Matt Levine is simply the best

[ValueArb]

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Over the weekend a friend pointed out to me that trucking company Yellow Corp.’s logo is orange. I don’t know what to do with this information, but I found it unsettling and have decided to inflict it on you. Anyway Yellow also made some other mistakes and is now bankrupt:

Yellow Corp. filed for bankruptcy and will remain shuttered — throwing 30,000 people out of work — after the trucking firm’s long-running financial woes were compounded by a dispute with the Teamsters Union.

The carrier will sell its warehouses and trucks in order to repay a pandemic-era, government loan of $737 million and another $485 million in debt it owes private lenders, according to court papers filed Monday in bankruptcy court in Wilmington, Delaware. The Chapter 11 petition gives Yellow breathing room from creditors as it winds down and solicits bids on its assets.

The company’s shares are already reversing some of last week’s gains, plunging as much as 40% as of 11:07 a.m. New York time Monday.

Yes “last week’s gains”: Yellow closed at $3.90 last Tuesday, its highest price since February, despite having shut down and being in plans for bankruptcy. Now that it is in bankruptcy — with a plan to liquidate and return nothing to shareholders — the stock is off a bit; it traded around $2.40 at noon today, still much higher than it was trading in early July, before it shut down operations. I don’t know, man. Here’s the Wall Street Journal on the return of meme stocks:

Trucking-business Yellow shut down operations around a week ago, but shares have jumped some 400% since. And shares of cash-strapped drugstore chain Rite Aid surged 68% in the past week—for no obvious reason. Their rallies contrast with the overall market. The S&P 500 just notched its worst weekly performance since March. ...

Ali Behzadpour ... started noticing moves in Tupperware and Yellow shares a couple of weeks ago through stock-scanning software and buzz on Discord. He said he has been “scalping” Tupperware and Yellow, or taking short-term positions as brief as seconds or minutes. In one recent session, he estimates, he made more than $3,000 from his short-term Tupperware trades.

“I knew there was some momentum behind it,” said Behzadpour. “And hype.” 

Individual investors’ daily net purchases of Yellow totaled nearly $5 million on Tuesday, according to Vanda Research. It had previously never cracked $1 million, according to data going back to 2014.

Terrific. The way it works now is that if US companies go bankrupt their stocks go up. The stock of a small-cap trucking company is just a boring stock, but the stock of a bankrupt company is an absurd lottery ticket, and that is just more fun. Yellow went from being a boring stock that had lost value to being a silly stock that has gone up, and that’s how modern finance works I guess. 

Though actually the Yellow story is stranger than that. The Journal also notes:

MFN Partners, a Boston-based investment firm, has accumulated more than 22 million common shares of Yellow in recent days, accounting for a 42% stake, according to Yellow’s securities filings. MFN didn’t return a request for comment on Tuesday. 

MFN took a significant stake last year in Yellow competitor XPO, according to filings by XPO. 

Here is MFN’s filing from last Tuesday, showing that it owned (as of last Tuesday) 42.5% of Yellow and that it bought almost half of that stake last Monday; its total cost was about $22.9 million, or a little more than a dollar a share. I have no idea what to tell you, except I guess that at today’s price MFN is sitting on about a $30 million profit, and more than 200 million shares have traded since last Tuesday. If you are a professional investor, “buy a ton of stock in a public company that has said it plans to file bankruptcy, and then sell the stock at a profit once it actually files for bankruptcy” is not, you know, a rational strategy, but it kind of works now? (Not investing advice!) But buying 42.5% of the company is too much, since it subjects you to short-swing profit rules that basically mean you can’t take your profits for six months. (Not legal advice!) Buying almost half a company a week before it files for bankruptcy as a long-term investment seems like a mistake.

 

 

From yesterdays Money Stuff column.

