separate him on terms much more favorable to him than those the Company would have offered and agreed to had it known the full truth of his behavior. Accordingly, Easterbrook's conduct served to benefit himself at the expense of the Company—a classic breach of the duty of loyalty. Did it? If he had said "actually there are three of these," would they have had a good enough reason to fire him for cause? Wouldn't it still have been "in McDonald's best interest if Easterbrook's separation was accomplished with as little disruption as possible"? It seems to me that lying to the board was very much not in his best interests; the alleged relationships probably weren't enough to cost him his severance, but the alleged lies might be. "High" yield Okay: Ball Corp. sold $1.3 billion of junk bonds at record-low yields amid a rally triggered by the Federal Reserve's historic support for the market and heavy inflows into funds that buy the risky debt. The aluminum packaging company priced the 10-year notes at a 2.875% yield, according to a person with knowledge of the matter. That's the lowest-ever for a U.S. junk bond with a maturity of five years or longer, according to data compiled by Bloomberg. I don't know what to tell you. I am old enough to remember when the 10-year U.S. Treasury note yielded more than 2.875%; that last happened in December 2018, and was continuously true from at least the 1960s through late 2008. I am also old enough to remember when the Federal Reserve did not buy high-yield bond exchange-traded funds, which was true from the founding of the Fed until this May; now the Fed owns hundreds of millions of dollars' worth of high-yield bond ETFs and I guess it might end up indirectly owning this bond. At 2.875%. It all makes a kind of sense? We are in a historically bad economic crisis, and the Fed, and the markets, have responded by creating the easiest financial conditions in … human history? If you want to borrow money to build an aluminum-can factory, now is the very best time ever to do that. It's something? Modern finance MicroStrategy Inc. is a publicly traded enterprise software company with a market capitalization of about $1.4 billion. It sells and supports software. This seems like a good business to be in. It has gross margins in the area of 80%. It has a lot of money in the bank; as of June 30, it had about $530 million in cash, cash equivalents and short-term investments. It probably doesn't need that much money; it makes software with high margins and good cash flow. What should it do with that money? Well, here is what it did: MicroStrategy Incorporated (Nasdaq: MSTR), the largest independent publicly-traded business intelligence company, today announced that it has purchased 21,454 bitcoins at an aggregate purchase price of $250 million, inclusive of fees and expenses. The purchase of Bitcoin cryptocurrency was made pursuant to the two-pronged capital allocation strategy previously announced by the company when it released its second quarter 2020 financial results on July 28, 2020. The company addressed the first prong, which called for returning a portion of its excess cash to shareholders, when it announced today that it had launched a cash tender offer for up to $250 million of MicroStrategy's class A common stock via a modified Dutch Auction offer. By acquiring 21,454 bitcoins, MicroStrategy addressed the other prong of its capital allocation strategy, which called for investing up to $250 million in one or more alternative investments or assets. "Our investment in Bitcoin is part of our new capital allocation strategy, which seeks to maximize long-term value for our shareholders," said Michael J. Saylor, CEO, MicroStrategy Incorporated. He goes on to talk at length about how Bitcoin is good, etc., but there are lots of people on the internet who will tell you that Bitcoin is good; you don't need a public-company CEO to do that. My interest here is not in whether Bitcoin is good, but in what a strange corporate finance strategy this is. MicroStrategy is a public company; its big outside shareholders include normal names like BlackRock Inc. (14.3% of the economic interest) and Vanguard Group (9.2%). It is also, however, a founder-controlled company with dual-class stock; Saylor controls 23.7% of the economic interest in the company but 72% of the votes. The company—owned by the public, controlled by the founder—makes more money than it needs. It has decided, quite sensibly it seems, to return a lot of that money to the shareholders so that they can reinvest it in whatever strikes their fancy. But only half of it. The other half is going into Bitcoin. If you buy shares of MicroStrategy, you get a combination of (1) a cash-flowing enterprise software company and (2) a pot of Bitcoins. (And so, if you buy a bunch of BlackRock index funds, you will also get a tiny pot of Bitcoins.) Why not just buy the Bitcoins