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Trading Is a Good Way to Set a Price

Trading Is a Good Way to Set a Price

(Bloomberg View) -- Spotify.

When you are a private company your stock doesn't really trade. When you become a public company your stock is listed on a stock exchange and trades all the time, like in microsecond increments. This is a jarring transition. All the people who will be trading your stock need to figure out what price it should trade at. For already-public companies, they look at the price it traded at a second ago, and extrapolate from that. But for newly public companies that data point is not available, and so those companies instead use a large expensive process -- the initial public offering -- to generate a trading price. In the IPO, the company hires bankers to sell a big chunk of stock to investors all at once. This jumpstarts trading in the stock, because all of a sudden there are a bunch of public-markets investors in the stock and they can trade with each other, and it also gives a reference point -- the IPO price -- that they can use to start thinking about the right trading price for the stock.

Spotify AB is a private company that is skipping this process: It will just list its stock on an exchange, without selling any in a big coordinated offering. We have talked a few times about how weird that is: Without selling a bunch of stock to investors all at once, there is no guarantee that there will be a lot of investors available to sell on the first day of trading, and so the stock price could be pretty wild. Spotify is doing things to mitigate that risk, hiring bankers (and paying them $30 million!) to go out and market the stock and more or less run a quasi-IPO process without the actual IPO. 

But Spotify also has an even better solution to the problem: Its stock already trades, so the transition just won't be that jarring. 

Private trading is expected to be a key part of the company’s effort to guide the market to a price, people familiar with the matter said.

The so-called secondary markets in private technology stocks are typically an afterthought in an IPO, in part because trading tends to be thin and not always a reliable indicator of value. But Spotify and its advisers at Goldman Sachs Group Inc., Morgan Stanley and Allen & Co. are closely watching trades among private investors and have taken steps to spur volume, the people said. The company recently informed existing investors that it waived its right to buy shares before they are offered to others.

Private markets, I often say around here, are the new public markets. One way in which they are the new public markets is that you can trade on them. It may take you more than a few microseconds, and there's no centralized exchange that lists orders and trade prices, but those are minor quibbles. And over time, you'd expect liquidity to beget liquidity: If big private companies allow secondary trading in their stocks, then ecosystems -- trading platforms, order books, research providers -- will spring up to support that trading, which will lead to more trading, which will lead to more ecosystems, etc.

This seems like a real threat to the IPO business. It's not just that IPOs are an afterthought because companies can raise all the money they need in the private markets. That was true when Facebook Inc. did its IPO too; public markets have for a long time been useful more for returning money to shareholders than for raising money for companies. It's not just that private-market trading makes an IPO less necessary, because founders and employees and venture capitalists can get liquidity in the private markets and don't need their companies to go public.

It's also that private-market trading diminishes the magic of the IPO. Every so often a company listed on Nasdaq will move to the New York Stock Exchange, or vice versa, but it's rarely front-page news and they never pay banks tens of millions of dollars to advise them on the relisting. It's just some administrative trivia, of no real practical significance. If moving from private markets to public markets becomes just a change in venue, then the IPO will lose a lot of its importance.

Crypto crypto crypto.

Here's Paul Singer's Elliott Management with the bull case for bitcoin:

"FOMO (fear of missing out) has solidly trumped WTHIT (what the hell is this??)," Elliott told clients in a January 26 letter seen by Business Insider. "When the history is written, cryptocurrencies will likely be described as one of the most brilliant scams in history."

The fund dedicated three pages to covering what it sees as issues with cryptocurrencies. The letter said:

"We all laugh at primitive tribes which used large stones (or pigs) as currency. Well, laugh as you will, but a stone or a healthy pig is something. Cryptocurrencies are nothing except the marketing power of inventors, financiers and others who love the idea of buying a black box (which is obviously empty) for the price of a Kia and dreaming that it will turn into a Mercedes. There have been times recently when this dream has materialized within hours. This is not just a bubble. It is not just a fraud. It is perhaps the outer limit, the ultimate expression, of the ability of humans to seize upon ether and hope to ride it to the stars."

I mean look. If I told you "X is a scam," you probably wouldn't buy X, because you are a savvy Money Stuff reader and you don't buy into scams. But maybe you should! What if I told you "X is a really good scam, and it's just getting started"? The stereotypical pump-and-dump scheme starts with some fraudster hyping a stock, and ends with a bunch of retail investors holding the bag when that stock crashes. But in between there are usually savvy people who buy the stock on the hype, knowing that it's a scam, but believing correctly that they'll be able to sell it to someone else on the way up and get out before the crash. Sometimes the right trade is to short a scam, but often it's to go along with the scam for a while.

