(Bloomberg View) -- Spotify will be dual-class.
Well of course it will!
Spotify’s co-founders are taking a page from the Google-Facebook playbook, with plans to maintain control over the music service after its stock listing by holding shares with super voting power, according to three people with knowledge of the matter.
Chief Executive Officer Daniel Ek and Vice Chairman Martin Lorentzon own a class of stock that assures their hold on the company after the shares begin trading, said the people, who asked not to be identified because the terms aren’t public. Another class will be tradable by investors.
Here is how I expect initial public offering conversations will go for a lot of hot unicorns:
Founder: I want to sell stock to the public, but I want to keep most of the voting power.
Banker: Yeah, look, about that. Investors really don't like that. They've ganged up and gotten to the index providers, and now if you issue low-vote stock to the public and keep all the votes for yourself, you won't be able to get into the major indexes.
Founder: Ehh, so what?
Banker: Well, if investors know there won't eventually be index demand, they might not buy the stock. Or at least they'll pay less for it than you want.
Is it the most convincing pitch? Not necessarily, but don't underestimate it. Most tech unicorns haven't gone public before. The founders really want their offering to be a success, because they are people who like success. The bankers, who know what they are doing, put on very serious faces and explain that the offering may not be a success because of the dual-class stock. The founders might feel some residual doubt -- they might wish that the bankers were a bit better at quantifying the price impact of the dual-class stock, for instance, so that they could choose between selling dual-class stock at $18 or single-class stock at $22 -- but there will be real pressure on them not to add risk to the IPO by using a governance structure that has been noisily rejected by the market.
You will notice that virtually all U.S. IPOs feature greenshoes and lockups, provisions that issuers find confusing and annoying but that bankers insist on. The issuers could just say no. But they don't, because the bankers tell them that those provisions are essential to a successful deal, and the issuers all want successful deals. After the investor revolt over Snap Inc.'s issuance of non-voting stock, single-class stock might be on its way to joining that list.
Spotify: We want to be a public company, but we want to keep most of the voting power.
Banker: Investors don't like that, you'll be kept out of indexes, they might not buy the stock.
Spotify: We're not selling stock.
Banker: Oh right.
There is no IPO to go well or poorly, so no reason to care if it goes well or poorly. The stock will be public, and it will trade, but Spotify will be cheerfully indifferent to its trading levels, because (1) it is not selling any stock to raise money and (2) its founders are keeping control via dual-class stock so they don't need to worry about an activist or an acquirer coming in if the stock price is too low.
Obviously there are constraints. The founders will, after all, own stock; they will want to be able to sell that stock eventually for high prices. (They are also presumably listing because they want their employees and early investors to be able to sell their stock, preferably at high prices.) But this is a lower-stakes constraint. The fear that IPO bankers will put into the hearts of founders is not so much "you might get a lower price for your stock" as it is "your IPO might fail in some embarrassing public way," by pricing below the range or trading down in the aftermarket. If you just don't care about that -- if you take the mystery and drama out of the IPO process -- then all you are left with is an economic tradeoff: Investors might pay more for single-class stock than they would for dual-class stock. If you value control more than the marginal money -- which it is perfectly rational for wealthy startup founders to do -- then you should take that trade.
The crypto.
Here is a story about Republic Protocol, a dark pool -- or protocol for dark pools -- for trading cryptocurrencies. Here is Republic's white paper. The idea is that if you own ether and want to buy Bitcoins, or whatever, instead of exposing your order on an exchange so that everyone can see it, you use Republic like this:
- You put your order into the Republic Protocol smart contract.
- A flurry of cryptography occurs, breaking down your order into fragments such that (a) participants in the dark pool cannot see your order but (b) they can nonetheless match it against an order (or orders) on the other side.
- The network then blindly goes and finds people who own Bitcoins and want to buy ether and matches you up so you can trade.
It is crypto overlaid on crypto: Republic miners work to match your order so that you can tell Ethereum miners to transfer your ether to your counterparty while she tells Bitcoin miners to transfer her Bitcoins to you. The distributed matching engine is separate from the two different distributed settlement ledgers.
