Money Stuff: Free Wirecard Money Costs SoftBank

Money Stuff
Bloomberg

SoftBank and Wirecard

A thing that I think about a lot is that when Warren Buffett invests Berkshire Hathaway Inc.'s money in a company, that company's stock goes up. I don't mean that it goes up in the long run because he is good at picking stocks (though that too); I mean that it goes up immediately because people admire Warren Buffett and think he is good at picking stocks. When he announces a stake in a company, other people buy the stock too, and it goes up. This is sometimes loosely called the "halo effect."

This is good for Buffett, since he has an immediate gain on his stock, but not that good. It is mostly good for other people—if Buffett buys 10% of a company and pushes the stock up, 90% of the benefit goes to other shareholders—and anyway Buffett isn't going to turn around and sell his shares the next day, so he can't capture the immediate benefit.

As a financial engineer, one is tempted to tinker. What if there was a way to distill this particular fact—the fact that a Warren Buffett investment makes the stock go up—and monetize it, directly, for Berkshire Hathaway? I once wrote that "there is a halo value to a Berkshire investment that is entirely distinct from the money it invests," and that "if you could somehow separate the Berkshire halo from Berkshire's actual balance sheet then you'd have something really valuable."

It's not Berkshire Hathaway, but SoftBank Group Corp. has its own sort of halo effect, or had for a while. Like Buffett, SoftBank's Masayoshi Son has a charismatic-folksy-genius vibe and a history of investing success; like Berkshire, SoftBank has a huge pot of money to support its favored businesses. When SoftBank puts money into a company, that means—or tends to mean, or is interpreted to mean, or used to be interpreted to mean—the company will have huge growth opportunities: SoftBank is good at picking winners, it will introduce the company to its many other portfolio companies, it will support the company's blitzscaling with piles of money at ever-increasing valuations, there is a virtuous cycle that other investors might want to come along for.

What if SoftBank could monetize that effect? What if it could package the immediate increase in value that a company gets from a SoftBank investment, separate it out from any actual SoftBank investment, and sell it?

Well, then you'd get pretty much exactly SoftBank's investment in Wirecard AG. My Bloomberg Opinion colleague Shuli Ren explains:

The tech conglomerate never put money into Wirecard itself.

Instead, SoftBank facilitated a 900 million euro ($1 billion) convertible bond deal for the German digital payments company. Without requiring any SoftBank cash, the deal appeared to give the company's stamp of approval to Wirecard, which had faced scrutiny over its accounting for years before admitting that 1.9 billion euros had gone missing from its accounts. Wirecard's shares soared more than 25% between the announcement of the tie-up and its signing. …

But shortly after Sept. 18, 2019 — when the companies' strategic tie-up was signed, and Wirecard's stock was trading at 158 euros per share — Credit Suisse Group AG repackaged and resold those instruments, which were issued just hours before, to a broader group of investors at substantially less attractive terms. 

SoftBank announced that it was buying a Wirecard convertible bond, sort of. (The investor was actually a fund run by SoftBank Investment Advisers, and the money came from SoftBank employees and Mubadala Investment Co.) There was also a strategic partnership where SoftBank would introduce Wirecard to its other portfolio companies and otherwise support Wirecard. "The market viewed the news as a vote of confidence in Wirecard, whose stock jumped 8.5% that day," and was up 25% between the announcement and the closing. In the interim, Credit Suisse built a Wirecard exchangeable bond that mirrored the SoftBank convertible; when the deal closed, the SoftBank investors sold the exchangeable. They bought the convertible at the pre-investment price, they sold the exchangeable at the post-investment price, and they effectively clipped the 25% upside for themselves without putting up any cash.

It's a perfect halo monetization trade. I guess the bad part is that SoftBank didn't make any money off of it, but even that feels somehow appropriate. The SoftBank halo effect comes in large part from the actions of its executives—in picking the right companies and supporting their growth—so I guess it makes sense for the executives, rather than SoftBank as a company, to profit from this trade.