But cryptocurrencies, in Elliott's telling, are not just a scam, or a good scam. They are "one of the most brilliant scams in history." (And they're only like 10 years old! Get in early!) What else is on that list? I like Yuval Noah Harari's argument, in "Sapiens," that Homo sapiens's major advantage as a species is our ability to generate collective fictions:

As far as we know, only Sapiens can talk about entire kinds of entities that they have never seen, touched, or smelled. Legends, myths, gods, and religions appeared for the first time with the Cognitive Revolution. Many animals and human species could previously say ‘Careful! A lion! Thanks to the Cognitive Revolution, Homo sapiens acquired the ability to say, ‘The lion is the guardian spirit of our tribe.' This ability to speak about fictions is the most unique feature of Sapiens language. ... You could never convince a monkey to give you a banana by promising him limitless bananas after death in monkey heaven.

Harari argues that fiction "has enabled us not merely to imagine things, but to do so collectively," and thus given us "the unprecedented ability to cooperate flexibly in large numbers." Harari's list of powerful fictions includes religion, nation-states, human rights, money and the limited liability corporation. Laugh as you will, but the limited liability corporation is not a stone, or a healthy pig. It is just an example of the ability of humans to generate abstract concepts and use them to coordinate action, "to seize upon ether and hope to ride it to the stars." Viewed in a certain light the corporation, or money, or nation-states, or religion, are some "of the most brilliant scams in history." Being on that list augurs well for a scam's longevity, and for its real value. If Bitcoin lasts for 10,000 years and facilitates a freer and more productive economy, then it really will be one of the most brilliant scams in history. And you'll be glad you bought Bitcoins.

That doesn't mean that Elliott is right! What do I know? Maybe cryptocurrency is not one of the most brilliant scams in history, but just a regular scam. This is not investing advice. My point is only that it is not a good objection, to an innovation in human culture, to say that it has no basis in physical reality. That's the whole point of culture, the defining feature of humanity.

Meanwhile, the absolute gibberish that is Venezuela's cryptocurrency, the petro, which will somehow be a commodity currency and a fiat currency and a cryptocurrency, is launching today. And: "Bitcoin is becoming a 'nightmare' for divorce lawyers," not just for the obvious reason (it's a way to hide assets) but also because its value is so volatile that it's hard to fairly divide up assets. And: "Despite the growth in both retail and institutional interest in the cryptocurrencies, the number of firms producing institutional quality research of this new asset class has clearly lagged." And "SEC Suspends Trading in Three Issuers Claiming Involvement in Cryptocurrency and Blockchain Technology." And: "South Korean Cryptocurrency Regulator Found Dead at Home." And: "The currency they were after was virtual, but the guns they carried were anything but."

Office culture.

Here is a story about Jerome Powell's revolutionary new approach to talking to staff at the Federal Reserve, which seems to involve actually going up to them and talking:

Spur-of-the-moment exchanges between the chair and junior staffers would have been largely unthinkable at the Fed a generation ago. Even in recent years, a request for information would often result in a carefully vetted formal presentation that might take weeks to prepare and an hour to deliver.

Powell, who spent a dozen years in banking and private equity, has no patience for that, the two current insiders said. Nor does he want staff to over-invest their time in a complex production when all he needs is a substantive and frank discussion with just the right expert -- but right now.

Think about that aside "who spent a dozen years in banking and private equity" for a minute. I worked in banking for four years, and I definitely saw a lot of people over-invest their time in complex productions when all that was needed was a substantive and frank discussion. (This describes every banking pitch I've ever seen.) And yet I am perfectly willing to believe that the Fed is (was?) worse. If you work in the financial industry and you need information from the people who work for you, you go and ask them, and they tell you, because your goal is to get the information and use it to acquire money. In government your goal is not to acquire money, but to exercise and perform power. If you have a question and your staff just answers it, then you know the information, but that may not be what you wanted. If you have a question and your staff spends weeks preparing a presentation to answer it, then you know how important you are.

And elsewhere in workplace culture, Conway's Law says that "organizations which design systems ... are constrained to produce designs which are copies of the communication structures of these organizations," and you could imagine a generalization that says something like "the foibles and blind spots of a company's culture will be reproduced in its products." Here is a story about literal blind spots at Apple Inc.'s fancy new headquarters:

There’s been one hiccup since it opened last year: Apple employees keep smacking into the glass.