The obvious benefit here is that you can trade without publicly disclosing your order to the market (until it executes). The more crypto-y benefit is that you can trade without privately disclosing your order to anyone: Rather than trusting some dark-pool manager to execute your order without displaying it, or trusting some broker's algorithms to break up the order and try to get it executed in pieces, you can trust Republic's (open-source) smart contract to match your order while hiding it. "Nobody ever has access to the order book," says Republic's chief executive officer.
If this works, there is no particular reason to limit it to cryptocurrency trading. Many stock trades in the U.S. are done using hidden orders, but a lot of end users deeply distrust the intermediaries who handle those hidden orders. Stock exchanges are accused of favoring high-frequency traders; dark-pool operators seem to favor their best customers or even themselves; brokers are accused of routing orders for their own benefit rather than their customers'. If you went to stock traders and promised them a dark pool in which they didn't have to trust the dark-pool operator to behave itself, I think a lot of them would be interested.
A basic thesis behind the rise of cryptocurrencies is something like "people do not trust the financial system." There is obviously a lot of truth to that. But, you know, not that much: Plenty of people -- even Bitcoin enthusiasts -- still have checking accounts. On the other hand there are some specific pockets of the financial system that seem to attract extra distrust. Electronic market structure seems to get way more than its share of distrust. ("Dark pools," "hidden orders" -- even the names sound sneaky.) That suggests that it's ripe for disruption by a trustless system.
Elsewhere: "Hackers hijack Tesla’s cloud system to mine cryptocurrency." You occasionally see people worrying that self-driving cars will be vulnerable to hacking, and that the hackers will take over the cars in order to cause crashes. (Today's xkcd is possibly relevant.) An underrated feature of cryptocurrency is that it seems to tempt hackers who gain control of powerful computer systems to ... just ... use those systems to solve math puzzles. Obviously this is bad; Tesla needs its computing power to drive the cars or whatever. But it is not as bad as, you know, deliberately crashing the cars. I look forward to reading stories, in the near future, about hackers who break into banks' computer systems and use those systems to mine for Bitcoins. Instead of stealing the banks' money, I mean. Cryptocurrency mining can be a nice diversion for hackers who would otherwise get up to something worse.
Everything is seating charts.
I keep saying it because it keeps being true. Here's the New York Times saying it:
If you want to understand the priorities of a technology company, first look at the seating chart.
That's from an article about how artificial-intelligence researchers are creeping ever closer to the chief executive officers of big tech companies. ("I can high-five Mark and Sheryl from my desk, and the A.I. team was right next to us," says Facebook's chief technology officer, and I hope he does; nothing expresses enthusiasm like a desk-high-five.) But of course it is true everywhere; if you want to understand the priorities of human beings you should look at whom they hang out with. It would be weird if that wasn't true of office space.
I suppose there is a contrarian reading. If you want to understand what tech CEOs think is cool and interesting, you should look at whom they sit next to. If on the other hand you want to understand where they get their vast wealth, you should look at their ad-tech department. Those people won't necessarily sit next to the CEO. The CEO might not want to be reminded of the awkward fact that he runs an advertising company. Running a company that is redefining what it means to be human and stretching the bounds of consciousness, sure, that is cool. Put the ad people in the basement, but keep taking their money.
A backlash.
Here are some good rules of thumb for investing:
- When stocks are going up a lot, you should own stocks.
- When stocks are going down, you should own something else.
These rules have some flaws -- arguably when stocks are going up a lot and Bitcoin is going up even more, you should own Bitcoin -- of which the biggest is that it can be hard to recognize the transition between states 1 and 2. ("When stocks are going up a lot, you should buy stocks," would not be an accurate rephrasing of this rule.)
Nonetheless they are trivially correct, and can be applied effectively in hindsight. When stocks were going up 13 percent a year and all your money was in market-neutral hedge funds that returned 2 percent, you were wrong to do that; your money should have been in stock index funds. They're cheaper, and they had better returns. When stocks went down, though, you should have been in hedge funds.