Oh the other problem with halo monetization trades is that they encourage a certain, uh, loss of focus. If you can get paid immediately, without putting up any capital, just for providing your seal of approval, you will be tempted to provide lots of seals of approval without doing a lot of due diligence. Who cares, whatever, free money. The bad news is that if you do enough of that you will tarnish the halo. The Wall Street Journal reports:

SoftBank Group Corp. is looking to distance itself from Wirecard AG, after the Japanese tech conglomerate helped arrange a $1 billion investment months before the German payments company went bust.

One of the world's largest technology investors, SoftBank is seeking to terminate a five-year partnership its investment arm formed with Wirecard in April 2019, according to people familiar with the matter.

Ren notes:

Now that Wirecard has filed for insolvency, one can't help wondering why SoftBank got involved in the first place. After a series of high-profile due diligence errors, SoftBank can ill afford any brush with a company battling corporate governance issues. 

Presumably they got involved in the first place because, you know, free money, who cares about the diligence. SoftBank didn't lose any money on its Wirecard trade because it didn't put up any money; all it did was put up its reputation, which was enough for it (well, for its executives) to make a nice quick profit. SoftBank invested nothing but its reputation, but it did invest its reputation, in Wirecard. Oops! If you harvest your reputation too ruthlessly, you end up losing it.

YRC

If I were the U.S. government, and I was taking huge equity stakes in companies that (1) run out of money and (2) are essential for national security, I would vote my shares. The point of being a company's biggest shareholder is not just that you make money if the stock goes up; it's also that you get to tell the company what to do. Often this is not of much interest to an ordinary investor, but if you are the biggest shareholder in a company that is on the verge of running out of money, you may want to keep a closer eye on it. Also though if you are the U.S. government and you are the biggest shareholder in the company explicitly for national security reasons, you may want to, you know, use your shareholder power to promote national security. "No we should not enter into this contract with Russia, even though it is lucrative," you might tell the chief executive officer, that sort of thing.

The actual U.S. government doesn't see it my way:

The U.S. government plans to lend $700 million in coronavirus stimulus funds to trucking firm YRC Worldwide Inc., in exchange for a 29.6% equity stake in the company, the Treasury Department said Wednesday.

The Treasury said publicly traded YRC qualified for the loan under a provision of the $2.2 trillion law Congress enacted in late March that authorized $17 billion for companies deemed essential to national security.

The loan is by far the biggest the government has extended to a U.S. business outside of the airline industry, and the first loan the government has awarded from a special fund for firms with ties to the Defense Department.

Overland Park, Kan.-based YRC is one of the largest U.S. trucking companies and does substantial business with the Defense Department, delivering food, electronics and other supplies to military locations around the country, as well as serving some 200,000 industrial, retail and commercial customers. … 

"This loan will enable a critical vendor to the Department of Defense to maintain significant employment while providing appropriate compensation to taxpayers," Treasury Secretary Steven Mnuchin said.

But:

UST will hold the shares of the Company's common stock through a voting trust, which will be required to vote the shares in the same proportion as all other unaffiliated shares of the Company's common stock are voted. The shares will be subject to certain transfer restrictions and the Company has agreed to register the shares for resale pursuant to a registration rights agreement.

Now obviously the U.S. government has other ways to influence YRC, other than by voting its 29.6% stake in the company. It is the government, for one thing; it can pass laws and regulations to make YRC do what it wants. It is a big customer, for another thing; if it is unhappy with YRC it can use someone else to ship its stuff. As it happens, it is unhappy with YRC, as a customer, and has sued:

In 2018, the Justice Department sued YRC for allegedly overcharging the Pentagon millions of dollars for shipping from 2005 to at least 2013. Mr. Hawkins called the lawsuit "a contractual dispute from over a decade ago" and said YRC has filed a motion to dismiss the case.

You might think that a 29.6% stake would give you a seat on the board and a say in settling that lawsuit, but I guess the government keeps its roles of regulator, customer and shareholder strictly separated.