yourself? I do not understand what advantage MicroStrategy has over its shareholders, in terms of buying and storing Bitcoins. I suppose I have said before that buying and storing Bitcoins is kind of a hassle, and it would be nice to have better retail products to do it for you, but it's still weird to staple those products to an operating company. The stock was up about 11% as of 11 a.m. today so I suppose this is good marketing. We talked the other day about a general theory of public markets in which public companies gradually become bigger, older, more profitable and less capital-intensive. Eventually all public companies will have dominant market positions, 80% margins, huge piles of cash and nothing to spend it on. Recycling the money by giving it back to shareholders is an obvious solution, but that doesn't mean it will be universal, and there are other traditional solutions. Lavish executive salaries and perks are one; spending the money on basic research and moonshot ideas is another; there are others. Alphabet Inc. has way too much money and is spending some of it on curing death. Sure! Fine! Good use of cash! Facebook Inc., I sometimes worry, has way too much money and is spending it on becoming a world government. Creepier! Putting it into Bitcoin is fine, too, I guess; why not? The money has to go somewhere. IPO pops We have talked a lot around here about disrupting the initial public offering. A lot of venture capitalists and startup founders think IPOs are bad because they leave money on the table: Companies sell stock at the IPO price, the stock immediately trades up to a higher price, and the company feels sad that it didn't sell at the higher price. To get around this problem, VCs and founders talk a lot about, and sometimes do, other, more arcane ways of going public, like direct listings and special-purpose acquisition companies. I sometimes think this is a bit overcomplicated: If your problem with the IPO is that it gets too low a price, why not just ask for a higher price? Last year I wrote: If you wanted to get rid of the IPO pop, how would you do it? I think the simplest answer is that you do your IPO the regular way, and then at the end the banks tell you how the order book looks, and you discuss the pros and cons of pricing at $28 ("that maximizes your proceeds," the bankers will say, "but a lot of the orders at that level are pretty soft and might flip their stock, leading to poor trading in the aftermarket and a real risk of breaking the IPO price") versus $27 ("you are giving up a little on price," the bankers will say, "but you are maximizing the chances of good trading tomorrow and a good long-term upward price path for your stock"), and you think for a minute and say "okay we're pricing at $30." And the bankers say "wait we didn't say $30" and you say "well I did, if you want to get paid for this deal you buy the stock at $30." And they scream for a while and then buy the stock at $30 and the next day it trades at, like, $30.25, and you feel smug. Well, here's a Twitter thread reminiscing about Tesla Inc.'s 2010 IPO, from venture capitalist Mark Goldberg, who was a junior banker at Morgan Stanley working on the deal. It was, in most ways, totally normal: Tesla hired a standard list of bankers, paid them a 6.5% fee, sold a bunch of stock in a book-built offering to big investors, etc. But Goldberg remembers one unusual aspect of the deal: Finally, pricing. Post Roadshow, bankers put on typical dog & pony show about how great it'd gone and recommend a starting price: $15. Elon says, "no, higher." Air sucked out of room. … Elon said $17 or no deal. Good for him! The deal priced at $17 and the stock closed at $23.89 on its first day, still a 40% pop, so, you know, imperfect, but he got $2 more than they were offering. It doesn't hurt to ask! Well, I mean, it could; I do not really recommend that every CEO, confronted with an investment bank's pricing recommendation for her CEO, demand a price that is $2 higher. Sometimes that genuinely won't work, there won't be enough demand to price there, and the deal will be pulled, to everyone's embarrassment and misery. Still I kind of wish there was more of it: There is clearly some room for it, and if it happened more often it would keep the capital markets bankers on their toes. Things happen A Guide to the World's New Benchmarks After Libor. Why Trump's Hong Kong sanctions are bad news for banks. Dimon, Bezos Among CEOs Pledging to Hire 100,000 New Yorkers. Black Finance Workers in London Face 'Dire' Prospects Despite CEO Pledges. 'Stranded Assets' Risk Rising With Climate Action and $40 Oil. SEC Charges Interactive Brokers With Repeatedly Failing to File Suspicious Activity Reports. NBA Hires Investment Banker to Promote Basketball Across Africa. "The business card is on life support." 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! |
Post a Comment