Short Selling as a Business Model

(Bloomberg View) -- Financialization.

Twelve years ago, my now-Bloomberg colleague Joe Weisenthal proposed that startups that planned to disrupt an established industry should short the stock of the incumbents in that industry. That way, if they were right -- if they were able to undercut big established public companies -- then they'd get rich as those public companies declined. Not coincidentally -- not, like, their business would grow as the incumbents' business shrinks -- but causally; their profits would come from the incumbents' shrinking.

Weisenthal's proposal was for disruptors offering a free product; the idea was that the entire business model would consist of (1) offering a free service that public companies offer for money and (2) paying for the service by shorting the public companies. But there's a more boring and more widely generalizable -- yet still vanishingly rare -- version of this approach in which it just augments the disruptors' business model: You sell better widgets cheaper and make a profit that way, while doubling down by also shorting your competitors. It's a more leveraged way to do the business you were going to do anyway, an extra vote of confidence in yourself.

Or here, from Jemima Kelly at FT Alphaville, is a slightly further generalization:

Back in September, one of the founders of a funeral services price comparison start-up called Beyond wrote a 13,000-word analysis entitled “The reaper calls for Dignity”, in which he argued that the FTSE 250 funeral services firm's business model was unsustainable. In particular he cited of a lack of transparency and high prices.

Beyond doesn't offer a free service -- it lets funeral directors list on its site and takes a 10 percent commission -- but I suppose it doesn't hurt to add revenue sources. (The price fell and Beyond made money, "and that's not to mention the press coverage the analysis generated for the London-based start-up.")

I don't know. Short-selling as an adjunct to running a price-comparison business makes a certain kind of goofy hyper-financialized sense, but Weisenthal's version is more interesting, isn't it? What is beautiful about the pure short-selling-supported version is how it inverts the logic of capitalism. A normal business is, you make a thing that people want, and you give it to them in exchange for money, and they value the thing more than the money, and you value the money more than the thing, and so everyone is better off. You profit by creating value. 

This is, you make a thing that people want, and you give it to them for free, and they stop buying it from someone else, and you have a side bet on the demise of that someone else, and that bet pays off. You profit by destroying value. The magic is that that is possible. Any primitive economy can produce gains from trade: If I raise goats and you grow grain, I can give you some milk in exchange for some grain and we'll both be better off, even if we don't have money or fractional-reserve banking or ATM cards or credit derivatives. But you need an advanced economy -- you need a complex financial system -- to profit from destroying value. There is no intuitive link between destruction and wealth; you need short-selling to do that.

Elsewhere: "Goldman Sachs asks in biotech research report: 'Is curing patients a sustainable business model?'" One: Umm? Don't think too hard about what that question says about the logic of capitalism. Two: If it's not, maybe you could subsidize it by shorting ... health insurers? Funeral homes?

Clarity Sachs.

"Consumers are too often overwhelmed by or don’t have a good handle on their finances," says ... wait a minute ... a guy at Goldman Sachs Group Inc.? "We think we can simplify that," says, again, this person who works at Goldman Sachs, which has now bought a company called Clarity Money and added its founder as a Goldman partner:

Clarity Money’s app is expected to serve as the smartphone storefront for Goldman’s growing suite of retail products, which the Journal has reported could include wealth-management tools, home mortgages, point-of-sale loans and insurance policies. Marcus doesn’t yet have a mobile app.

Clarity Money uses algorithms and artificial intelligence to help consumers cancel or lower their bills, find a better credit card, and set savings goals. It aggregates information about their bank accounts and spending habits, and collects fees for referring them to credit-card and other financial companies.

Great! Some things:

  1. I guess if you're going to dive into retail banking, you might as well dive right into retail-banking conflicts of interest. "Goldman will have to strike a balance between keeping Clarity Money as a neutral platform -- recommending the products best-suited for its users, even if they come from a Goldman competitor -- and using it to push its own offerings." The good news is that everyone trusts Goldman Sachs to put its customers' interests ahead of its own! That is definitely Goldman's brand! Certainly regulators and plaintiffs' lawyers won't be carefully parsing every Clarity Money recommendation to see if it's favoring Goldman products!
  2. Disclosure: I used to work at Goldman Sachs.
  3. Further disclosure: I have a savings account at Marcus, Goldman's online retail bank. 
  4. Further further disclosure: I am currently in the business of ... I don't know ... let's say simplifying finances for people? Or something? On their phones, if they want? And yet no one at Goldman has called me up asking to buy Money Stuff and bring me in as a partner. 
  5. I really enjoy Goldman's apparent addiction to buying personal-finance businesses with aggressively wholesome names. Back in 2016 when Goldman bought a startup called Honest Dollar, I suggested that Goldman should rebrand its whole business as "Honest Dollar." ("Honest Dollar is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money" just ... sounds ... less plausible, you know?) Similarly I hope they roll out the Clarity brand more broadly. When I was at Goldman I pitched structured equity transactions to corporate clients, and I am sure it would have been easier to explain a convertible bond with call options overlay and synthetic stock borrow facility if it had been called a Clarity convertible bond with a call options overlay and a synthetic stock borrow facility. 
  6. Really I hope that Goldman will at least copy the Beyond business model and short the stocks of companies whose products Clarity recommends against?