We talked last week about a theory of mine that government and shareholder governance are to some extent substitutes for, and competitors with, each other. Big social issues are contested and regulated both by the U.S. government telling companies what to do, and by big institutional shareholders telling those companies what to do. Sometimes the government and the institutional shareholders regulate the same big social issues—competition, pollution, etc.—and sometimes they come to different conclusions.

When we talked about it last week, I suggested that the U.S. government can be a bit territorial about this, that it gets mad when institutional shareholders try to intrude on its turf by, for instance, setting broad policies on coal mining or guns. (Thus the Labor Department announced that retirement funds can't consider social and environment issues in making investment decisions, and members of Congress have 

threatened sanctions on banks and asset managers who refuse to invest in coal or guns as a matter of policy.) You could see this as part of the same basic idea: The government doesn't want to do any of its policymaking by shareholder voting; it wants to keep its share holdings strictly separate from its work as a government. It doesn't want to use its corporate voting power to try to accomplish things that are good for society or taxpayers or national security, because it has other, more traditional government powers to do that. Mixing them up might give other shareholders ideas.

Farewell John Paulson

He has met the fate that awaits us all, converting into a family office. Hema Parmar reports:

Just over a decade after John Paulson shot to fame and fortune, he's become the latest big-name money manager to quit the hedge-fund business, saying this week he's converting his firm into a family office.

Paulson never managed to sustain the success and notoriety he found by betting against the housing market in the run up to the last financial crisis. Now, in the midst of an another period of economic turmoil, he's returning outside investors' money to focus on his own fortune, which the Bloomberg Billionaires Index puts at $4.4 billion.

I sometimes say that, while many people believe that the essential skill of being a hedge fund manager is picking good investments, in fact the essential skill is continuing to run a large hedge fund that pays you a lot of money. If your investments go down and you collect hundreds of millions of dollars in fees from perpetually locked-up investors, that is better, for you, than making a lot of money for your clients and keeping none of it. Building a robust institution with high fees, loyal investors and long lockups is a deeper and more fundamental skill than picking the right stocks.

There are limits to that, though. One of them is that you probably have a lot of your own money in your fund, so if you invest poorly your personal investment losses can be bigger than your share of the fees. Paulson might be a useful demonstration. In his heyday, 2007 to 2010, he invested very very well; his big short on mortgages in 2007 "earned his firm $15 billion — almost $4 billion for him personally — and rocketed Paulson to the ranks of superstar managers," and he reportedly made $5 billion personally on gold in 2010. At its peak, Paulson & Co. "was one of the largest hedge funds in the world." And how were the fees? Here's how Paulson once lovingly described them:

"The other thing I love about this business, when I say why I went into this business, is the fee structure," he added, detailing how much he could make in charging a 1 per cent management fee and 20 per cent performance fee on different levels of assets.

"The more money you manage, the greater the fees," he said. "Now ultimately we managed over $30bn, and there were years our returns were well in excess of 20 per cent, so to get to those levels, the fees just pour out of the sky."

If you add $4 billion and $5 billion you get $9 billion; if you then add years of fees pouring out of the sky you get an even bigger number. Bloomberg Billionaires estimates Paulson's fortune at $4.4 billion, which is simultaneously (1) a lot of money and (2) apparently a negative return since 2010. Where'd it go? Parmar:

Ever since his big win, Paulson stumbled from one losing trade to another, chipping away at the 2007 gains that are still among the largest in hedge-fund history. He wanted the next big trade, but was too optimistic about the U.S. economic recovery and overly bearish about the European debt crisis. He forecast that gold would strengthen as investors sought a hedge against inflation. Instead, the metal entered a bear market.

"It's like Wimbledon. When you win one year, you don't quit; you want to win again," he told Gregory Zuckerman in his book "The Greatest Trade Ever."

Paulson's first big misstep was in 2011 when one of his largest hedge funds lost 51% after wagers on a U.S. recovery went awry. It was one of the worst years of his career and resulted in clients yanking about $2 billion across his portfolios. Still, things soured even more over the next two years as he produced $9.4 billion in losses for clients.

Investors continued to pull money after the string of slip-ups, and the losses continued. After a series of wrong-way bets on drug stocks, he called 2016 "our most challenging year since inception," in a report to investors.