Edited August 8, 2023 by ValueArb
quoting

[aws]

It is strange which meme stocks catch on. Obviously most bankruptcy announcements do not have this impact even in this environment (see PTRA today for example), but once they do the pumps seem pretty durable. Almost seems like there is some paid promotion going on behind the scenes.  Just when it looked like Yellow would start to bleed out, it jumped as much as 50% right before the close on a report by Charlie Gasparino which essentially said: If you ignore the $1 billion in unsecured claims, there might be money leftover for shareholders. 

[Saluki]

I remember that right before it went bankrupt there was a day where it went something like 120%, then it opened the next morning down about 30%.  Stay away from the mosh pit. It's not for people who have a mortgage and a day job. 

[ValueArb]

I have a friend who was betting on BBBY, all I could do is review the balance sheet and give him my take. Don't even want to ask if he got out or not.

[aws]

Yeah, that one is especially cultlike, but you can at least see how it caught on since it originated with the Gamestop guy. Why they still think he's coming back to an empty shell to bail them out after pumping and dumping on them a year ago is another matter.

 

Others seem like they must have a promotional aspect behind them, like Yellow or Tupperware recently.

[ValueArb]

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Look, as a trade, I am always going to love a founder selling high at the peak of the cycle and then buying back low when valuations have collapsed. (“The Wag trade,” I have sometimes called it, after the dog-walking startup that extracted a bunch of money out of SoftBank Group Corp. when SoftBank was particularly enthused about, you know, throwing hundreds of millions of dollars at dog-walking startups, and then bought SoftBank out cheap when that enthusiasm waned.) And I suppose if this is your plan, then it helps to (1) sell high, (2) continue running your startup as a division of the buyer and (3) be controversial and bad at it, so the value goes down and the buyer feels forced to sell. Crafty!

But “Dave Portnoy sold Barstool high at the peak of legalized sports gambling in 2020, and then bought it back low when the bubble popped in 2023,” does not seem quite right? I would not exactly say that Penn got what it paid for, with Barstool, but on the other hand Penn’s “interactive” segment — consisting largely though not exclusively of its “online sports betting and casino app called Barstool Sportsbook and Casino” and its in-casino Barstool-branded retail sportsbooks — went from $121 million in revenue in 2020 to $663 million in 2022, and was up another 66% year-over-year in the first half of 2023, for a run rate of almost $1 billion. “Barstool has been a great partner and we are thankful to Dave Portnoy, Erika Ayers, Dan Katz and their team for helping to rapidly scale our digital footprint across 16 jurisdictions in the U.S. and introducing their audience to our retail and digital products,” said Penn in announcing yesterday’s deal. Could Penn have added $500 million of annual sports gambling revenue without the marketing partnership? Could it have added more, without the public-relations and licensing problems that Barstool brought? Quite possibly! There really was a pretty big sports-gambling gold rush, and it does look like Penn spent lavishly and imprecisely to get in on it.

But basically Penn paid $550 million to Barstool to get into online sports gambling with a popular brand, and amortized that cost over about three years, or call it $180 million a year. And now it is paying ESPN $2 billion for a 10-year licensing agreement, or $200 million a year. Portnoy didn’t exactly sell Barstool at the peak and buy at the bottom: He sold Barstool at the point when it made sense for Penn to partner with Barstool, and bought it back at the point when it made sense for Penn to partner with Disney.

One assumes that Penn would have preferred to sell Barstool back to Portnoy for some price higher than zero, but:

It didn’t make sense for them to keep it,
It was perhaps too controversial for most other media or gaming companies, and
Presumably any buyer would have to come to terms with Portnoy for it to make sense.
So I guess Portnoy was the only bidder? I dunno, I just Googled “Dave Portnoy enemies” and got this list that he tweeted last year beginning with Henry Blodget, and if I were Penn I would have called Blodget (a wealthy media mogul!) and said “hey you can have Dave Portnoy for $10,000” just to see if I could spark a bidding war. It is possible though that Portnoy’s non-compete promises are worth more to Penn than a buyer would pay.