Do not call.

A well-known fact about securities fraud is that it creates valuable mailing lists, but I suppose that a plausible hypothesis about illegal telephone badgering is that it would create useless telephone lists?

West Virginia attorney John Barrett really wants his clients to know he won a $61 million verdict against Dish Network Corp. on their behalf after a company contractor badgered people with marketing phone calls.

There is just one hitch: His clients keep hanging up when he calls to convey the good news.

One woman said “that’s ridiculous” and hurried off the phone when told that every unwanted Dish call is now worth $1,200.

He is calling people who have opted into the do-not-call list, "many on nights and weekends," to try to get them to take money on the settlement. "I do see the irony of a bunch of lawyers calling people who have been bombarded with telemarketing calls," he says.

Does he, though? The central difficulty of class-action litigation is that, while it is perhaps a necessary way to prevent corporate misconduct, it tends to actually result in trivial recoveries for actual plaintiffs and huge fees for lawyers. Class-action litigation is fundamentally a way to create incentives for lawyers (fees) to create incentives for companies (large damages awards) to avoid misconduct, but it is not a particularly good way to give the victims of that misconduct what they want. (Thus merger class actions tend to be settled with additional disclosure that no one reads.) Let's just assume that Dish Network's calls were awful and that the only way to deter such misbehavior is by making Dish pay $61 million to the people who received the calls. But the result of the lawsuit is that (1) this lawyer will get a lot of money in fees, (2) a lot of people he's never met will get smaller (though still surprisingly large!) amounts of money as his "clients," and (3) he will pester those "clients" with exactly the sort of unwanted phone calls whose illegality made him rich. 

From first principles you might imagine that what these people -- who have never heard of Barrett's lawsuit, but who are on the do-not-call list -- want is not $1,200 but to stop getting annoying phone calls. But in the U.S. legal system, just fixing the problem is not on offer. Giving them money, and giving the lawyers a cut, and making the problem worse, is the standard approach.

People are worried about unicorns.

Actually this seems to be the most golden of golden ages for unicorns. For one thing, with SoftBank Group Corp. pouring money into private technology companies, unicorns can raise all the money they want; the main inconvenience is that when private tech companies try to raise money they keep raising more money than they want:

The Silicon Valley money machine is once again in high gear, thanks largely to SoftBank. The conglomerate is injecting billions of dollars into tech, in turn causing deep-pocketed global investors—and some U.S. venture firms—to arm up in response. A record level of late-stage money is flooding in, threatening to keep some startups out of the public markets even longer while heightening concerns that the sector is overvalued.

In recent months, hotly contested companies like ride-hailing service Lyft Inc. and dog-walking app Wag Labs Inc. have received hundreds of millions of dollars more than they sought.

Ah, but good news for unicorns is also worrying news: If unicorn fund-raising is hot and valuations are high, that just means that venture capitalists will be unable to take their unicorns public, right? But, no, actually, the exits from the Enchanted Forest seem pretty enchanted themselves:

Investors, bankers and analysts said they expected a wave of initial public offerings to bring some of the most highly valued and recognizable start-ups to the public market over the next 18 to 24 months — and billions of dollars in returns to their executives and investors. The potential bonanza would follow years of waiting as a few dozen companies amassed valuations without precedent in the private market.

Already, 2018 has gotten off to a fast start. Two of the biggest start-ups still sitting on the sidelines — Dropbox, an online file storage company, and Spotify, the streaming music service based in Sweden — successfully went public over the past month. Tech I.P.O.s have already raised more than $7 billion this year — more than all of 2015 and 2016, and more than half the $13 billion they raised last year, according to the market-data firm Dealogic.

We talk a lot around here about how private markets are the new public markets, how private companies can now get most of the benefits (limitless fund-raising, secondary liquidity, name recognition) of being public without the inconveniences (financial disclosure, shareholder pressure) of actually going public. So why are the big unicorns heading to the exits? I don't know. The answers are not super satisfying:

While private capital has been so accessible that start-ups have been able to get ample funding without the headaches of an I.P.O., several factors are encouraging companies to go public now, investors and bankers said. Public investors are hungry to buy shares of fast-growing companies. Early employees are getting antsy to cash in their stakes. And some start-up executives are eager to prove themselves as public company chief executives after founders like Facebook’s Mark Zuckerberg and Twitter’s Jack Dorsey have said going public improved their discipline and focus on profits.