I don't know. It seems like if he had quit in 2010, not only would he have had more free time over the last decade, but he'd also be richer. But once you have $9 billion, presumably you are optimizing for something other than increasing, or even maintaining, wealth. For myself, I would be optimizing for leisure and consumption, but that is (part of) why I am not a billionaire hedge fund manager. Presumably reputation, wanting one last big score, etc., were important factors for Paulson during the bad years, and spending a few billion dollars on losing bets was acceptable. Plus he clearly enjoyed getting the fees.

WeShrink

At the peak of WeWork's, uh, thing, back when it was changing its name to "The We Company" and planning to "encompass all aspects of people's lives, in both physical and digital worlds," it started a school. The school was named WeGrow. It did not seem especially core to WeWork's actual business of sprucing up and renting out office space, but I suppose it was part of the broader plan of encompassing all the aspects. Plus it was part of WeWork's unstated but central business of enriching and entertaining its founders: Co-founder Rebekah Neumann started the school, with WeWork's money, so her own children could go to a school that would teach "mindfulness, yoga, meditation, and farming" and encourage them to be entrepreneurs. "In my book, there's no reason why children in elementary schools can't be launching their own businesses," Neumann said. "The whole thing was about her and what was right for her children," another person close to the school said.

Now that WeWork's husband-and-wife co-founders Adam and Rebekah Neumann have left the company, they are picking up some assets that were non-core to WeWork and core to them:

Rebekah Neumann has purchased the assets of WeGrow, the private elementary school she founded within WeWork, back from the company, suggesting she could salvage her passion project after the co-working startup co-founded by her husband imploded.

A spokesperson for the We Co. confirmed Neumann's purchase of WeGrow's curriculum and furniture from the school, which was housed in WeWork's Manhattan headquarters and cost more than $40,000 a year, but didn't give a price for the transaction and said it doesn't include the brand name. Neumann is starting a new school as Students of Life For Life, abbreviated as SOLFL, which is pronounced as "soulful," Forbes reported.

My favorite part about this may be that she didn't get the WeGrow brand name. If there is a single event that caused WeWork's downfall, it is probably the fact that Adam Neumann managed to trademark the name "We" and sell it to WeWork for $5.8 million. Like, he picked the name! He came into the boardroom and was like "we should rename the company," and the board was like "okay," and then he was like "we should name it We," and they were like "okay," and then he was like "oh but someone else already owns that name," and they were like "oh well," and he was like "but actually the someone else is me," and they were like "what," and he was like "we can buy it from me," and they were like—look, I don't know, it probably didn't go down quite like this, it was probably some weird tax situation that no one really thought about, but it is nonetheless one of the weirdest transactions in the history of corporate governance. And it was the spark for the investor revolt that led to WeWork's failed initial public offering, the Neumanns' ouster and the dismantling of WeWork's wild ambitions. 

Now, of course, the Neumanns don't own the word "We," and WeWork understandably won't sell any variations on We back to them, so they're stuck with SOLFL. Which is just as well. I'm not sure the WeGrow brand is as good as it used to be.

Things happen

The lockdown death of a 20-year-old day trader. Inside Moderna: The Covid Vaccine Front-Runner With No Track Record and an Unsparing CEO. Oil majors face up to plunging asset values. Exxon Mobil Resists Write-Downs as Oil, Gas Prices Plummet. Fed's Bullard says risk of financial crisis remains. How Liquid Is the New 20-Year Treasury Bond? Hertz, Creditors in $11 Billion Standoff Over 494,000 Used Cars. Can BNP Paribas beat the investment banking jinx? Sanctioned Billionaire Finds a Haven in Tiny Congolese Bank. Private Equity on Edge With U.S. Plan to Name Relief Recipients. Chinese police say Tencent likely swindled by chilli sauce impostors. 'Beavis and Butt-Head' is returning. A Lost Dog's Brief Stint as Brazil's Presidential Mascot. Shark migration gambling. Dark AcademiaOily House Index.

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