Also Penn gets 50% of the proceeds if Portnoy sells. He “has no plans to sell Barstool Sports again,” and why would he? He sold it for $550 million and got it back for free; selling it again would just be greedy. Once you’ve cashed out $550 million and kept the business, it can be a lifestyle business. I assume that Penn’s 50% is just schmuck insurance.3 It’s embarrassing enough to buy it from Portnoy for $550 million and then sell it back to him for $0, but it would be much worse if he turned around and sold it to someone else for $550 million again.

 

[ValueArb]

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If you have a bunch of trees, and you chop them down to make paper or lumber or whatever, you can sell the paper or lumber or whatever for money, but on the other hand trees store carbon and cutting them down is bad for climate change. If instead you do not chop down the trees, that is good for the environment, and it is a great innovation of modern finance that, now, you can get paid for not chopping down the trees. This is called “carbon credits.” There are measurement problems.

 

If you mine Bitcoin, you use a lot of electricity to run computers to perform calculations to get Bitcoins for yourself, which you can sell for money. But this is bad for the environment, because it uses electricity that is probably generated in ways that release carbon.1If you were to stop mining Bitcoin, conversely, that would be good for the environment. Can you get paid, though, for not mining Bitcoin? Oh yes, modern finance has solved that one too:

Bitcoin miner Riot Platforms Inc. made millions of dollars by selling power rather than producing the tokens in the second quarter as the crypto-mining industry continued to grapple with the impact of low digital asset prices.

The Castle Rock, Colorado-based company had $13.5 million in power curtailment credits during the quarter, while generating $49.7 million in mining revenue. Riot booked $27.3 million in power curtailment credits last year and $6.5 million in 2021 from power sales to the Electric Reliability Council of Texas, which is the grid operator for the Lone Star state. …

The company had $18.3 million in power credits in June and July based on its latest monthly operational updates, including $14.8 million in power curtailment credits received from selling power back to the ERCOT grid at market-driven spot prices under its long-term power contracts and $3.5 million in credits received from participation in ERCOT demand response programs.

Here is the 10-Q; this stuff is described in Note 8. Some of what is going on here is that Riot has a long-term power supply agreement in which TXU Energy Retail Co. has to supply it with electricity at fixed prices through 2030, and Riot has the option to sell the power back to TXU, at market rates, for credit against its future electric bills, when the spot price exceeds the contract price. But part of it is demand response, where ERCOT pays Riot cash for using less than its typical electrical load during periods of peak demand. 

 

As with carbon credits, there are measurement problems; I have never mined a single Bitcoin, yet ERCOT has never sent me a penny for my forbearance. Still, how great is modern finance? Twenty years ago, if you had told people that one day they could get paid for not mining Bitcoin, they would have said “what?” But now it is possible. Modern finance created the problem (Bitcoin mining) and the solution (paying people not to mine Bitcoin); the overall result is that nothing happens and yet people get paid. Just a miracle of financial engineering.

 

Also: Riot is getting paid for not using electricity, but if you are an enterprising Bitcoin miner surely you should look into getting paid for not using carbon when you are not mining Bitcoin. Riot is not there yet, but it is possible to imagine a warming world in which energy prices go up and Bitcoin prices go down and Bitcoin miners can get paid more for not mining Bitcoin than for mining Bitcoin. Giant fortunes will be made by people who got in early to the business of not mining Bitcoin. The future is so good, man.

 

 

[ValueArb]

From a week or so ago, thought it was interesting in how ARM's price has been "set". 

 

Arm 

Schematically a very good trade is:

1. Buy 10% of a private company at a $1 billion valuation, paying $100 million.
2. Buy another 5% at a $2 billion valuation, paying another $100 million.
3. Now you own 15% of a company worth $2 billion. Your stake is worth $300 million, but you paid only $200 million for it.
4. You have a profit of $100 million.