I guess "private markets are the new public markets" is an oversimplification. The model is really that early-stage speculative companies used to be private, and middle-stage growing companies used to be public, and late-stage cash-flowing incumbent companies also used to be public. And now that middle stage is shifting: You can get the capital you need to grow while you're private, so you stay private longer, but once you're not growing as fast and don't need as much capital you go public to cash out your employees or improve your profit discipline. The private markets have taken over the public markets' role in capital raising, but the public markets have retained their role in capital return. If that's the model then you'd expect an IPO slowdown during the transition, and then a return to IPOs once the transition is complete. All the big unicorns that grew while being sheltered in the Enchanted Forest are now finally ready to come out. 

How's Theranos doing?

Theranos Inc., the Zombie Blood Unicorn that the Securities and Exchange Commission accused of running a "massive fraud" and that recently laid off most of its employees while still, amazingly, trying to squeeze a bit more money out of its defrauded investors, also ... did this:

Not only did Theranos employees once chant "f--- you, Carreyrou" at an all-hands meeting, but employees even built a "Space Invaders"-style game in which players were to shoot little pictures of Carreyrou's head, as well as the Zika virus, he tweeted on Thursday.

John Carreyrou is of course the Wall Street Journal reporter who exposed Theranos's fraud. He tweeted a screenshot from the game. I suppose in hindsight if Theranos had spent less time building video games to snipe at their critics, and more time building the blood-testing devices that they told reporters and investors that they had built, then maybe they'd be in less trouble?

My Robert Mercer movie.

We have talked before about the movie that I am working on based on my Bloomberg colleague Zachary Mider's remarkable story about hedge-fund magnate and right-wing donor Robert Mercer, who apparently occasionally worked as a part-time volunteer policeman in a tiny New Mexico town in order to qualify to carry a concealed gun anywhere in the United States. In my "Twin-Peaks"-tinged version of the story, the Mercer character's occasional patrols of the tiny town would bring him into contact with quirky local characters, uncanny events, dark secrets, and of course a romantic subplot.

But the real story just keeps being weirder than I can imagine. Mider and Zeke Faux have a follow-up about a different small town where Mercer is also a law-enforcement volunteer. This one is in Colorado, and Mercer is part of the "sheriff's volunteer posse," and his foundations have donated things to the department (including a pickup truck and some Tasers) in transactions that are, one assumes, entirely unrelated to the badge that he received from the department. And this story takes a dark and/or hilarious turn when the sheriff refuses to provide information about his volunteers:

“Some of my volunteer resources are directly involved in confidential undercover operations that involve direct ties and associations with the Mexican Cartel which has a presence in my area,” Day wrote in an earlier email. “It would not be safe tactically or personally to identify individuals who serve in association with those types of cases.”

Lees, the lawyer, wouldn’t say if Mercer or his associates have been infiltrating cartels. “What they do is entirely confidential,” Lees said. “I’m neither confirming nor denying that they serve in those roles.”

OH BOY DO I EVER HOPE THAT ROBERT MERCER IS INFILTRATING CARTELS ON HIS DAYS OFF. Don't get me wrong: I doubt it! But if he is, then I will forever give up making jokes about writing movies based on financial news. I can't compete with that! And I congratulate Mider and Faux in advance on the undoubtedly lucrative movie deal they'll get for that story.

Bowl stuff.

It's been a while since we focused on the Rise of the Bowl, but apparently it's having a moment again: "Grain bowls, harvest bowls, Buddha bowls, smoothie bowls, burrito bowls, poke bowls, KFC mashed potato bowls—from obsessively healthy super foods, to 'cheat-day' fried chicken, we’re eating more food than ever out of bowls," writes Annaliese Griffin at Quartz. The bowl "evokes a way of eating that for me is more about something of comfort and sustenance," says the "culinary director at Dig Inn, a bowl food-centric fast casual chain." "The concept of the bowl meal was very unfashionable for much of the twentieth century," as "formal plates with discrete piles of food were symbols of American identity and wealth, one of the many spoils of capitalism and the rising middle class." But "bowl food was the diet of the revolution." "A bowl that we pick up and touch is more likely to set an expectation of a hearty, filling and healthy meal." It's a lot of sentences about bowls really. I'm sort of overwhelmed by the abundance, of the sentences, about the bowls.

Me elsewhere.

I was on the Slate Money podcast this weekend talking about lawyers, credit-default swaps, etc.

Things happen.

Bank of America’s Cost-Cutting Drive Pushes Profit to Record. (Earnings release, presentation, supplement.) Hank Greenberg is trying to end state securities-fraud enforcement. Guggenheim Partners’ Asset-Management Unit Is Under SEC Investigation, Sources Say. Larry Fink is a billionaire now. A Sixth Sense For Biotech Has Made Joe Edelman A Hedge Fund Star. If Fed Moves Unlock Billions at Banks, Here’s Who Might Win Most. Aramco Accounts Show Expanding Refining Business Lagged Big Oil. My Bloomberg Gadfly colleague Liam Denning values Saudi Aramco at about $1.2 trillion. WPP CEO Departure May Herald Breakup, Strategy Shift at Empire. Stephen Schwarzman’s Painful High School Homecoming

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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.

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.

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