Stocks have had a boringly good run in recent years -- good returns, low volatility -- and hedge funds have had a correspondingly bad run. The difference is exacerbated by the fact that hedge funds remain stubbornly expensive, while stock investing is basically free now because indexing has become so popular. The cheaper thing has gotten better returns than the expensive thing, without much more (realized) risk. One way to interpret that is that it is a regime change: Indexed stock investing is always the best thing you can do, so you should always do it. Another way to interpret it is that it is cyclical: Indexed stock investing is good when stocks are going up, but sometimes stocks go down and then you should have been doing something else. The latter interpretation seems to have the weight of history behind it, but the former interpretation has the weight of, like, last year behind it, and memories are short. In any case there is no shortage of calls for public pensions, in particular, to get out of hedge funds and put more money in stock index funds.
But stocks have had an excitingly mixed run in recent weeks -- a big drop from the highs, lots of volatility -- and so everything has changed:
Public pension funds that lost hundreds of billions during the last financial crisis still face significant risk from one basic investment: stocks.
That vulnerability came into focus earlier this month as markets descended into correction territory for the first time since February 2016. The California Public Employees’ Retirement System, the largest public pension fund in the U.S., lost $18.5 billion in value over a 10-day trading period ended Feb. 9, according to figures provided by the system.
The sudden drop represented 5% of total assets held by the pension fund, which had roughly half of its portfolio in equities as of late 2017.
You might remember Calpers for its decision to get out of hedge funds in 2014, which even in hindsight -- even after the recent sell-off -- looks fairly well timed.
Fannie and Freddie.
We talked last week about the view, which I mostly share, that the status quo for Fannie Mae and Freddie Mac -- in which they are wholly-owned arms of the U.S. government but everyone has to pretend otherwise -- is mostly fine and can continue indefinitely. There are a few concerns, though, that might complicate that conclusion. For instance, there is the lush proliferation of lawsuits challenging that status quo and demanding that the government give them back to the investors who used to own them.
Those lawsuits presented two problems for the government. One problem was that discovery in those lawsuits dredged up some potentially embarrassing facts about how the government made the decision to nationalize Fannie and Freddie. But this problem has more or less gone away now that the Obama administration that made those decisions has been replaced by a Trump administration that (1) rejects everything Obama did and (2) is unembarrassable anyway.
The other problem is that the government might lose and have to pay billions of dollars to those shareholders. That problem also seems mostly gone. The government won a big decision last year, when a federal appeals court ruled that a lot of the shareholders' claims were barred by statutory language saying that the government's actions as a conservator of Fannie and Freddie were not subject to court review. Yesterday the government won a less interesting but more final victory, when the Supreme Court declined -- without comment, on a list of denials -- to review that decision. Some contract claims in that case still survive, but overall the government's record is pretty good:
In addition to those contract-based claims, the hedge funds and other investors have several cases ongoing around the U.S. though most of them are still in early stages. The funds have been allowed limited discovery in the U.S. Court of Federal Claims and they say the discovery shows the government lied when it decided to sweep Fannie’s and Freddie’s profits. However, no court has yet said that the government’s motives even matter, and the only courts to rule so far have dismissed the cases.
If these lawsuits were a live threat, they might put some pressure on the government to wrap up Fannie and Freddie's conservatorship and do something else with them. As it is, though, the status quo still seems fine.
Things happen.
U.S. Pays Up to Auction $179 Billion of Debt in a Span of Hours. Qualcomm, Moving to Fend Off Broadcom, Raises Bid for NXP to $44 Billion. Wall Street welcomes Trump’s approach on regulation. Apple in Talks to Buy Cobalt Directly From Miners. AT&T Loses Bid to Obtain White House Call Logs. How a $1.8 Billion Indian Bank Fraud Lasted Seven Years. "If you are a company of amateur-hour technology, so that everything becomes some nightmarish Rube Goldberg construction, in some cases, the best people to keep around are the ones who understand how the Rube Goldberg machines work." A new Netflix show wants to manipulate people into committing murder. Olympic bobsledders, snowboarders are crushing it on Tinder. "Scientists have debunked a centuries-old legend about rabbit domestication."
If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Thanks!
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.
For more columns from Bloomberg View, visit http://www.bloomberg.com/view.
©2018 Bloomberg L.P.