The problem is that, while on a mark-to-market basis you have a $100 million profit, on a cash-flow basis you have paid $200 million and not gotten any cash back. If you sell your 15% stake for $300 million then, great, $100 million profit, but if you were the only buyer at the $2 billion valuation (or at the $1 billion one!) then you might end up with a loss. On the other hand, markets do tend to anchor on the last trade. If the last trade was you buying at a $2 billion valuation, then the best guess is that the next trade will also be at around a $2 billion valuation. If that’s you selling, then, good.

 

I think of this trade — buy a stake in a private company, then buy some more at a higher valuation — as being a specialty of SoftBank Group Corp., mostly because SoftBank did this in a very prominent way with WeWork Inc. It did not work: SoftBank invested in WeWork at a $20 billion valuation, and then a few months later it invested again at a $47 billion valuation, and then a few months later it utterly failed to sell WeWork to the public market at a $96 billion, or any, valuation. (And now WeWork has a public market capitalization of less than $300 million.) 

 

Still. In 2016, SoftBank took chip design company Arm Holdings Ltd. private at a $32 billion valuation. Then it sold about a quarter of the company to the Vision Fund, an investment fund managed by SoftBank, at that valuation. And then this month it bought that stake back from the Vision Fund for $16.1 billion, a $64 billion valuation. The Vision Fund doubled its money (in cash), while SoftBank doubled the valuation of its stake (on paper). Yesterday Arm filed to go public again. There are skeptics; the Financial Times’s Lex column writes:

SoftBank has tried to set the stage for a high price. The listing document reveals an internal transaction in which it acquired its own Vision Fund’s stake in Arm for $16bn, a deal that valued the chip company at more than $64bn.

Investors should take little notice of this figure. On a broader, average industry earnings multiple, Arm’s enterprise value would be closer to $30bn. This is not far off the price SoftBank paid when it bought the company in 2016.

To be fair, Arm says that itself; a risk factor in the prospectus warns:

The purchase price paid by SoftBank Group to acquire shares in Arm Limited from SoftBank Vision Fund may not be, and should not be treated as, indicative of the trading price of our ADSs following the completion of this offering.

In August 2023, a subsidiary of SoftBank Group acquired substantially all of SoftBank Vision Fund’s approximately 25% interest in Arm Limited at a purchase price of approximately $16.1 billion, with the associated payments to be made in installments over a two-year period. The purchase price for this transaction was established by reference to the terms of a prior contractual arrangement between the parties. Moreover, the transfer was part of a larger transaction that also involved transfers of certain other entities from SoftBank Vision Fund to SoftBank Group. The consideration for such transfers is not included in the purchase price paid for the shares of Arm Limited. In light of the foregoing, investors are cautioned that the purchase price paid in respect of the Arm Limited shares may not be indicative of, and is not intended to reflect, expectations regarding the trading price of our ADSs following the completion of this offering.

On the other hand, if you don’t think that the stake is worth at least $16 billion, it's a bit odd to pay $16 billion for it? Apparently the “prior contractual arrangement” was a cap on the Vision Fund’s return at two times its money; paying out the maximum return just before the initial public offering is a pretty bold bet that the IPO will go even better.

 

[ValueArb]

My Forex Funds

Two stylized facts about the foreign exchange markets are:

• It is very hard for retail traders to reliably make money trading currencies, and
• They keep trying?

From first principles, it seems like a good idea to be on the other side of their trades. If retail traders want to buy pounds, sell them pounds. If they want to sell yen, buy yen from them. Etc.