Surrounding the building, located in Cupertino, California, are 45-foot tall curved panels of safety glass. Inside are work spaces, dubbed “pods,” also made with a lot of glass. Apple staff are often glued to the iPhones they helped popularize. That’s resulted in repeated cases of distracted employees walking into the panes, according to people familiar with the incidents. 

Some staff started to stick Post-It notes on the glass doors to mark their presence. However, the notes were removed because they detracted from the building’s design, the people said.

If you run into a glass wall one too many times you will probably think removing the headphone jack is a good idea.

And here's a story about WeWork, a commercial landlord that invests heavily in blather:

Indeed, to assess WeWork by conventional metrics is to miss the point, according to Mr. Neumann. WeWork isn’t really a real estate company. It’s a state of consciousness, he argues, a generation of interconnected emotionally intelligent entrepreneurs. And Mr. Neumann, with his combination of inspiration and chutzpah, wants to transform not just the way we work and live, but the very world we live in.

Ah.

Are people in the financial industry really not aware of the boom in dystopian young-adult fiction?

I mean:

Chris Babu, who ran government-backed mortgage-bond trading at Deutsche Bank AG until 2016, has gotten used to funny looks when people hear about his career change.

He now spends his time holed up with Buddy, his Great Dane, writing post-apocalyptic fiction for young adults from his home in Southampton, New York.

“You’re nuts,” Babu says old colleagues sometimes tell him. “Get a job that’s going to pay you a lot of money.”

Yes right look maybe you haven't seen all the "Hunger Games" movies but I promise that lots of people have. As far as I can make out people have even seen the "Maze Runner" movies. "Post-apocalyptic fiction for young adults" is a robust field, which is probably more than you can say for agency MBS trading.

One thing about working on a trading desk at a bank is that you need to have some risk appetite, but not too much. Sure you have taken a job in which you are constantly evaluated based on your ability to make high-stakes decisions with imperfect information, but at the same time, all your friends on the Dartmouth lacrosse team have taken the same job. It is not exactly a huge leap into the unknown. And the huge leaps into the unknown are where the real money is. Though at this point young-adult-dystopia seems like a pretty mature industry. It's like getting into hedge funds in 2016.

Anyway "the novel was partly inspired by what Babu called his 'daily hellish commute' from Manhattan’s Upper West Side to Wall Street on the 2/3 subway line," which sounds like a pretty reasonable inspiration for a dystopian novel. 

People are worried about stock buybacks.

This is maybe the weirdest stock buyback story I've ever read. It starts normally enough:

North American energy producers survived the recent oil bust in large part by selling more than $60 billion of new stock. Now they’re beginning to buy it back.

Yes that is the way stock buybacks work: When you are in trouble and need money, you issue stock; when you are flush with cash, you buy it back. There is a very good reason for that: The purpose of the corporation is to generate cash for shareholders, and the purpose of the stock market is to raise cash to fund companies, so it would be weird to sell stock when you don't need the money or to do buybacks when you're desperate for cash. But the result is that companies tend to look like terrible traders of their own stock: If you sell stock when you're desperate and buy it back when you're flush, you tend to do a lot of buying high and selling low. 

But the weird part is that the energy producers -- who sold stock when they were desperate and are now buying it back when they're flush -- are somehow mostly buying low after selling high anyway:

Laredo’s shares are trading more than 20% below what the company sold stock for in three offerings during the downturn.

Noble Energy Inc. and Gulfport Energy Corp. are likely to buy at even bigger discounts to what they sold shares for in recent years. Noble said last week it would use proceeds from the sale of its Gulf of Mexico fields to repurchase $750 million of its stock, which is trading about 45% below the $47.50 its shares fetched in a $1.15 billion offering three years ago. Gulfport said it plans to buy back $100 million of the stock it sold at prices ranging from $21.50 to $47.75 in four offerings between April 2015 and December 2016. The Oklahoma City company’s shares ended Friday at $8.75.

Don't get used to this! It is traditional to make fun of companies for buying high and selling low when they trade their own stock, but it is surely better than the alternative. After all, there is someone on the other side of those trades, and it's the shareholders. If companies could regularly raise money by selling stock when business was bad, and then buy that stock back more cheaply when business recovered, then what would be the point of investing in stocks?

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.

To contact the author of this story: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net.

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