 

If you do this as a full-time business, you will want to make some refinements. Here are the three main refinements:

1. It can’t really be the case that retail investors lose money because they consistently bet the wrong way on currency movements. (That would take skill!) They lose money because (1) they make essentially random-chance bets on currency movements, with zero expected value, and (2) they lose a bit of money on each trade from commissions and spreads. So, if you are in the business of trading with retail traders, make sure to charge them lots of commissions and spreads.
2. Meanwhile you don’t want to incur the costs of going out and buying yen, pounds, etc., each time your retail customers do a trade. Ideally you will “bucket” their trades: A customer comes to you and says “I want to buy $1,000 worth of yen,” they give you $1,000, and you say “okay great you have 14,400 yen in your account.”1 You don’t actually go and buy them any yen (you just make a note in your books saying that you owe them 14,400 yen), and they don’t actually want yen (they just want to bet on the price). They will eventually close out the bet by selling you the 14,400 yen back for dollars, and when they do you will cheerfully deliver them, like, $970. You keep their $30 loss as your profit. No yen are ever involved.
3. You will want them to make leveraged bets: Instead of giving you $1,000 to buy $1,000 worth of yen, they give you, like, $100 to buy $10,000 worth of yen. Then if the yen moves against them by 1%, they have lost all their money. If the yen moves in their favor by 1% they have doubled their money, but the odds are in your favor. 

The straightforward way to combine Refinements 2 and 3 is to trade FX futures, where the customers put down a small amount of collateral to enter into a contract with you that pays out based on the price movements of some currency pair, so (1) the trade is leveraged and (2) you never have to go out and actually buy any foreign currencies. FX futures are a very standard way to trade currencies, so customers will be happy to trade them with you.

 

It should go without saying that none of these refinements are legal advice.2

You can make further, shadier refinements. For instance, if your customers are only trading with you — if you never go out and buy any actual currencies or do futures trades with outside dealers — you might think, well, it is not strictly necessary that the prices I charge customers reflect actual market prices. They could just be different prices. If yen futures currently trade at 147.4 and a customer comes to you looking to buy yen, you sell them yen at 146.9 to the dollar. Why not, who cares, it’s all just happening on your own computer systems. You have to be careful with this: You probably have to show your customers some screen of bid and ask prices before they trade, and if you show them that yen are 147.5 bid / 147.4 offered and they hit “buy,” they might be puzzled to get only 146.9 yen for their dollar.3 But (1) they might not be (not everyone pays attention) and (2) you can explain it away. “Ah, price impact, market slippage, the market was at 147.4 but then your big buy order moved it,” you can say.

 

Another important set of refinements is: Some customers might actually be good at trading foreign exchange, and will cost you money; what do you do about them? Your answer might be some combination of:

• Shut down their accounts.
• Jack up the commissions, spreads, fake prices, etc., that you charge them, so that they start losing money.
• Stop bucketing their orders, route them to real markets, and let them trade with their own money with someone else; you charge commissions but no longer take the other side of their bets.

The last important refinement, of course, is that you probably want to lie about all of this? “We charge zero commissions and all of our customers make money!” might be a lie, but it is a better pitch than, like, “we have found a maximally efficient way to fleece rubes like you.” Everything else I said above can get you in trouble — none of it is legal advice! — but the lying is its own separate way to get in trouble.

On Friday the US Commodity Futures Trading Commission brought a fun enforcement action against Traders Global Group Inc., which runs an online FX trading platform called “My Forex Funds” that “offers retail customers the opportunity to become ‘professional traders,’ using Traders Global’s money to trade against third-party ‘liquidity providers’ and sharing in any trading profits”:

In return for the opportunity, customers pay certain fees to Traders Global, and are required by Traders Global to maintain a certain minimum amount of account equity, referred to as a “drawdown limit.” Traders Global assures customers that “your success is our business,” and “we only make money when you do.” Traders Global’s pitch has proven appealing to customers; more than 135,000 of them signed up during the relevant period, paying at least $310 million in fees.

But Traders Global is allegedly on the other side of all the trades:

Traders Global is a fraud. In reality, Traders Global is the counterparty to substantially all customer trades. When customers make money, it means that Traders Global loses money. … Customers do not trade “live funds” against “multiple liquidity providers” nor do customers share in “trading profits,” as Traders Global claims. In reality, customers trade against Traders Global in an electronic trading environment that Traders Global controls.

The CFTC’s complaint hits all the highlights. There are commissions of course:

Traders Global claims on its website that customer trades are subject to “commissions” of $3 per lot. Because Traders Global tells its customers that they are using Traders Global’s funds to trade, the customer is led by Traders Global to believe that the commissions are those being charged to Traders Global by a liquidity provider, exchange, or other third party.

In fact, Traders Global is not charged commissions by any third party on “trades” for which it acts as counterparty. Traders Global fails to disclose, however, that it—not some third party—assesses these commissions. The so-called “commissions” are simply a charge against customer account equity imposed by Traders Global.

And customers make leveraged futures trades, maximizing their likelihood of losing all their money and having to put in more:

A customer who signs up for an account is required to stay within a “drawdown limit” imposed by Traders Global. The drawdown limit requires a customer to maintain a certain minimum amount of equity in his or her trading account. The amount varies with the size of account. …

In a December 11, 2021, YouTube video, Kazmi explained that the drawdown is designed “to force traders to get into that habit of locking in some of the profits . . . .” “If you lose all that money,” Kazmi explained, “it’s not only you that’s losing, it’s us as well right. Because we want to make you profitable so we can be profitable . . . .”

If a customer exceeds the drawdown limit, Traders Global will “disable” (i.e., terminate) the customer’s account. If the customer wishes to continue with Traders Global, the customer is required to re-start their account and pay another fee.

 

There is, uh, slippage:

Traders Global uses specialized software to automatically add “delay” or “slippage” to customer orders. Traders Global does this in order to reduce the likelihood, or amount, of a customer’s profitable trading….

By dialing the “slippage” up, Traders Global sets the software to automatically execute a customer’s market order at a worse price than the best bid or offer displayed at the time the customer entered the order. For example, if a customer entered an order to buy a leveraged contract for Euros when the offer price displayed on the customer’s computer screen was $1.759, imposition of slippage would result in the order being executed at a higher price, e.g., $1.800.

Traders Global subjects most of its customers to some amount of delay or slippage.

And there is the handling of profitable traders, which involves dialing up the slippage:

Customers whose trading generates consistent profits, however, are subjected to longer delays and increased slippage, implemented by Traders Global.

And then, if that doesn’t work, routing them to other counterparties so they are no longer Traders Global’s problem:

A very small number of customers trading “live” accounts manage to trade profitably despite Traders Global’s attempts to handicap them. After identifying such customers, Traders Global may route some or all of these customers’ orders to an off-exchange leveraged forex and commodities dealer outside the U.S. (hereinafter, the “Dealer”). Traders Global refers to this as “STP’ing” a customer’s account; “STP” stands for “straight-through processing.”

STP’ing a customer is very rare. Of 24,000 customers with “live” accounts during the Relevant Period, fewer than 100 of them had a single trade STP’d.

In one respect, the STP’d customers get what they were promised—the opportunity to trade against a liquidity provider using Traders Global’s money, which Traders Global has on deposit with the Dealer, in a margin account. …

For customers on STP, Traders Global uses its specialized software to impose an additional “spread” on the price feed visible to STP’d customers. This spread results in a customer seeing—and believing himself or herself to be executed at—a worse price than what Traders Global got from the Dealer.

All the good stuff. I guess one question is how much of this is illegal. The bones of it — “we will trade futures clients with our customers, charge them commissions, close their contracts when their equity gets too low, and route orders we don’t want to other deals” — seems kind of fine? As long as you don’t lie about it?4 But the combination, plus the alleged lying, is quite lucrative:

[Chief Executive Officer Murtuza] Kazmi has used the proceeds from the Traders Global fraud to fund a luxury lifestyle.

In April 2022, Kazmi paid $1.6 million to purchase a Lamborghini Aventador at auction. In December 2022, Kazmi paid $3.3 million for a Bugatti racecar.